Betting on the New Frontier

John Dickson, the 46-year-old chief executive and chairman of Frontier Bank, lays his cards on the table, face up: the top job was never handed to him on a silver platter.

It is true, of course, that his father, Robert Dickson, founded the bank almost 30 years ago, in 1978. And, yes, it is true that he took over the helm at the bank when, a little more than four years ago, dad retired. But the governing system at the $3.6 billion regional banking company headquartered in Everett, Wash.-seat of evergreen-rich and rainy Snohomish County, a historically working-class city of some 100,000 souls a 45-minute drive north of Seattle-is meritocratic.

And, not only did he not inherit his current position, Dickson says, but he had to prove himself worthy. “Strangers coming here for the first time might look at me and think, ‘John Dickson was appointed head of the bank because he’s his father’s son,’” he says. “But that couldn’t be further from the truth. I had to work as hard as anyone else to get promotions and recognition. But I wouldn’t have wanted it any other way.”

He admits he has large shoes to fill. “I still live somewhat in his shadow,” Dickson says of his father. “But I’m proud of dad. He worked harder than anybody to make the bank successful. People would drive by his office at nine at night and the light would be on. That was the way he built the bank.”

Dickson’s father spent nearly a quarter of a century forging a business culture marked by an ethos of hard work, dedication to high standards of banking and finance, exceptional customer service, and deep community involvement. Along the way, Frontier went from a single storefront office in Everett to the largest independent bank in western Washington State.

Under the younger Dickson, Frontier continues to burnish its shiny reputation. Now boasting 45 branch offices in western Washington, it recently announced its second bank acquisition in three years-one that will take it across the state line into Oregon-and, with de novo bank openings, by year’s end Dickson says Frontier will open its 51st branch.

“It’s a juggernaut,” Jeff Rulis, a Portland-based banking analyst at regional brokerage D.A. Davidson & Co, says of Frontier. “It’s at the top of community banks in profitability. It’s highly efficient and has good credit quality and superior net interest margins.”

Much of that credit now accrues to Dickson the son. “John has really stepped up and shown that there’s not going to be a lot of change and that he’s committed to keeping Frontier a high-quality bank,” Rulis adds. “He’s a straightforward guy and he has a lot of experience behind him. And, more and more, he’s been presenting at investor conferences and he’s become the face of the bank.”

Today, Frontier Financial Corp., the parent company of Frontier Bank, can claim bragging rights as the most profitable of the largest 150 banks and thrifts in the U.S., according to rankings provided to Bank Director by Sandler O’Neill & Partners L.P., a New York investment bank that specializes in bank stocks.

For 2006, the bank holding company reported net earnings of $68.9 million on $265.8 million in revenues, a 33.6% increase in profits compared with 2005. That translates into an astonishing 2.23% return on assets and an improvement over the still stellar 2.09% ROA recorded the previous year.

For the record, the bank has posted 27 years of record profits in 28 years of business, which begs the question: How do they do it?

It hasn’t hurt, of course, that Frontier’s lifespan just happened to coincide with a period of steady growth and general prosperity in western Washington. Over the last three decades, the Puget Sound economy has undergone a striking transformation. From a region largely reliant on natural resources and manufacturing-fishing, logging, paper and pulp mills-the rain-soaked, verdant communities west of the Cascade Mountains are increasingly home to “knowledge-based” high-technology and life-sciences industries as well as health care and retail.

“One thing everyone agrees on,” Lundberg adds of the regional economy, “is that we are more diversified now. There are a lot more centers of strength and the economy is more stable and balanced than it was 20 years ago.”

The region’s natural beauty, opportunities for recreation, reputation for livability, and cultural offerings have been a magnet for tourism dollars and vacation getaway homes as well. As many as 40,000 people a year have been migrating from California alone since the early 1990’s, according to the Washington State’s Office of Financial Management. Population growth in Washington State is up roughly a half-million since the 2000 census and is expected to expand by a million persons before the decade is out, reports the OFM.

For its part, Frontier Bank has played an integral part in financing the economic development and growth along the Interstate-5 corridor. The bank earns almost all of its money on net interest margins from its lending portfolio and depends very little on fee income. And it is not timid: Total loans increased by $175.3 million to $3.2 billion during the second quarter, surprising stock analysts like Rulis at D.A. Davidson, who described the increase as “$27 million more than we had anticipated.”

In a diversified and robust economy that is expanding and where new businesses are being created and property values continue to rise, “you can afford to be careful and selective in your lending,” says Robert Robinson, chief credit officer and executive vice president at Frontier.

Over the last four years, Dickson adds, the bank has switched from being principally a commercial lender to one focused on lending for construction and land development. The two lending areas have essentially traded places: commercial lending, mostly to small businesses, was just 29% of the bank’s loan portfolio at the end of the second quarter of 2007, down markedly from 47% at the end of 2003. By comparison, construction and land development grew to 49% of the portfolio at this year’s halfway mark, up from 29% in 2003. “This has been a fantastic housing market,” Dickson adds.

But even the commercial loans are, in effect, real estate loans. “We definitely lend to small business,” Dickson says. “That’s our bread and butter. But real estate is our preferred collateral-not inventory and accounts receivable,” he adds. “Without a very good monitoring procedure, that collateral vaporizes if a business fails. It’s usually gone, or nearly gone. But the real estate doesn’t disappear.”

Even though Wall Street gets the jitters over real estate lending at all financial institutions-Frontier’s stock was down about 20% to roughly $23 from as high as $31, following a 3-for-2 stock split last year-the bank nonetheless has surprised analysts with its positive performance. Rulis, the D.A. Davidson analyst, noted in a recent investment comment that net interest margin expanded by 17 basis points in the second quarter to 5.75% “while we had modeled a 3 basis points decline.”

A major reason for the bank’s continued upside success is Frontier’s knack at getting plenty of bang for the buck. “What really strikes me about the bank is how remarkably efficient they are,” says Joseph Fenech, a bank analyst and managing director at Sandler O’Neill. “They are lean on the personnel side and everyone keeps a watchful eye on expenses.”

A 50% efficiency ratio is generally considered satisfactory in the banking industry, yet Frontier can boast a 38% efficiency ratio, a decline of 3 percentage points from last year’s 41%. “Its efficiency and return yields are both tied into the same philosophy,” says Rulis. “It’s just a well-run machine.” So, do they burn candles to keep expenses in check? “No, we don’t burn candles,” Dickson remarked. “But we don’t build Taj Mahals either.”

Before Dickson undertook his lengthy, two decades-long apprenticeship at Frontier that led to his becoming CEO, he first considered a professional career as an auditor and certified public accountant. Fresh out of the University of Puget Sound, where he majored in economics and accounting, Dickson took a job with the Seattle office of Arthur Andersen, known then as one of the “Big Eight” professional service firms.

While there, however, moral lessons he learned about human nature have counted more than understanding the components of a balance sheet. “I was fresh out of college and they put me on a special assignment auditing a big petroleum company,” he says. “And I remember they brought in these oil-and-gas experts from Arthur Andersen’s offices in Dallas, Houston, and Tulsa. After spending the day reviewing oil-and-gas leases, these guys asked me to make dinner reservations.

“Well, I’d been living on a student budget and probably didn’t own two suits,” Dickson went on, “but I was able to find some safe, middle-of-the-road restaurants. Soon afterward, though, I got reassigned. But I found out that they ignored my suggestions and instead went to the finest, most expensive restaurants in town where they followed dinner with drinks and cigars.

“I remember talking to my dad about it. I said, ‘I didn’t know this is the way things work in the business world.’ And dad said, ‘It really doesn’t sound right. It may not be totally appropriate.’ Sure enough, when they presented out-of-pocket expenses, the client flipped his wig.”

Years later, Dickson says, he turned on his television set and saw one of those same Arthur Andersen accountants testifying before Congress on the role that he had played in bringing Houston energy giant Enron to its knees. “That really stayed with me,” he says. “I learned more from situations like that about the importance of being ethical and treating people with respect than learning how companies work.”

A hard-won business philosophy shared by both father and son-that ultimately a strong and profitable balance sheet depends on a top-notch staff able to build trust and forge durable relationships with both customers and the greater community-lies at the heart of Frontier’s success.

It manifests itself in ways both large and small. For example, unlike most conglomerate banks, the bank honors check payments according to the number in which they are written-not according to the largest dollar amounts. Says Dickson: “We don’t want to stick it to the consumer.”

Frontier’s operating philosophy of maintaining a “family-style” atmosphere, while compensating its employees fairly helps provide customers with attentive service while aligning the employees’ own interests with that of the bank. The bank’s success at doing so also helps explain why employees exhibit a ready willingness to keep a wary eye on costs.

As much as 20% of an employee’s overall compensation, including the 401(k) match, profit sharing, and cash bonuses, depend on the company’s overall performance. And employees are regularly reminded that the payout can be substantial: A single share of Frontier stock, purchased in 1978, would be worth $25,468 today. “One half to two-thirds of the employees are stockholders,” says Dickson, “so they become much more engaged in controlling costs and caring about the bank’s profitability.”

Stories on employee frugality are legion. Executive vice president Barbara McCarthy, a 26-year veteran at the bank and the head of the marketing department, says she recently hired a photographer friend to do a photo shoot for an advertising campaign featuring prominent satisfied customers. “We did a survey of 12 ad agencies and graphic designers and their prices ranged from $1,200 on up to $3,000 per ad,” she says. “But we were able to do them for $300.”

The corporate culture of providing branch managers, lenders, and other key employees with both autonomy and the broad authority to make key decisions speeds up the decision-making process and eliminates costly bureaucratic red tape. It also helps keeps customers happy. “Once I deposited $60,000 at Wells Fargo and it mistakenly credited me for $6,000,” says Duane Stiemert, a longtime customer of Douglas. “It took me forever to get the zero tacked back on. It was a hassle. But I daresay that at Frontier, I’d just call Milt and get it resolved.”

Robinson, the chief credit officer, says having seasoned and savvy lending officers is a double-edged sword in battling the competition. The superior service and personal connections can help win over plum customers even if the bank’s loan rates are not the most competitive. At the same time, their professionalism minimizes costs. “Most of our lenders are from the area-many grew up in the towns they’re working in-so they know their customers. Some of the larger banks will just look at the credit score and may not be looking at all the pieces that we see.”

While the bank competes for loans on service, not price, the slimmed-down organizational structure makes it possible to offer other banking services at lower costs. Douglas, a manager at Frontier’s Bellevue branch, says he recently was able to provide a package of banking services to a distribution and manufacturing company’s area representative-one that included a line of credit, payroll accounts, and bankcard services combined with online account management-that involved annual savings of $4,500. “Other banks charge fees for that business-to-business bankcard but don’t tack on much in the way of charges,” Douglas explains.

Since assuming control, John Dickson has led the bank through the 2005 acquisition of $175 million North Star Bank, headquartered in Seattle. And in July Frontier announced acquisition of the Bank of Salem in Oregon, which operates three branches, including one in Portland.

This acquisition marks a watershed for Frontier. It means that the bank would be crossing over the Washington state line for the first time. It could also spell something of a departure for the bank’s philosophy of recruiting top people first and then locating a bank branch in the community-although Dickson is quick to note that Frontier has on occasion shunned planned acquisitions when it found a bank’s culture did not jibe with its own. (Or, in the case of one merger, the discovery that an acquisition candidate’s lending portfolio contained subprime mortgage loans put the kibosh on the deal.)

For example, Dickson says, the bank did not have immediate plans to open a branch in Gig Harbor, a close-knit community and one-time fishing village about an hour southwest of Seattle. But all that changed when Frontier’s management team learned that Joyce Taylor, a 53-year-old veteran bank manager and loan officer, who was twice president of the Chamber of Commerce in Gig Harbor, was available for hire.

Taylor reports that she was “doing a good book of business,” underwriting loans and opening accounts for new customers-usually meeting them at local restaurants and coffee shops, while temporarily working out of an office in Tacoma. (Frontier’s Gig Harbor branch opened Oct. 1.) “The more interviews and discussions I had with Frontier, the more I realized that we shared the same vision of community banking,” she says.

For Frontier, such additions will likely mean a continued growth spurt and added prosperity as it goes from 45 branches to 51 by the end of 2007. The challenge, however, will be to stay nimble and somehow avoid the complacency that too often accompany middle age and success.

Whether Frontier can the retain its carefully constructed homespun values-and not become just another big bank-bears watching.

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