<PAGE>   1
                                                                   EXHIBIT 13

                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

THANKS FOR HELPING US FULFILL OUR BILLION DOLLAR DREAM

Frontier Bank, which began as a dream for a group of successful and dedicated
business men and women of Snohomish County, has made history.

Our dream was to build a "high-touch" bank with one-on-one personal service,
where customers interact with caring, sensitive employees. Today we have reached
over one billion dollars in assets. Frontier Bank is the first financial
institution headquartered in Snohomish County to exceed $1 billion...and we
thank you for helping us get there!

Frontier Bank pledged to continue offering innovative products and value-added
service to our countless business clients and professionals, to our consumer
customers, our many loyal shareowners, and the dedicated group of senior clients
whom we serve. All of you are very important to us.



                                       1
<PAGE>   2



                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
                                                                                                                           % CHANGE 
AT YEAR END                               1998            1997            1996            1995             1994            1997-1998
                                       ----------      ----------      ----------      ----------       ----------         ---------
<S>                                    <C>             <C>             <C>             <C>              <C>                  <C>  
  Total assets                         $1,147,873      $  973,052      $  874,946      $  796,730       $  704,115          +18.0%
  Net loans                               880,044         721,122         643,644         539,517          506,528          +22.0%
  Deposits                                926,642         810,348         732,389         694,278          592,663          +14.4%
  Long-term debt                                0             695           1,059           1,394            1,823         -100.0%
  Investment securities                   145,601         115,999         132,340         146,645          137,995          +25.5%
  Shareowner's equity                     129,249         107,384          88,351          72,214           57,321          +20.4%
FOR THE YEAR
  Interest income                      $   93,562      $   83,324      $   73,971      $   68,443       $   58,302          +12.3%
  Interest expense                         37,890          34,369          32,062          31,091           22,383          +10.2%
  Securities gains (losses)                     0               0               0              (4)            (355)             nm
  Provision for loan losses                 1,800           2,095           2,133           1,621            3,996          -14.1%
  Net income                               21,649          18,594          16,012          13,837           11,620          +16.4%
  Basic earnings per share             $     2.49      $     2.15      $     1.87      $     1.62       $     1.37          +15.8%
  Fully diluted earnings per share     $     2.46      $     2.14      $     1.84      $     1.59       $     1.34          +15.0%
  Return on Average
     Assets                                  2.06%           2.03%           1.96%            1.84%           1.82%
     Equity                                 18.27%          18.84%          20.15%           21.34%          22.26%
  Ave. equity/avg. assets                   11.30%          10.78%           9.71%            8.63%           8.18%
</TABLE>


                                       2
<PAGE>   3


                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

                               A REMARKABLE YEAR!


A REMARKABLE YEAR!

The twentieth anniversary year for Frontier Bank was truly remarkable. We
celebrated with record earnings, substantial growth in total assets, loans,
deposits, capital, and an expanded servicing area. Three major events occurred,
any one of which would have stood out in any prior year.

First, Frontier Financial Corporation stock began trading on April 16, 1998 on
the NASDAQ National Market under the symbol FTBK. Our goal was to (1) reduce
paperwork within the bank which was becoming excessive, due to our expanding
shareowner base; (2) obtain greater liquidity for our shareowners; and (3) to
create a currency for future acquisitions by having a stock whose value is
established in a public market.

The second major event was our merger with Valley Bancorporation and its
subsidiary, Bank of Sumner. The merger was completed on December 21, 1998 and
expands Frontier's servicing area into Pierce County with offices in Buckley,
Orting, Puyallup, and Sumner. It added approximately $100 million in assets plus
an experienced staff.

On October 13, 1998, total assets of Frontier Bank surpassed one billion dollars
for the first time. Thus, Frontier becomes the first bank headquartered in
Snohomish County to reach "a billion," our third achievement in 1998.

Earnings increased 16.4% in 1998 to $21.6 million, or $2.46 per fully diluted
share, up from $18.6 million, or $2.14 per fully diluted share in 1997. The
numbers were adjusted to reflect the 7% stock dividend paid in March, 1998. This
marks the 20th consecutive year of record earnings for Frontier, and the fourth
quarter of 1998 was the 60th consecutive quarter in which earnings exceeded the
same quarter of the prior year. I don't know of any other commercial bank I the
United States that can match our record for consecutive quarterly income gains
at this time.

Assets increased $175 million during the year to $1.15 billion or 18% while
deposits grew by $116 million to $927 million or 14.4%. Loans increased by $161
million to $898 million, and shareowners' equity increased from $107 million to
$129 million reflecting gains of 22% and 20%, respectively.

The investment portfolio totaled $146 million up from $116 million in 1997, a
gain of 26%. At year-end, the market value of our investment portfolio exceeded
our cost by over $2.6 million reflecting an unrealized gain.

The above numbers include Bank of Sumner's totals for both 1997 and 1998 to
comply with "pooling of interests" accounting requirements.

The corporation earned 2.06% on average assets (ROA) compared to 2.03% and
18.27% on average equity (ROE) compared to 18.84% in 1998 and 1997 respectively,
which places Frontier among the leaders when comparing peer group performance.

Some of the other achievements during 1998 include:

- Completed another record year in the Trust Department where department assets
increased by 11% and earnings grew by 28% over 1997.

- Expense management was solid, reflected by our efficiency ratio of 43.3% 

- Increased the number of ATM's from 8 to 15.

- Continued to maintain a quality loan portfolio. During the year recoveries
from prior year losses exceeded 1998 loan losses by $500 thousand.

- Paid a 7% stock dividend in March, 1998. This was our seventeenth stock
dividend paid to shareowners, and, in addition, we have had five stock splits.
As a results of stock splits and stock dividends, an original one share
investment, when Frontier Bank was opened in 1978, would have grown to 251
shares. In monetary terms, an original $1,000 investment in Frontier stock would
have a market value of almost $115,000 at year-ended 1998. While we have had
greater volatility in the stock price since we started public trading,
nonetheless, Frontier stock increased in value by 32.3% from January 1 to
December 31, 1998.

- Both our Investment Center, which handles the sales of mutual funds and other
investments, and our Real Estate Mortgage Center had record performances.

                                       1

<PAGE>   4

                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

The Year 2000 problem, or Y2K, has been receiving increasing media coverage. Our
"Year 2000 Task Force" has been working diligently for almost two years to make
certain that all Frontier systems and all vendor systems are Year 2000
compliant. We have also been working closely with larger borrowing clients to
make certain that their systems will be compliant. Obviously, this is a big
challenge for every business. We believe that our early preparations and close
monitoring of all associated costs will enable our bank to be ready well ahead
of 2000, and without squandering valuable financial resources to get there. In
spite of the past year's success, our spirits were saddened by the loss of our
director, Ed Novack. Ed was very active in the initial organization of Frontier
Bank, and always displayed great pride in our achievements. He served as the
first Chairman of the Board of Directors. We will miss Ed's wisdom and good
counsel. Our deepest sympathy has been conveyed to his wife, Lorraine, and to
the Novack family.

Looking forward, we continue to recognize the challenges that face us. Rapidly
changing technology and keen competition keep us on our toes. Not only is the
competition from other banks, but specialized non-regulated national firms have
increased their presence and aggressively compete for business.

While we have been blessed with a strong local economy for several years, we do
expect some slowdown in the rate of growth in 1999. Nationally, we expect 
continued strength in the economy marked by a low interest rates and low rate 
of inflation.

As we look to the future, there is no shortage of opportunities for Frontier
Financial Corporation.

All it takes to succeed is the desire, commitment, and creativity to take
advantage of these opportunities, and we know Frontier staff members possess
these qualities in abundance. We are very proud of our company and are excited
about the future.

Again, thanks to our Board of Directors for their leadership during 1998, and to
our hard working staff for their commitment to serving our clients with skill
and dedication. We want to thank you, our fellow shareowners for your support,
and we want you to know that we are going to do everything we can to continue to
reward your commitment.

All of us working together as a team will move this organization to further
growth and success... "it's really the people who make the difference."

Sincerely,

/s/ Bob Dickson
Bob Dickson
President & CEO

                                       2

<PAGE>   5

                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES


REPORT OF MANAGEMENT

The management of Frontier Financial Corporation and its subsidiaries has
prepared and is responsible for the integrity and fairness of the financial
statements and other financial information included in this annual report. The
financial statements are prepared in accordance with generally accepted
accounting principles and prevailing practices of the banking industry and, when
appropriate, include amounts based on management's best estimates and judgment.

Management has established and is responsible for maintaining an internal
control environment designed to provide reasonable assurance that transactions
are properly authorized, assets are safeguarded and financial records are
reliably maintained. The internal control environment includes: an effective
financial accounting structure; a comprehensive internal audit function; and
independent Audit Committee of the Board of Directors, and extensive financial
and operating policies and procedures. The Corporation's management also fosters
an ethical climate supported by a code of conduct along with appropriate
selection and training of personnel.

The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with management, the independent accountants and
the internal auditors to ensure that each is properly discharging its
responsibilities with regard to the financial statements and internal accounting
controls. The independent accountants have full and free access to the Audit
Committee and meets with it to discuss auditing and financial matters.

The Corporation's financial statements are audited by Moss Adams LLP, the
Corporation's independent auditors. Their audits were conducted in accordance
with generally accepted auditing standards and include a consideration of the
internal control structure, tests of accounting records and other audit
procedures necessary to allow the auditors to express their opinion on the
fairness of the financial statements.

Management recognizes that there are inherent limitations in the effectiveness
of any internal control environment. However, management believes that, as of
December 31, 1998, the Corporation's internal control environment provided
reasonable assurance as to the integrity and reliability of the financial
statements and related financial information.

Management is responsible for compliance with the federal and state laws and
regulations concerning restrictions and loans to insiders designated by the FDIC
as safety and soundness laws and regulations.

Management assessed the Corporation's compliance with the designated laws and
regulations relating to safety and soundness. Based on this assessment,
management believes that the Corporation complied, in all significant respects,
with the designated laws and regulations related to safety and soundness for the
year ended December 31, 1998.

/s/ Robert J. Dickson                       /s/ James F. Felicetty

ROBERT J. DICKSON                           JAMES F. FELICETTY
President and Chief Executive Officer       Secretary/Treasurer



                                       -1-
<PAGE>   6


                                 MOSS ADAMS LLP
                          INDEPENDENT AUDITOR'S REPORT



To the Board of Directors and Shareowners
Frontier Financial Corporation

We have audited the accompanying consolidated balance sheet of Frontier
Financial Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in shareowner's equity, and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion of these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Frontier Financial
Corporation and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.


                                               /s/ Moss Adams LLP
                                               MOSS ADAMS LLP   

Everett, Washington
January 19, 1999

                                      -2-

<PAGE>   7



                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEET
                                 (In Thousands)

<TABLE>
<CAPTION>
                                                                                      DECEMBER 31,
                                                                               ----------------------------
ASSETS                                                                             1998             1997
                                                                               -----------      -----------
<S>                                                                            <C>              <C>        
Cash and due from banks                                                        $    44,233      $    33,704
Federal funds sold                                                                  45,712           71,885
Investment securities
        Available for sale, at fair value                                          112,707           83,019
        Held to maturity (Fair value 1998: $34,517; 1997:$34,491)                   32,894           32,980
                                                                               -----------      -----------
                       Total investment securities                                 145,601          115,999

Loans                                                                              898,142          736,946
Less allowance for loan losses                                                     (18,098)         (15,824)
                                                                               -----------      -----------
                       Net loans                                                   880,044          721,122
Premises and equipment, net                                                         15,647           15,757
Other real estate owned                                                              1,287            1,200
Other assets                                                                        15,349           13,385
                                                                               -----------      -----------
                       Total assets                                            $ 1,147,873      $   973,052
                                                                               ===========      ===========
LIABILITIES
Deposits
      Noninterest bearing accounts                                             $   147,981      $   119,808                
      Interest bearing accounts                                                    778,661          690,540
                                                                               -----------      -----------
                       Total deposits                                              926,642          810,348
Federal funds purchased and securities sold under agreements to repurchase          31,858           17,962
Other liabilities                                                                    9,910            6,663
Federal Home Loan Bank advances                                                     50,214           30,000
Long-term debt                                                                           -              695
                                                                               -----------      -----------
                       Total liabilities                                         1,018,624          865,668
                                                                               -----------      -----------

SHAREOWNERS' EQUITY
Common stock, no par value; 50,000,000 shares authorized; 8,697,261 and
      8,144,461 shares issued and outstanding in 1998 and 1997                      90,547           72,354
Retained earnings                                                                   38,076           34,577
Accumulated comprehensive income, net of tax                                           626              453
                                                                               -----------      -----------
                       Total shareowners' equity                                   129,249          107,384
                                                                               -----------      -----------
                       Total liabilities and shareowners' equity               $ 1,147,873      $   973,052
                                                                               ===========      ===========
</TABLE>



   The accompanying notes are an integral part of these financial statements.



                                      -3-
<PAGE>   8
                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES


                        CONSOLIDATED STATEMENT OF INCOME
                  (In Thousands, except for per share amounts)

<TABLE>
<CAPTION>
                                                                                YEAR ENDED DECEMBER 31,
                                                                       --------------------------------------------
                                                                         1998              1997              1996
                                                                       --------          --------          --------
<S>                                                                    <C>               <C>               <C>     
INTEREST INCOME
    Interest and fees on loans                                         $ 82,450          $ 72,898          $ 63,086
    Interest on federal funds sold                                        3,417             2,515             1,676
    Interest on investment securities
       Taxable                                                            6,092             6,222             7,435
       Exempt from federal income tax                                     1,603             1,689             1,774
                                                                       --------          --------          --------

           Total interest income                                         93,562            83,324            73,971
                                                                       --------          --------          --------

INTEREST EXPENSE
    Interest on deposits                                                 34,748            31,907            29,963
    Interest on FHLB advances                                             1,946             1,632             1,470
    Interest on federal funds purchased and securities
       sold under agreements to repurchase                                1,196               761               538
    Interest on long-term debt                                                -                69                91
                                                                       --------          --------          --------

           Total interest expense                                        37,890            34,369            32,062

           Net interest income                                           55,672            48,955            41,909

PROVISION FOR LOAN LOSSES                                                (1,800)           (2,095)           (2,133)
                                                                       --------          --------          --------

           Net interest income after provision for loan losses           53,872            46,860            39,776
                                                                       --------          --------          --------

NON INTEREST INCOME
    Service charges                                                       1,999             1,956             1,846
    Other                                                                 3,329             2,409             2,316
                                                                       --------          --------          --------

           Total other income                                             5,328             4,365             4,162
                                                                       --------          --------          --------

NON INTEREST EXPENSE
    Salaries                                                             11,638            10,099             8,787
    Employee benefits                                                     4,253             4,113             3,601
    Occupancy                                                             3,307             3,253             2,738
    FDIC insurance premium                                                  100                86                 2
    State business taxes                                                  1,147               945               872
    Other                                                                 6,257             5,049             4,255
                                                                       --------          --------          --------

           Total other expense                                           26,702            23,545            20,255
                                                                       --------          --------          --------

INCOME BEFORE INCOME TAX                                                 32,498            27,680            23,683

PROVISION FOR INCOME TAX                                                (10,849)           (9,086)           (7,671)
                                                                       --------          --------          --------

NET INCOME                                                             $ 21,649          $ 18,594          $ 16,012
                                                                       ========          ========          ========

BASIC EARNINGS PER SHARE                                               $   2.49          $   2.15          $   1.87
                                                                       ========          ========          ========
DILUTED EARNINGS PER SHARE                                             $   2.46          $   2.14          $   1.84
                                                                       ========          ========          ========
</TABLE>


   The accompanying notes are an integral part of these financial statements.

                                      -4-


<PAGE>   9

                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

            CONSOLIDATED STATEMENT OF CHANGES IN SHAREOWNERS' EQUITY
                     (In Thousands, except number of shares)

<TABLE>
<CAPTION>
                                                                                                  Accumulated
                                                     Common Stock        Compre-                     Other
                                                ----------------------   hensive      Retained   Comprehensive
                                                  Shares      Amount     Income       Earnings   Income/(Loss)        Total
                                                ----------  ----------  ----------   ----------  -------------     ----------
<S>                                             <C>         <C>         <C>          <C>         <C>               <C>
Balance, December 31, 1995                       7,116,155  $   44,540               $   26,741     $      933     $   72,214
                                                                                                                  
Comprehensive Income                                                                                              
   Net income for 1996                                   -           -  $   16,012       16,012              -         16,012
   Other comprehensive income, net of tax $433           -           -                        -              -              -
   Unrealized gain (loss) on available                                                                            
        for sale securities                              -           -        (804)           -           (804)          (804)
                                                                        ----------                                
        Total comprehensive income                                      $   15,208                                
                                                                        ==========                                
Ten-for-one stock split                                  -         371                     (371)             -              -   
Stock options exercised                             31,283         186                        -              -            186
Stock dividend                                     442,831      11,956                  (11,956)             -              -
Fractional shares purchased, (net)                     797          20                        -              -             20
Stock issued for Washington Banking                                                                               
   Company stock                                    33,500         971                        -              -            971
Cash dividend declared by VBC                            -           -                     (248)             -           (248)
                                                ----------  ----------               ----------    -----------     ----------
                                                                                                                  
Balance, December 31, 1996                       7,624,566      58,044                   30,178            129         88,351
                                                                                                                  
Comprehensive Income                                                                                              
   Net income for 1997                                   -           -  $   18,594       18,594              -         18,594
   Other comprehensive income, net of tax $174           -           -                        -              -              -
   Unrealized gain (loss) on available                                                                            
      for sale securities                                -           -         324            -            324            324
                                                                        ----------
       Total comprehensive income                                       $   18,918                                
                                                                        ==========
Stock options exercised                             40,548         365                        -              -            365     
Stock dividend                                     478,475      13,920                  (13,920)             -              -
Fractional shares purchased, (net)                     872          25                        -              -             25
Cash dividend declared by VBC                            -           -                     (275)             -           (275)
                                                ----------  ----------               ----------     ----------     ----------
                                                                                                                  
Balance, December 31, 1997                       8,144,461      72,354                   34,577            453        107,384
                                                                                                                  
Comprehensive Income                                                                                               
   Net income for 1998                                   -           -  $   21,649       21,649              -         21,649
   Other comprehensive income, net of tax $93            -           -                        -              -              -
   Unrealized gain (loss) on available                                                                            
       for sale securities                               -           -         173            -            173            173
                                                                        ----------                                
        Total comprehensive income                                      $   21,822                                
                                                                        ==========                                
Stock options exercised                             36,765         356                        -              -            356     
Stock dividend                                     514,999      17,809                  (17,809)             -              -
Fractional shares purchased, (net)                   1,036          28                        -              -             28
Cash dividend declared by VBC                            -           -                     (341)             -           (341)
                                                ----------  ----------               ----------     ----------     ----------
Balance, December 31, 1998                       8,697,261  $   90,547               $   38,076     $      626     $  129,249
                                                ==========  ==========               ==========     ==========     ==========
</TABLE>


   The accompanying notes are an integral part of these financial statements.


                                      -5-

<PAGE>   10

                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                 (In Thousands)

<TABLE>
<CAPTION>
                                                                                        YEAR ENDED DECEMBER 31,
                                                                            -----------------------------------------------
                                                                               1998               1997               1996
                                                                            ---------          ---------          ---------
<S>                                                                         <C>                <C>                <C>      
CASH FLOWS FROM OPERATING ACTIVITIES
    Net income                                                              $  21,649          $  18,594          $  16,012
    Adjustments to reconcile net income to net
           cash provided by operating activities
       Depreciation and amortization                                            1,675              1,708              1,567
       Provision for loan losses                                                1,800              2,095              2,133
       Loss on sale of other real estate owned                                   (230)                 -                  -
       Deferred taxes                                                            (742)              (727)              (870)
       Increase (decrease) in income taxes payable                              1,088               (290)                 2
       Increase (decrease) in interest receivable                                (751)               267               (305)
       Increase (decrease) in interest payable                                    394             (2,740)              (580)
       Proceeds from sales of mortgage loans                                   34,788             20,054             20,712
       Origination of mortgage loans held for sale                            (36,180)           (19,950)           (20,884)
       Dividend income from Federal Home Loan Bank                               (525)              (685)              (672)
       Increase (decrease) in other operating activities                         (979)               438               (405)
                                                                            ---------          ---------          ---------

           Net cash provided by operating activities                           21,987             18,764             16,710
                                                                            ---------          ---------          ---------

CASH FLOWS FROM INVESTING ACTIVITIES
    Net federal funds sold                                                     26,173            (35,800)            31,380
    Proceeds from maturities of available for sale
       and held to maturity securities                                         86,225             49,564             42,700
    Purchase of investment securities available for sale                      (87,406)           (17,492)           (11,013)
    Purchase of investment securities held to maturity                        (27,146)           (14,822)           (16,750)
    Net cash flows from loan activities                                      (159,813)           (79,843)          (108,058)
    Purchases of premises and equipment                                        (1,394)            (1,262)            (1,404)
    Proceeds from the sale of other real estate owned                           1,537                261                349
    Cash invested in other real estate owned                                        -               (755)              (281)
    Net cash provided from acquisition of branch                                    -             13,136                  -
    Other investing activities                                                      -               (181)              (478)
                                                                            ---------          ---------          ---------

           Net cash used by investing activities                             (161,824)           (87,194)           (63,555)
                                                                            ---------          ---------          ---------

CASH FLOWS FROM FINANCING ACTIVITIES
    Net change in core deposit accounts                                        63,976             47,122             24,834
    Net change in certificates of deposit                                      52,318             16,595             13,635
    Net change in federal funds purchased and securities sold under
       agreements to repurchase                                                13,896              5,951               (336)
    Advances from the Federal Home Loan Bank                                   20,240             40,000              4,415
    Repayments to the Federal Home Loan Bank                                      (26)           (45,000)            55,000
    Principal payments on long-term debt                                         (695)              (364)           (35,000)
    Other financing activities                                                    657               (209)              (250)
                                                                            ---------          ---------          ---------

           Net cash provided by financing activities                          150,366             64,095             62,298
                                                                            ---------          ---------          ---------

INCREASE (DECREASE) IN CASH AND DUE FROM BANKS                                 10,529             (4,335)            15,453
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR                                   33,704             38,039             22,586
                                                                            ---------          ---------          ---------
CASH AND DUE FROM BANKS AT END OF YEAR                                      $  44,233          $  33,704          $  38,039
                                                                            =========          =========          =========

SUPPLEMENTAL DISCLOSURE OF CASH
       FLOW INFORMATION
    Cash paid during the year for interest                                  $  37,504          $  34,211          $  32,258
    Cash paid during the year for income taxes                              $   9,650          $   9,995          $   8,595

SUPPLEMENTAL INFORMATION ABOUT NONCASH INVESTING AND FINANCING ACTIVITIES Other
real estate acquired in settlement of loans in 1998 was $1.7 million.
Sales of other real estate financed by the Bank in 1998 and 1996 were $1.4
million and $570 thousand, respectively.
</TABLE>

   The accompanying notes are an integral part of these financial statements.


                                      -6-
<PAGE>   11

                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

                          NOTES TO FINANCIAL STATEMENTS


NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of Frontier Financial Corporation (the Corporation or FFC), a bank
holding company, and its wholly-owned subsidiaries, Frontier Bank (the Bank),
and FFP, Incorporated (FFP). FFP owns certain real property which is leased to
the Bank for use in its operations. Significant intercompany account balances
and transactions have been eliminated. Assets held by the Bank in an agency or
fiduciary capacity are not included in the accompanying financial statements.

NATURE OF OPERATIONS - The Corporation is primarily engaged in providing a full
range of banking and mortgage services to individual and corporate customers
through the Bank. The Bank also provides other services such as trust services
and insurance and financial service brokerage activities. The Corporation is
subject to competition from other financial institutions. The Corporation is
also subject to regulation by certain federal and state agencies and undergoes
periodic examinations by those regulatory authorities.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) INVESTMENT SECURITIES - Investments in equity and debt securities are
classified into one of three categories: 1) held to maturity, 2) available for
sale, or 3) trading. Investment securities are categorized as held to maturity
when the Corporation has the positive intent and ability to hold those
securities to maturity. Securities which are held to maturity are stated at
cost, adjusted for amortization of premiums and accretion of discounts which are
recognized as adjustments to interest income. Investment securities categorized
as available for sale are generally held for investment purposes (to maturity),
although unanticipated future events may result in the sale of some securities.
Available for sale securities are recorded at fair value, with the net
unrealized gain or loss included in comprehensive income, net of the related tax
effect. Realized gains or losses on dispositions are based on the net proceeds
and the adjusted carrying amount of securities sold, using the specific
identification method. The Corporation did not have any investment securities
categorized as trading securities at December 31, 1998 and 1997.

Declines in the fair value of individual held to maturity and available for sale
securities below their cost that are other than temporary are recognized by
write-downs of the individual securities to their fair value. Such write-downs
would be included in earnings as realized losses. Premiums and discounts are
recognized in interest income using the interest method over the period to
maturity.

(b) FEDERAL HOME LOAN BANK STOCK - The Bank's investment in Federal Home Loan
Bank (the FHLB) stock is carried at par value ($100 per share), which reasonably
approximates its fair value. As a member of the FHLB system, the Bank is
required to maintain a minimum level of investment in FHLB stock based on
specific percentages of its outstanding FHLB advances. The Bank may request
redemption at par value of any stock in excess of the amount the Bank is
required to hold. Stock redemptions are at the discretion of the FHLB.

(c) LOANS AND RELATED INCOME - Loans that management has the intent and ability
to hold for the foreseeable future, or until maturity or payoff are reported at
their outstanding principal, are adjusted for unearned discounts, the net of
unamortized nonrefundable fees and related direct loan origination costs, and
direct charge-offs. Interest income is accrued as earned.



                                      -7-
<PAGE>   12


NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Net deferred fees and costs are generally amortized into interest income as an
adjustment to the loan yield. Expenses deferred (principally personnel expense)
and recognized in the yield adjustment result in a reduction in noninterest
expense.

Nonrefundable fees related to lending activities other than direct loan
origination or purchase are recognized as credit related fees and included in
noninterest income during the period the related service is provided. These fees
include agency, standby letter of credit, loan commitment, and loan servicing
fees.

A loan is considered impaired when management determines it is probable that all
contractual amounts of principal and interest will not be paid as scheduled in
the loan agreement. These loans include nonaccruing loans past due 90 days or
more, loans restructured in the current year, and other loans that management
considers to be impaired.

Loans are placed on nonaccrual status when, in the opinion of management, the
collection of additional interest is doubtful or when the loan becomes 90 or
more days past due. When a loan is placed on nonaccrual status, all interest
previously accrued, but not collected, is reversed and charged against interest
income. Income on nonaccrual loans is then recognized only to the extent cash is
received and where the future collection of principal is probable. Accruals are
resumed only when the loan is brought current, or when, in the opinion of
management, the borrower has demonstrated the ability to resume payments of
principal and interest. Interest income on restructured loans is recognized
pursuant to the terms of the new loan agreement. Interest income on other
impaired loans is monitored and based upon the terms of the underlying loan
agreement. However, the recorded net investment in impaired loans, including
accrued interest, is limited to the present value of the expected cash flows of
the impaired loan or the observable fair market value of the loan or the fair
market value of the loan's collateral.

(d) ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is maintained at a
level management believes is adequate to provide for potential loan, loan
commitment and standby letter of credit losses. The allowance is based on a
continuing review of loans, loan commitments and standby letters of credit which
includes consideration of actual loss experience, changes in the size and
character of the portfolio, identification of individual problem situations
which may affect the borrower's ability to repay, and evaluations of the
prevailing and anticipated economic conditions.

Material estimates that are particularly susceptible to significant change,
relate to the determination of the allowance for loan losses and the valuation
of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowance for loan losses and
the valuation of foreclosed assets held for sale, management obtains independent
appraisals for significant properties.

Management believes the allowance for loan losses and the valuation of
foreclosed assets held for sale are adequate. While management uses available
information to recognize losses on loans and foreclosed assets held for sale,
changes in economic conditions may necessitate revision of these estimates in
future years. In addition, various regulatory agencies, as an integral part of
their examination processes, periodically review the Corporation's allowance for
loan losses and valuation of foreclosed assets held for sale. Such agencies may
require the Corporation to recognize additional losses based on their judgment
using information available to them at the time of their examination.

(e) LOANS HELD FOR SALE - Mortgage loans originated and designated as held for
sale are carried at the lower of cost or estimated fair value, as determined by
quoted market prices, in aggregate. Net unrealized losses are recognized in a
valuation allowance by charges to income. Gains or losses on the sale of such
loans are based on the specific identification method.



                                      -8-
<PAGE>   13



NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(f) PREMISES AND EQUIPMENT - Premises and equipment are shown at cost and
depreciated using the straight-line and accelerated methods. Depreciation
expense is computed over the following estimated useful lives:

<TABLE>
<S>                                                        <C>     
            Premises                                       7 to 40 years
            Furniture, fixtures and equipment               3 to 7 years
</TABLE>

(g) OTHER REAL ESTATE OWNED - Other real estate owned consists principally of
properties acquired through foreclosure and is stated at the lower of cost or
estimated market value. Losses arising from the acquisition of property, in full
or partial satisfaction of loans, are charged to the allowance for loan losses.

Subsequent to the transfer to foreclosed assets held for sale, these assets
continue to be recorded at the lower of cost or fair value (less estimated costs
to sell), based on periodic evaluations. Generally, legal and professional fees
associated with foreclosures are expensed as incurred. Costs incurred to improve
property prior to sale are capitalized, however, in no event are recorded costs
allowed to exceed fair value. Subsequent gains, losses, or expenses recognized
on the sale of these properties are included in noninterest income or expense.

(h) INCOME TAX - The Corporation reports income and expenses using the accrual
method of accounting and files a consolidated tax return. Deferred tax assets
and liabilities are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
Deferred taxes result from temporary differences in recognition of certain
income and expense amounts between the Bank's financial statements and its tax
returns.

(i) RETIREMENT PLANS - The Corporation has a profit sharing and salary deferral
plan and a money purchase pension plan which covers eligible employees. The
Corporation's contributions to the plans were $1.4 million in 1998, $1.3 million
in 1997, and $1.3 million in 1996. Contributions to the profit sharing plan are
discretionary while contributions to the money purchase pension plan are
currently 5% of employees eligible salaries. Both plans are funded during the
period in which they are committed by the Board of Directors.

(j) ADVERTISING COSTS - The Corporation expenses advertising costs as they are
incurred and are not considered to be material.

(k) FINANCIAL INSTRUMENTS - In the ordinary course of business the Bank has
entered into off-balance sheet financial instruments consisting of commitments
to extend credit, commitments under credit card arrangements, commercial letters
of credit, and standby letters of credit. Such financial instruments are
recorded in the financial statements when they are funded or related fees are
incurred or received.

(l) STOCK OPTION PLANS - The Corporation recognizes the financial effects of
stock options in accordance with Accounting Principles Board Opinion No. 25
Accounting for Stock Issued to Employees (APB 25). Stock options are issued at a
price equal to the fair value of the Corporation's stock as of the grant date.
Under APB 25 options issued in this manner do not result in the recognition of
employee compensation in the Corporation's financial statements.

(m) EARNINGS PER SHARE - Basic earnings per share amounts are computed based on
the weighted average number of shares outstanding during the period after giving
retroactive effect to stock dividends, stock splits and mergers accounted for as
poolings of interests. Diluted earnings per share are computed by determining
the number of additional shares that are deemed outstanding due to stock options
under the treasury stock method.



                                      -9-
<PAGE>   14


NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(n) CASH EQUIVALENTS - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, and amounts due from banks. Cash and cash
equivalents have an original maturity of three months or less.

(o) COMPREHENSIVE INCOME - On January 1, 1998 the Corporation adopted Statement
of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. The unrealized gain or loss on investments is the only
component of comprehensive income for the Corporation and is displayed in the
statement of changes in shareowners' equity, net of tax. All prior periods have
been restated to conform with the Statement.

(p) USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.

(q) RECLASSIFICATIONS - Certain amounts in prior years' financial statements
have been reclassified to conform to the 1998 presentation.

NOTE TWO - MERGER CONSUMMATED DURING 1998

In December 1998, Valley Bancorporation and Subsidiary (VBC) was merged into the
Corporation. In connection with this transaction, the Corporation issued 793,900
shares of common stock to the shareowners of VBC in an exchange that gave VBC
shareowners .8625 shares of the Corporation's stock for one share of VBC stock.
The merger has been accounted for as a pooling of interests as allowed by
generally accepted accounting principles. Accordingly, the Corporation's
consolidated financial statements have been restated for all periods prior to
the acquisition to include the financial position, results of operations, and
cash flow of VBC. At the date of acquisition, VBC had total assets of $95.8
million, revenue of $6.1 million, and net income of $2.1 million. The effects of
the restatement on revenues, net income and shareowner's equity are shown below:

<TABLE>
<CAPTION>
In Thousands                                         1997         1996
                                                   --------     --------
<S>                                                <C>          <C>     
Revenues
      The Corporation (as previously reported)     $ 80,186     $ 71,708
      VBC                                             7,503        6,425
                                                   --------     --------

As Restated                                        $ 87,689     $ 78,133
                                                   ========     ========

Net Income
      The Corporation (as previously reported)     $ 16,902     $ 14,617
      VBC                                             1,692        1,395
                                                   --------     --------

As Restated                                        $ 18,594     $ 16,012
                                                   ========     ========

Shareowners' equity
      The Corporation (as previously reported)     $ 97,839     $ 80,317
      VBC                                             9,545        8,034
                                                   --------     --------

As Restated                                        $107,384     $ 88,351
                                                   ========     ========
</TABLE>



                                      -10-
<PAGE>   15


NOTE THREE - Investments

Investments in federal funds sold are made with major banks which are approved
by the Board of Directors. The Bank has an investment policy that permits
holding securities rated only in one of the four highest rating categories by a
nationally recognized credit rating organization.

The aggregate amortized cost and fair values of investment securities at
December 31 are as follows:


<TABLE>
<CAPTION>
In Thousands
                                                    Gross         Gross
1998                                Amortized     Unrealized    Unrealized    Fair
                                      Cost          Gains         Losses      Value
                                    ---------     ---------     ---------   ---------
<S>                                 <C>           <C>            <C>         <C>      
Available for sale
        U.S. Treasury bonds         $     252     $      50          -      $     302
        U.S. Agency bonds              74,516           132      $(290)        74,358
        Corporate bonds                25,054           896         (6)        25,944
        Equities                       11,923           180          -         12,103
                                    ---------     ---------      -----      ---------

                                      111,745         1,258       (296)       112,707
                                    ---------     ---------      -----      ---------

Held to maturity
        Municipal securities           28,144         1,623          -         29,767
        Certificates of deposit         4,750             -          -          4,750
                                    ---------     ---------      -----      ---------

                                       32,894         1,623          -         34,517
                                    ---------     ---------      -----      ---------
               Total Securities     $ 144,639     $   2,881      $(296)     $ 147,224
                                    =========     =========      =====      =========
</TABLE>

<TABLE>
<S>                                 <C>          <C>           <C>          <C>     
1997

Available for sale
        U.S. Treasury bonds         $    754     $     38           -      $    792
        U.S. Agency bonds             43,490          173       $ (96)       43,567
        Corporate bonds               28,151          589          (7)       28,733
        Equities                       9,927            -           -         9,927
                                    --------     --------      ------      --------

                                      82,322          800        (103)       83,019
                                    --------     --------      ------      --------

Held to maturity
        U.S. Agency                      549            -           -           549
        Municipal securities          28,881        1,513          (2)       30,392
        Certificates of deposit        3,550            -           -         3,550
                                    --------     --------      ------      --------

                                      32,980        1,513          (2)       34,491
                                    --------     --------      ------      --------

               Total Securities     $115,302     $  2,313       $(105)     $117,510
                                    ========     ========      ======      ========
</TABLE>



                                      -11-
<PAGE>   16


NOTE THREE - INVESTMENTS (CONTINUED)

Contractual maturities of investment securities as of December 31, 1998 are
shown below. Expected maturities will differ from contractual maturities because
issuers may have the right to call or prepay obligations with or without
prepayment penalties.

<TABLE>
<CAPTION>
In Thousands
                                     Available for Sale                 Held to Maturity
                                  -------------------------         -------------------------
                                  Amortized          Fair           Amortized          Fair
                                    Cost             Value            Cost             Value
                                  --------         --------         --------         --------
<S>                               <C>              <C>              <C>              <C>     
Maturity
       Less than one year         $ 15,353         $ 15,581         $  5,100         $  5,103
       One to five years            23,222           23,922            3,919            4,156
       Five to ten years            68,723           68,719           23,438           24,798
       Over ten years                4,447            4,485              437              460
                                  --------         --------         --------         --------
                                  $111,745         $112,707         $ 32,894         $ 34,517
                                  ========         ========         ========         ========
</TABLE>

Investments in state and political subdivisions represent purchases of municipal
bonds, with localities principally in western Washington. Investments in
corporate bonds are made in companies located and doing business throughout the
United States. Approximately 52% and 51% of the investments in corporate bonds
at December 31, 1998 and 1997, respectively, consisted of investments in
companies doing business in the financial services sector. Approximately 25% and
26% of the investments in corporate bonds at December 31, 1998 and 1997,
respectively, consisted of investments in companies doing business in the
industrial sector.

Investment securities, with a book value of $49.4 million and $31.2 million with
fair values of $49.4 million and $31.2 million in 1998 and 1997, respectively,
were pledged to secure public deposits and securities sold under agreements to
repurchase as required by law.

NOTE FOUR - LOANS

The Bank originates commercial, real estate mortgage, construction and land
development, and installment loans primarily in Snohomish, Skagit, King and
Pierce Counties. Although the Bank has a diversified loan portfolio, local
economic conditions may affect borrowers' ability to meet the stated repayment
terms. Collateral for each loan is based on a credit evaluation of the customer,
and such collateral may, depending on the loan, include accounts receivable,
inventory, equipment, real estate or other collateral. Loans are originated at
both fixed and variable interest rates.

Major classifications of loans at December 31 are as follows:

<TABLE>
<CAPTION>
In Thousands                               1998               1997
                                         ---------          ---------
<S>                                      <C>                <C>      
        Commercial                       $ 207,887          $ 158,394
        Real estate commercial             383,840            295,297
        Real estate construction           176,036            152,770
        Real estate mortgage               103,998            107,024
        Installment                         32,106             28,348
                                         ---------          ---------
                                           903,867            741,833
        Less deferred loan fees             (5,725)            (4,887)
                                         ---------          ---------
                                         $ 898,142          $ 736,946
                                         =========          =========
</TABLE>



                                      -12-
<PAGE>   17


NOTE FOUR - Loans (continued )

Contractual maturities of loans as of December 31, 1998 are shown below.
Expected maturities will differ from contractual maturities because borrowers
may have the right to prepay loans with or without prepayment penalties.

<TABLE>
<CAPTION>
In Thousands                      Within            1-5             After
                                  1 Year           Years           5 Years           Total
                                 --------         --------         --------         --------
<S>                              <C>              <C>             <C>               <C>     
Commercial                       $121,013         $ 75,605        $  10,741         $207,359
Real estate commercial             48,685          262,850           70,691          382,226
Real estate construction          125,017           42,169            6,039          173,225
Real estate mortgage               31,133           62,607            9,476          103,216
Installment                         8,634           13,566            9,916           32,116
                                 --------         --------         --------         --------

                                 $334,482         $456,797         $106,863         $898,142
                                 ========         ========         ========         ========

Loans maturing after                                1-5             After
  one year with:                                   Years           5 Years
                                                  --------         --------
 
Fixed rates                                       $403,992         $ 75,837
Variable rates                                      52,805           31,026
                                                  --------         --------

                                                  $456,797         $106,863
                                                  ========         ========
</TABLE>

LOAN LOSS RESERVE

Changes in the allowance for loan losses are summarized below:

<TABLE>
<CAPTION>
In Thousands                                                  1998              1997              1996
                                                            --------          --------          --------
<S>                                                         <C>               <C>               <C>     
 Balance at beginning of year                               $ 15,824          $ 14,033          $ 12,601
 Provision charged to operating expense                        1,800             2,095             2,133
        Deduct
                Loans charged-off                             (1,283)           (1,798)           (2,041)
                Less recoveries                                1,757             1,494             1,340
                                                            --------          --------          --------

         Net recoveries (charge-offs)                            474              (304)             (701)
                                                            --------          --------          --------

 Balance at year-end                                        $ 18,098          $ 15,824          $ 14,033
                                                            ========          ========          ========
</TABLE>


The Bank had loans amounting to $972 thousand at December 31, 1998 and $4.4
million at December 31, 1997 that were specifically classified as impaired with
an average balance of $1.1 million and $4.2 million, respectively. The allowance
for loan losses related to these loans was approximately $46 thousand in 1998
and $1.1 million in 1997. Interest collected on these loans in cash and included
in income amounted to $41 thousand in 1998 and $384 thousand in 1997. If
interest on these loans had been accrued, such income would have approximated
$42 thousand in 1998 and $289 thousand in 1997. At December 31, 1998 there were
no commitments to lend additional funds to borrowers whose loans were classified
as impaired.

The effects of troubled debt restructurings are not considered material to the
Corporation's financial position and results of operations.


                                      -13-
<PAGE>   18

NOTE FOUR - Loans (continued)

OTHER REAL ESTATE OWNED

From time-to-time management has written-off various parcels of other real
estate owned due to unresolved issues relating to permitting, zoning and
wetlands. Management is attempting to work through the above mentioned issues to
be able to effectively market these properties. Contingent gains could be
realized, should the above issues be favorably resolved.

NOTE FIVE - Premises And Equipment

Premises and equipment at December 31 are comprised of the following:

<TABLE>
<CAPTION>
In Thousands                                        1998              1997
                                                  --------          --------
<S>                                               <C>               <C>     
        Premises                                  $ 12,679          $ 11,956
        Furniture, fixtures and equipment            7,445             6,816
        Land                                         5,160             5,160
        Construction in progress                        98                66
                                                  --------          --------

                                                    25,382            23,998
        Less accumulated depreciation               (9,735)           (8,241)
                                                  --------          --------

                                                  $ 15,647          $ 15,757
                                                  ========          ========
</TABLE>

Depreciation expense on premises and equipment totaled $1.3 million in 1998,
$1.4 million in 1997, and $1.1 million in 1996.

NOTE SIX - Interest Bearing Deposits

The major classifications of interest bearing deposits at December 31 are as
follows:

<TABLE>
<CAPTION>
In Thousands                                       1998             1997
                                                 --------         --------
<S>                                              <C>              <C>     
        Money market and NOW accounts            $137,000         $119,780
        Savings                                   184,226          165,643
        Time deposits, $100,000 and over          164,829          118,309
        Other time deposits                       292,606          286,808
                                                 --------         --------

                                                 $778,661         $690,540
                                                 ========         ========
</TABLE>

The total remaining maturity schedule for time deposits is as follows:


<TABLE>
<CAPTION>
In Thousands

<S>                             <C>        <C>     
Year ending December 31,        1999       $382,840
                                2000         35,598
                                2001         17,433
                                2002          6,772
                                2003         13,074
                          Thereafter          1,718
                                           --------

                                           $457,435
                                           ========
</TABLE>



                                      -14-
<PAGE>   19


NOTE SEVEN - Credit Arrangements

The Bank is a member of the Federal Home Loan Bank (FHLB) of Seattle. As a
member, the Bank has a committed line of credit up to 15% of total assets. At
December 31, 1998, committed lines of credit agreements totaling approximately
$31 million were available to the Bank from unaffiliated banks. Such lines
generally provide for interest at the lending bank's federal funds rate or other
money market rates. There were no borrowings outstanding or compensating balance
requirements under these credit arrangements at December 31, 1998 and 1997.

In addition, at December 31, 1998 the Bank has a committed line of credit up to
$900 thousand from the Federal Reserve Bank (FRB). Borrowings generally provide
for interest at rates as published by the FRB and are secured by U.S. Treasury
and Agency securities. There were no borrowings outstanding at December 31, 1998
and 1997.

NOTE EIGHT - Federal Home Loan Bank (FHLB) Advances

At December 31, 1998, FHLB advances were scheduled to mature as follows:

<TABLE>
<CAPTION>
                                                   Interest
In Thousands                    Amount              Rates
------------                   -------            -----------
<S>                            <C>                <C>

    Within one year            $ 5,000                5.4%
    Two to three years           5,028            5.80%-7.08%
    Four to nine years          25,090(1)         4.34%-7.32%
    Ten to fifteen years        15,096(2)         4.13%-5.67%
                               -------
                               $50,214
                               =======
</TABLE>

------------

(1) $25 million of this advance may be put by the FHLB quarterly.

(2) $10 million of this advance may be put by the FHLB quarterly.

Advances from FHLB are collateralized by qualifying first mortgage loans and
government agency securities as required by the Agreement with the FHLB.

The maximum outstanding and average outstanding balances and average interest
rates on advances from the FHLB were as follows for the year ended December 31:

<TABLE>
<CAPTION>
  In Thousands                                        1998                 1997
  ------------                                        ----                 ----
<S>                                                 <C>                 <C>    
Maximum outstanding at any month-end                $50,214             $30,000
Average outstanding                                  35,274              30,274
Weighted average interest rates:
   Annual                                             5.51%               5 .39%
   End of year                                        5.24%               5 .46%
</TABLE>


NOTE NINE - Securities Sold Under Agreements To Repurchase

The Bank has sold certain securities of the U.S. Government and its agencies and
other approved investments under agreements to repurchase. The securities
underlying the agreements were held by a safekeeping agent under control by the
Bank.

Securities sold under agreement to repurchase were $26.3 million in 1998 and
$13.2 million in 1997. The average daily balance of outstanding agreements
during the period was $18 million in 1998 and $11 million 1997, with maximum
outstanding agreements at any month-end of $26.3 million and $16.4 million,
respectively.


                                      -15-
<PAGE>   20


NOTE TEN - Long-Term Debt

At December 31, long-term debt was as follows:

<TABLE>
<CAPTION>
In Thousands                                                                         1998         1997
------------                                                                       --------      ------
<S>                                                                                <C>           <C> 

Installment note, due in monthly principal payments of $3,378, including
   interest at rates varying between 5.67% and 7.32%.  Collateralized by
   a blanket pledge agreement                                                           -         $240

   Installment note, due in monthly payments of $27,821, including interest
   at 7% per annum.  Collateralized by shares of common stock                           -          399

   Mortgage note, due in monthly installments of  $3,100, including interest
   at 7.5% per annum. The principal is due upon demand.  Collateralized
   by a deed of trust                                                                   -           56
                                                                                    -----         ----

                                                                                        -         $695
                                                                                    =====         ====
</TABLE>

NOTE ELEVEN - Income Tax
The components of the provision for income tax are as follows:

<TABLE>
<CAPTION>
In Thousands               1998              1997              1996
                         --------          --------          --------
<S>                      <C>               <C>               <C>     
        Current          $ 11,591          $  9,813          $  8,541
        Deferred             (742)             (727)             (870)
                         --------          --------          --------

                         $ 10,849          $  9,086          $  7,671
                         ========          ========          ========
</TABLE>

The following table shows the nature and components of the Corporation's net
deferred tax assets, established at an estimated tax rate of 35% at December 31:


<TABLE>
<CAPTION>
In Thousands                                                    1998             1997
                                                              -------          -------
<S>                                                           <C>              <C>    

        Deferred tax assets
               Allowance for possible loan losses,
                       in excess of tax reserves              $ 6,334          $ 5,483
               Other deferred tax assets                        1,195            1,372
                                                              -------          -------
                       Total deferred tax assets                7,529            6,855
                                                              -------          -------

        Deferred tax liabilities
               Other deferred tax liabilities                  (1,488)          (1,556)
                                                              -------          -------

                       Total deferred tax liabilities          (1,488)          (1,556)
                                                              -------          -------

                       Net deferred tax assets                $ 6,041          $ 5,299
                                                              =======          =======
</TABLE>



                                      -16-
<PAGE>   21


NOTE ELEVEN - Income Tax (continued )

The Corporation believes, based upon the available information, that all
deferred assets will be realized in the normal course of operations.
Accordingly, these assets have not been reduced by a valuation allowance.

A reconciliation of the effective income tax rate with the federal statutory tax
rate is as follows:

<TABLE>
<CAPTION>
In Thousands                                 1998                              1997                              1996
                                  ---------------------------       ---------------------------       -------------------------
                                   Amount              Rate          Amount              Rate          Amount            Rate
                                  --------           --------       --------           --------       --------         --------
<S>                               <C>                <C>            <C>                <C>            <C>              <C>

Income tax provision
        at statutory rate         $ 11,374                 35%      $  9,688                 35%      $  8,289               35%

Effect of nontaxable
        interest income               (486)                -2%          (613)                -2%          (620)               -3%

Other                                  (39)                 -             11                  -              2                -
                                  --------           --------       --------           --------       --------         --------

                                  $ 10,849                 34%      $  9,086                 33%      $  7,671               32%
                                  ========           ========       ========           ========       ========         ========
</TABLE>

NOTE TWELVE - Shareowners' Equity And Regulatory Matters

The Corporation is authorized to issue up to 10 million shares of preferred
stock with no par value. The Board of Directors have the authority to determine
the rights and privileges to be granted to holders of the stock.

The Corporation and Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's financial statements. Under capital
adequacy guidelines in the regulatory framework for prompt corrective action,
the Corporation must meet specific capital adequacy guidelines that involve
quantitative measures of each entity's assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy
require maintenance of minimum amounts and ratios (set forth in the table). Tier
I capital includes common stock, surplus, retained earnings and undivided
profits less goodwill. Total capital includes Tier I capital and the loan loss
reserve. Tier I capital to average assets is referred to as the average ratio.
Management believes, as of December 31, 1998 and 1997 that the Corporation and
Bank meet capital adequacy requirements to which they are subject.

As of the most recent notification from the Bank's primary regulator, the Bank
was categorized as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed this category.


                                      -17-
<PAGE>   22


NOTE TWELVE - Shareowners' Equity And Regulatory Matters (continued )

<TABLE>
<CAPTION>
In Thousands                                                              To Be Well
                                                                       Capitalized Under
                                                                       Prompt Corrective                    For Capital
                                          Actual                       Action Provisions                 Adequacy Purposes
                                  -----------------------          -------------------------         -------------------------
1998                              Amount            Ratio            Amount            Ratio           Amount            Ratio
----                             --------           -----          ---------          ------         --------            -----
<S>                              <C>                <C>            <C>                <C>            <C>                 <C>  

 Total Capital (to risk
        weighted assets)
        Consolidated             $139,469           14.42%         $ 96,695           10.00%         $ 77,356            8.00%
        Frontier Bank             134,168           13.92%           96,635           10.00%           38,678            8.00%

 Tier I Capital (to risk
        weighted assets)
        Consolidated              127,227           13.16%           58,017            6.00%           38,678            4.00%
        Frontier Bank             122,065           12.67%           57,811            6.00%           38,541            4.00%

 Tier I Capital (to
        average assets)
        Consolidated              127,227           12.11%           52,423            5.00%           41,938            4.00%
        Frontier Bank             122,065           11.64%           52,504            5.00%           42,003            4.00%

                                                                                                                         1997

1997
----
 Total Capital (to risk
        weighted assets)
        Consolidated             $115,300           14.68%         $ 78,535           10.00%         $ 62,828            8.00%
        Frontier Bank             111,115           14.19%           78,315           10.00%           62,652            8.00%

 Tier I Capital (to risk
        weighted assets)
        Consolidated              105,409           13.46%           47,121            6.00%           31,414            4.00%
        Frontier Bank             101,252           12.93%           46,989            6.00%           31,326            4.00%

 Tier I Capital (to
        average assets)
        Consolidated              105,409            9.23%           45,956            5.00%           36,605            4.00%
        Frontier Bank             101,252            9.09%           47,752            5.00%           38,202            4.00%
</TABLE>


Under federal regulations, the Bank is limited, unless previously approved, as
to the amount it may loan the holding company and other affiliates to 10% of its
capital stock and surplus (approximately $4.2 million and $3.4 million at
December 31, 1998 and 1997, respectively).

Federal Reserve Board regulations require maintenance of certain minimum reserve
balances on deposit with the Federal Reserve Bank. The average amount of such
balances was $10.7 million in 1998 and $7.9 million in 1997.


                                      -18-
<PAGE>   23


NOTE THIRTEEN - Employee Stock Option Plan

In 1992, the shareowners of the Corporation approved an Incentive Stock Option
Plan (the Plan) to promote the best interest of the Corporation, its
subsidiaries and its shareowners, by providing an incentive to those key
employees who contribute to the operating success of the Corporation.

The maximum number of shares that may be issued under the Plan is ten percent
(10%) of the common stock of the Corporation. Options issued and outstanding are
adjusted to reflect any future common stock dividends, splits, recapitalization
or reorganization. The Board of Directors make available sufficient shares for
each option granted, subject to the remaining number of shares.

Options are granted at the then fair market value and vest in six months.
Options expire ten years from the date of grant, and are subject to certain
restrictions and limitations.

Proforma information regarding net income and earnings per share is required by
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation . The proforma recognizes, as compensation, the estimated present
value of stock options granted using an option valuation model known as the
Black-Scholes model. Proforma earnings per share amounts reflect an adjustment
as if the present value of the options were recognized as compensation for the
period.

For the most part, variables and assumptions are used in the model. For the
periods 1998 and 1997, the risk-free interest rate is 4.70% and 5.67%, the
dividend yield rate is not meaningful; the price volatility is 54.73% and
15.59%; and the weighted average expected life of the options has been measured
at 7 years.

Management believes that the variables and assumptions used in the options
pricing model are subjective and represent only one estimate of possible value.
The fair value of options granted that are recognized in proforma earnings is
shown below:


In Thousands, except for per share amounts

<TABLE>
<CAPTION>
Proforma disclosures                         1998             1997               1996
                                           --------         --------         ----------
<S>                                        <C>              <C>              <C>       
  Net income as reported                   $ 21,649         $ 18,594         $   16,012
  Additional compensation for
       fair value of stock options              378              465                140
                                           --------         --------         ----------

Proforma net income                        $ 21,271         $ 18,129         $   15,872
                                           ========         ========         ==========

Earnings per share
  Basic
      As reported                          $   2.49         $   2.15         $     1.87
                                           ========         ========         ==========
      Proforma                             $   2.45         $   2.10         $     1.85
                                           ========         ========         ==========
        Diluted
      As reported                          $   2.46         $   2.14         $     1.84
                                           ========         ========         ==========
      Proforma                             $   2.42         $   2.09         $     1.83
                                           ========         ========         ==========
</TABLE>



                                      -19-
<PAGE>   24


NOTE THIRTEEN - Employee Stock Option Plan (continued )

Stock option transactions were:

<TABLE>
<CAPTION>
                                                                      Weighted
                                    Shares of Common Stock           Average of
                                  --------------------------      Exercisable Price
                                  Available for        Under          of Shares
                                  Option/Award         Plan          Under Plan
                                  -------------       -------     -----------------
<S>                               <C>                 <C>         <C>   
Balance, December 31, 1995           77,543           206,200          $10.84
       Authorized                         -                 -               -
       Granted                      (12,624)           12,624           31.00
       7% stock dividend             (2,083)           10,687               -
       Exercised                          -           (31,283)           5.11
       Forfeited                        810              (810)            N/M
                                    -------           -------          ------

Balance, December 31, 1996           63,646           197,418           12.92
       Authorized                         -                 -               -
       Granted                      (18,748)           18,748           28.55
       7% stock dividend             (3,767)           10,093               -
       Exercised                          -           (40,548)           6.66
       Forfeited                        174              (174)            N/M
                                    -------           -------          ------

Balance, December 31, 1997           41,305           185,537           16.38
       Authorized                   434,950                 -
       Granted                      (13,836)           13,836           46.00
       7% stock dividend                  4             5,323
       Exercised                          -           (36,765)           9.70
       Forfeited                        254              (254)            N/M
                                    -------           -------          ------

Balance, December 31, 1998          462,677           167,677          $17.00
                                    =======           =======          ======
</TABLE>

The following table summarizes information concerning currently outstanding and
exercisable options:


<TABLE>
<CAPTION>
                              Options Outstanding          Options Exercisable
                            -----------------------      ------------------------
                             Weighted
                             Average       Weighted                      Weighted
Range of                    Remaining      Average                       Average
Exercise       Number       Contractual    Exercise       Number         Exercise
Prices       Outstanding      Life          Price        Exercisable      Price
--------     -----------    -----------    --------      -----------     --------
<S>          <C>            <C>            <C>           <C>             <C>

$ 1-10         89,531         1.31         $ 7.86         89,531         $ 7.86
 10-20         25,875         3.83          15.75         25,875          15.75
 20-30         24,461         5.25          25.38         24,461          25.38
 30-40         13,974         6.30          34.58         13,974          34.58
 40-50         13,836         7.00          46.00
</TABLE>



                                      -20-
<PAGE>   25

NOTE FOURTEEN - Earnings Per Share

The numerators and denominators of basic and fully diluted earnings per share
are as follows:

In Thousands, except for per share amounts

<TABLE>
<CAPTION>
                                                    1998               1997               1996
                                                  ---------          ---------          ---------
<S>                                              <C>                <C>                <C>       
Net income (numerator)                           $   21,649         $   18,594         $   16,012
                                                 ==========         ==========         ==========

Shares used in the calculation
     (denominator)
     Weighted average shares outstanding          8,678,033          8,633,763          8,580,195
     Effect of dilutive stock options               107,555             56,852             81,005
                                                  ---------          ---------          ---------
     Fully diluted shares                         8,785,588          8,690,615          8,661,200
                                                  =========          =========          =========

Basic Earnings per share                         $     2.49         $     2.15         $     1.87
                                                 ==========         ==========         ==========
Fully Diluted Earnings per share                 $     2.46         $     2.14         $     1.84
                                                 ==========         ==========         ==========
</TABLE>

NOTE FIFTEEN - Related Party Transactions

Loans to directors, executive officers and their affiliates are subject to
regulatory limitations. Such loans had aggregate balances and activity during
1998, 1997 and 1996 as follows and were within regulatory limitations:

<TABLE>
<CAPTION>
In Thousands                                   1998              1997              1996
                                             --------          --------          --------
<S>                                          <C>               <C>               <C>     
        Balance at beginning of year         $ 21,960          $  7,028          $  9,475
        New loans or advances                   8,630            22,219             3,808
        Repayments                             (8,471)           (7,287)           (6,255)
                                             --------          --------          --------

        Balance at end of year               $ 22,119          $ 21,960          $  7,028
                                             ========          ========          ========
</TABLE>

NOTE SIXTEEN - Commitments and Contingent Liabilities

The Bank leases various branch offices under agreements which expire between
1999 and 2014. The agreements contain various renewal options and require the
Bank to maintain the properties.


The total future minimum rental commitment through 2002 and thereafter is as
follows:

In Thousands

<TABLE>
<S>                                          <C>   
Year ending December 31, 1999                 $  332
                         2000                    302
                         2001                    244
                         2002                    235
                         2003                    235
                         Thereafter            2,535
                                              ------
                                              $3,883
                                              ======
</TABLE>



                                      -21-
<PAGE>   26

Rental expense charged to operations was $1.4 million in 1998, $453 thousand in
1997 and $410 thousand in 1996.

The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet financing needs of its customers. These
financial instruments include commitments to extend credit, standby letters of
credit and financial guarantees. Those instruments involve, to varying degrees,
elements of credit and interest-rate risk in excess of the amount recognized in
the balance sheet. The contract amount of those instruments reflect the extent
of the Bank's involvement in particular classes of financial instruments.

The Bank's exposure to credit loss in the event of nonperformance by the other
party to the instrument for commitments to extend credit, standby letters of
credit, and financial guarantees written is represented by the contractual
amount of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.


COMMITMENTS TO EXTEND CREDIT AND FINANCIAL GUARANTEES - Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. The Bank's experience has been that approximately 49 percent of
loan commitments are drawn upon by customers. While approximately 100 percent of
commercial letters of credit are utilized, a significant portion of such
utilization is on an immediate payment basis. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
it is deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the borrower. Collateral held varies but may
include accounts receivable, inventory, property, plant, and equipment, and
income-producing commercial properties.

Standby letters of credit and financial guarantees written are conditional
commitments issued by the Bank to guarantee the performance of a customer to a
third party. Those guarantees are primarily issued to support public and private
borrowing arrangements, bond financing, and similar transactions. The Bank
underwrites its standby letters of credit using its policies and procedures
applicable to loans in general. Standby letters of credit are made on an
unsecured and secured basis. The Bank has not been required to perform on any
financial guarantees during the past two years. The Bank has not incurred any
significant losses on its commitments in 1998 or 1997.

A summary of the notional amount of the Bank's financial instruments with
off-balance sheet risk at December 31, 1998 follows: 



<TABLE>
<CAPTION>
                                       Amount
                                      --------
<S>                                   <C>     
Commitments to extend credit          $190,124
Credit card arrangements                10,423
Commercial letters of credit               156
Standby letters of credit                3,024
</TABLE>

NOTE SEVENTEEN - Fair Value of Financial Instruments

The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, Disclosures About Fair
Value of Financial Instruments . The estimated fair value amounts have been
determined by the Bank using available market information and appropriate
valuation methodologies. However, considerable judgment is necessary to
interpret market data in the development of the estimates of fair value. The use
of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts. The following methods and
assumptions were used to estimate the fair value of each class of financial
instruments for which it is practicable to estimate that value:


                                      -22-
<PAGE>   27


NOTE SEVENTEEN - Fair Value of Financial Instruments (continued)

The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:

(a) CASH EQUIVALENTS AND FEDERAL FUNDS SOLD - For these short-term instruments,
the carrying amount is a reasonable estimate of fair value.

(b) INVESTMENT SECURITIES - For investment securities fair values are based on
quoted market prices or dealer quotes, if available. If a quoted market price is
not available, fair value is estimated using quoted market prices for similar
securities.

(c) LOANS - The fair value of loans generally is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities.
For certain homogeneous categories of loans, such as Small Business
Administration guaranteed loans, fair value is estimated using the quoted market
prices for securities backed by similar loans, adjusted for differences in loan
characteristics.

(d) DEPOSITS AND FEDERAL FUNDS PURCHASED - The fair value of demand deposits,
savings accounts, certain money market deposits, and federal funds purchased, is
the amount payable on demand at the reporting date. The fair value of
fixed-maturity certificates of deposit is estimated by discounting the future
cash flows using the rates currently offered for deposits of similar remaining
maturities.

(e) FHLB ADVANCES, SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND LONG-TERM
DEBT - Fair value is determined by discounting future cash flows using rates
currently available to the Bank for debt with similar terms and remaining
maturities.

(f) OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - Commitments to extend credit and
letters of credit represent the principal categories of off-balance sheet
financial instruments (see Note 16). The fair value of these commitments is not
material since they are for a short period of time and subject to customary
credit terms.


<TABLE>
<CAPTION>
In Thousands                                               1998                               1997
                                                 -------------------------         --------------------------
                                                 Carrying           Fair           Carrying          Fair
Assets                                            Value            Value            Value            Value
                                                 --------         --------         --------         --------
<S>                                              <C>              <C>              <C>              <C>     
        Cash and due from banks                  $ 44,233         $ 44,233         $ 33,704         $ 33,704
        Investment securities
               Available for sale                 112,707          112,707           83,019           83,019
               Held to maturity                    32,894           34,517           32,980           34,491
        Federal funds sold                         45,712           45,712           71,885           71,885
        Net loans                                 880,044          898,441          721,122          729,390

Liabilities

        Noninterest bearing deposits              147,981          147,981          119,808          119,808
        Interest bearing deposits                 778,661          782,017          690,540          691,805
        Federal funds purchased
               and securities sold under
               agreements to repurchase            31,858           31,858           17,962           17,962
        FHLB Advances                              50,214           49,641           30,000           30,173
        Long-term debt                                  -                -              695              695
</TABLE>



                                      -23-
<PAGE>   28


NOTE EIGHTEEN - Parent Company (Only) Financial Information

Condensed balance sheets at December 31:

<TABLE>
<CAPTION>
In Thousands                                                  1998             1997
                                                            --------         --------
<S>                                                         <C>              <C>     
ASSETS
       Cash                                                 $    121         $    354
       Investment in subsidiaries:
              Bank                                           123,714          103,637
              Nonbank                                          2,499            2,418
       Investment in Washington Banking Company                1,929              971
       Other assets                                            1,177              480
                                                            --------         --------
                                                            $129,440         $107,860
                                                            ========         ========
LIABILITIES
       Other liabilities                                    $    191         $    476
                                                            --------         --------
SHAREOWNERS' EQUITY
       Common stock                                           90,547           72,353
       Retained earnings                                      38,586           35,031
       Accumulated comprehensive income, net of tax              116                -
                                                            --------         --------
       Total Shareowners' equity                             129,249          107,384
                                                            --------         --------
                                                            $129,440         $107,860
                                                            ========         ========
</TABLE>


Condensed statements of income for the years ended December 31:

<TABLE>
<CAPTION>
In Thousands                                                            1998            1997            1996
                                                                       -------         -------         -------
<S>                                                                    <C>             <C>             <C>    
              Income
                     Dividend from Bank                                $ 2,173         $   765         $   691
                     Other dividends                                        21              19              18
                     Rental                                                  -               -               1
                     Interest                                                3               5               4
                                                                       -------         -------         -------
                            Total income                                 2,197             789             714
                                                                       -------         -------         -------
              Expenses
                     Interest                                                1              42              58
                     Personnel                                             241             268             124
                     Depreciation and amortization                          64              77              77
                     Other                                               1,031             269             209
                                                                       -------         -------         -------
                            Total expenses                               1,337             656             468
                                                                       -------         -------         -------
              Income before equity in undistributed income
                     of subsidiaries and benefit equivalent to
                     income taxes                                          860             133             246
              Benefit equivalent to income taxes                           438             194             123
                                                                       -------         -------         -------

              Income before equity in undistributed income
                     of subsidiaries                                     1,298             327             369

              Equity in undistributed
                     income of subsidiaries                             20,351          18,267          15,643
                                                                       -------         -------         -------
                            Net income                                 $21,649         $18,594         $16,012
                                                                       =======         =======         =======
</TABLE>


                                      -24-
<PAGE>   29


NOTE EIGHTEEN - Parent Company (Only) Financial Information (continued)

Condensed statements of cash flows for the years ended December 31:

<TABLE>
<CAPTION>
In Thousands                                                                   1998              1997              1996
                                                                             --------          --------          --------
<S>                                                                          <C>               <C>               <C>     
Cash flows from operating activities
              Net income                                                     $ 21,649          $ 18,594          $ 16,012
              Adjustments to reconcile net income to net cash
                            provided by operating activities
                     Equity in undistributed income of subsidiaries           (22,524)          (19,032)          (16,334)
                     Depreciation and amortization                                 63                77                77
                     Other operating activities                                  (617)              (99)              (46)
                                                                             --------          --------          --------
                            Net cash flows from operating activities           (1,429)             (460)             (291)
                                                                             --------          --------          --------
Cash flows from investing activities
              Dividends received                                                2,173               765               691
              Purchase of available for sale securities                          (779)
                                                                             --------          --------          --------       
                            Net cash flows from investing activities            1,394               765               691
                                                                             --------          --------          --------
Cash flows from financing activities
              Sales of common stock                                               384               390               206
              Principal payments of long-term debt                               (283)             (294)             (274)
              Other financing activities                                         (299)             (274)             (249)
                                                                             --------          --------          --------
                            Net cash flows from financing activities             (198)             (178)             (317)
                                                                             --------          --------          --------
Increase (decrease) in cash                                                      (233)              127                83
Cash at beginning of year                                                         354               227               144
                                                                             --------          --------          --------
Cash at end of year                                                          $    121          $    354          $    227
                                                                             ========          ========          ========
</TABLE>

NOTE NINETEEN - New Accounting Pronouncements

The Financial Accounting Board issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities . This Statement establishes accounting and
reporting standards for derivative financial instruments and for hedging
activities. Upon adoption of the Statement, all derivatives must be recognized
at fair value as with assets of liabilities in the statement of financial
position. Changes in the fair value of the derivatives not designated as hedging
instruments are to be recognized currently in earnings or are to be recognized
as a component of other comprehensive income, depending on the intended use of
the derivatives and the resulting designations. Upon adoption, retroactive
application of this Statement to financial statements in prior periods is not
permitted. The standard becomes effective January 1, 2000 for the Corporation,
and is not anticipated to have a material effect on its financial position or
results of operation. The Corporation does not use interest rate risk management
products such as interest rate swaps, hedges, or derivatives, nor does
management intend to use such products in the future.

The Financial Accounting Standards Board also issued SFAS No. 134 , Accounting
for Mortgage-Backed Securities Retained After Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise in October of 1998. The Statement
establishes accounting and reporting standards for certain activities of
mortgage banking enterprises. SFAS No. 134 becomes effective for fiscal quarters
beginning after December 15, 1998. Management believes that adoption of this
standard will not have a material impact on its reported financial condition or
results of operation.


                                      -25-
<PAGE>   30


NOTE TWENTY - Unaudited Quarterly Financial Data - Condensed Consolidated
Statement of Income



<TABLE>
<CAPTION>
                                                                   1998 Quarter Ended
In Thousands                                                         (Unaudited)
------------                               ---------------------------------------------------------------
                                           December 31       September 30       June 30           March 31
                                           -----------       ------------       -------           --------
<S>                                        <C>               <C>                <C>               <C>     
Interest income                             $ 24,874          $ 23,809          $ 22,766          $ 22,113
Interest expense                               9,920             9,672             9,207             9,091
                                            --------          --------          --------          --------
  Net interest income                         14,954            14,137            13,559            13,022
Provision for loan losses                       (875)             (425)             (175)             (325)
                                            --------          --------          --------          --------
Net interest income after provision
    for loan losses                           14,079            13,712            13,384            12,697
Non interest income                            1,604             1,209             1,365             1,150
Non interest expense                           7,611             6,278             6,833             5,980
                                            --------          --------          --------          --------
Income before income tax                       8,072             8,643             7,916             7,867
Provision for federal income tax              (2,375)           (3,109)           (2,579)           (2,786)
                                            --------          --------          --------          --------
Net Income                                  $  5,697          $  5,534          $  5,337          $  5,081
                                            ========          ========          ========          ========
Basic earnings per common share             $   0.66          $   0.64          $   0.62          $   0.59
Diluted earnings per common share           $   0.65          $   0.63          $   0.61          $   0.58
Average basic shares outstanding               8,678             8,675             8,672             8,667
Average diluted shares outstanding             8,786             8,799             8,788             8,775
</TABLE>

<TABLE>
<CAPTION>
                                                                    1997 Quarter Ended
In Thousands                                                          (Unaudited)
------------                               ---------------------------------------------------------------
                                           December 31       September 30       June 30           March 31
                                           -----------       ------------       --------          --------
<S>                                         <C>               <C>               <C>               <C>     
Interest income                             $ 22,052          $ 21,369          $ 20,458          $ 19,445
Interest expense                               8,981             8,713             8,380             8,295
                                            --------          --------          --------          --------
  Net interest income                         13,071            12,656            12,078            11,150
Provision for loan losses                     (1,215)             (410)             (310)             (160)
                                            --------          --------          --------          --------
Net interest income after provision
    for loan losses                           11,856            12,246            11,768            10,990
Non interest income                            1,099             1,093             1,281               892
Non interest expense                           6,957             5,467             6,079             5,042
                                            --------          --------          --------          --------
Income before income taxe                      5,998             7,872             6,970             6,840
Provision for federal income tax              (1,689)           (2,708)           (2,347)           (2,342)
                                            --------          --------          --------          --------
Net Income                                  $  4,309          $  5,164          $  4,623          $  4,498
                                            ========          ========          ========          ========
Basic earnings per common share             $   0.50          $   0.60          $   0.54          $   0.52
Diluted earnings per common share           $   0.50          $   0.59          $   0.53          $   0.51
Average basic shares outstanding               8,634             8,629             8,624             8,621
Average diluted shares outstanding             8,691             8,734             8,735             8,736
</TABLE>


                                      -26-
<PAGE>   31



                         FRONTIER FINANCIAL CORPORATION
                                AND SUBSIDIARIES

           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                            AND RESULTS OF OPERATION

OVERVIEW OF REPORTED RESULTS

The Corporation again completed the most profitable year since opening, and the
twentieth consecutive year of increased net income. Net income for 1998 was
$21.6 million, up $3.1 million or 16.4%. Net income for 1997 was $18.6 million,
up 16.1% from 1996 and net income in 1996 was $16.0 million, or up 14.3% as
compared to 1995. Highlights of 1998 include a 13.7% growth in net interest
income, excellent expense control, outstanding asset quality, and a strong
allowance for credit losses. Capital increased 20.4% and diluted earnings per
share increased from $2.14 to $2.46. Earnings per share have been adjusted to
reflect the 7% stock dividend paid in 1998.

Return on average assets (ROA) was 2.06% in 1998; 2.03% for 1997; and 1.96% for
1996. Return on average equity (ROE) for 1998 was 18.27%; 1997 was 18.84%; and
20.15% for 1996.

REGIONAL ECONOMY

The Bank's lending and other activities are concentrated in Snohomish County,
Washington, but also includes the northern part of King County, by having
branches located in Bothell, Redmond, Woodinville and the Lake City area in
north Seattle; Skagit County by having a branch located in Burlington; and
Pierce county, by having branches located in Sumner, Orting, Puyallup and
Buckley. The major city in Snohomish County is Everett; the major city in King
County is Seattle, the largest city in the state; and the largest city in Pierce
County is Tacoma. These four counties would be considered the market or service
area of the Corporation. The information below regarding the Washington State
and local economy was written by Mr. Michael Cade, Vice President, Snohomish
County Economic Council.

1998 REVIEW OF SNOHOMISH COUNTY 

Within the Seattle/Bellevue/Everett PMSA, the labor market maintained excellent
strength. Payrolls of area employers increased the number of wages and salary
jobs in the PMSA at an annual growth rate of 3.3% above the prior year's levels.
Business and government in King, Snohomish and Island counties have created over
43,000 jobs. Strictly within Snohomish County, job growth in the public and
private sectors combined registered 2.5% over the year. By comparison,
employment in Snohomish County rose 7.1% averaged throughout 1997. The margin of
over the year job gains has slipped steadily throughout 1998. In Washington
State, 1998 was closing with a seasonally adjusted unemployment rate of 4 .8%
with a resident civilian labor force of 3,100,100. Statewide, manufacturing
employment payrolls fell somewhat during the last quarter of 1998. (Several
issues outside of the Everett, Snohomish County region had a large impact upon
the statewide figures. These including the Kaiser Aluminum labor-management
disputes that has disrupted production at plans in Tacoma and Spokane.)
Additionally, a declining work force in computer and office equipment and
aircraft and parts continued to tug away at the year-to-year spread.

Meanwhile statewide, construction and services continue bolstering the economy.
Over the year job growth in the services producing industries registered in the
3.7% range in October--up from 3.1% a year ago. Construction came in at 4.5%;
wholesale and retail trade at 3.9%; and services at 5.3%. The most spectacular
run-up over the past 12 months has been centered in business
services--specifically temporary help agencies (up 13%) and computer data
processing and software (up 20%). These two sectors, more than any other has
consistently led the economy throughout the lengthy business up-cycle and both
are expected to continue strong into the new year.


                                      -27-
<PAGE>   32

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


1999 PREVIEW OF SNOHOMISH COUNTY

The following section is intended to address the significance of technology
based industries in the Snohomish County economy. What is most important in any
discussion of the future performance of the local economy is whether or not the
recent announcements by the Boeing Company to reduce payroll or employee counts
in western Washington will have any major impacts on the economy's overall
performance. What the following stresses is that while Boeing still is the "800
pound gorilla" the remainder of the economy, and in particular Snohomish County,
is no longer the "80 pound weakling." Recently, Washington CEO magazine
published an article regarding the changing economy of the Puget Sound basin.
From the article, they quoted several expert opinions regarding the trends and
the changing dynamics of our area. Ms. Roberta Pauer is the Regional Analyst for
the Research Branch of the Washington State Employment Security and is easily
recognized as the expert on economic trends for labor and market in Snohomish
County. In the article Ms. Pauer addresses the differences between Snohomish
County in latter part of the 90's and the middle to early 80's. A very telling
quote from her reads in part:

        The Snohomish County economy is so extremely strong in a fundamental
        structural sense. Snohomish County never was a slouch county, but is
        much stronger now. That bodes so well for the coming decades. Snohomish
        County is economically quite a bit different in this last part of the
        90's than it ever has been.

The current 1998 population estimate for Snohomish County is 568,100. The year
2012 forecasted population for the County is 714,244, an increase of 146,144.
The City of Everett has a 1998 estimated population of 84,240; the forecasted
2012 population is 96,000 (an increase of 11,750). The southwest Snohomish
County planning areas have a combined 1998 estimated population of 350,110. The
year 2012 forecasted population for the southwest Snohomish County area is
443,740 (an increase of 93,630). This 26% projected countywide growth represents
a fairly significant residential growth for the community of Everett and for all
of Snohomish County.

PIERCE COUNTY

The following economic data was provided by the Tacoma-Pierce County Chamber of
Commerce:

Five years after it started in 1992, Pierce County economy continued its growth
through the first half of 1998. The local economy has grown at an average rate
of just under 2.5% which is .5% above the long-term historical growth rate. The
outlook is for some cooling off and slower growth through 1999.

After a combination of running at or near capacity for two years, and
deteriorating external forces, the local economy is expected to experience a
mild recession of short duration in the second quarter of 1999. While mild by
historical standards, the two consecutive quarters of decline does represent a
local recession. The beginnings of a recovery is expected in the forth quarter
of 1999.

However, a mild recession hitting a strong economy may not be very perceptible.
National and international events are primarily responsible for the change in
the Pierce County economy. Local conditions will keep the downturn from becoming
more sever.

Most of the new jobs and employment opportunities will come from small to medium
sized manufacturing plants or from the service sector located in the metro areas
of Pierce County. The dollar volume of retail sales was expected to grow by 7.5%
in 1998. Each quarter in 1999 will have dollar sales activity expected to exceed
the 1998 level. 1999 may see a record $4.1 billion in total retail sales.

                                      -28-
<PAGE>   33

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued

The pace of sales activity for single-family housing is expected to moderate,
but remain strong, into the first half of 1999. However, the fourth quarter of
1999 is expected to decline a moderate 1% from the same time in 1998.

The growth of real personal income is expected to be 2.7% in 1998, and it is
expected to slow further in 1999. When inflation is included, nominal income
growth will be 4-5%. By the end of 1999, per capita income is expected to reach
a record high of $20,440, measure in 1992 constant dollars.

Although the Corporation expects to be successful in competing with the
abundance of financing sources, which may, or may not, have regulatory
constraints, management continues to be cautiously optimistic regarding the
level of future business opportunities for the Corporation.

FINANCIAL REVIEW/BALANCE SHEET

The Corporation manages its balance sheet to meet the needs of its business
strategy, which adapts to the changing economic environment, along with business
and competitive factors.

Based on the balances at year-end 1998, assets increased $174.8 million, or
18.0%; increased $98.1 million or 11.2% in 1997; and increased $78.2 million, or
8.9% in 1996. Average earning assets as a percent of total average assets (see
page 42), were $994.7 million or 94.9% in 1998; 95.1% or $870.7 million in 1997;
and 95.5%, or $781.5 million in 1996. Local economic conditions and the merger
with Valley Bancorporation was the largest factor contributing to the growth in
earning assets from 1994 through 1997.

Total loans increased $161.2 million, or 21.9% in 1998; $79.3 million, or 12.1%
in 1997; and $105.6 million or 19.1% in 1996. In 1998 the investment portfolio
increased $29.1 million or 25%, reversing the trend over the last five years.
This was due mainly to management taking advantage of the medium-term,
short-call yields available in 1998. Most of the securities purchased during
this time had three to six month call dates with yields to the call in excess of
6.00%. In 1997, the investment portfolio decreased $16.1 million, or 12.2%. In
1996 decreased $14.3 million or 9.8%. The reason for the decline in 1997 was to
shift funds from maturing investments into the loan portfolio. In 1998 federal
funds sold decreased $26.2 million or 36.4% due to the substantial increase in
the loan portfolio for the year, and increase in the investment portfolio
activity. In 1997, federal funds sold had increased $38.8 million or 117.2% due
to the unattractive intermediate to long-term rates on investments, and less
than expected loan demand. However, 1997 was a year of an exceptional number of
early calls for redemption of investments which contributed substantially to the
increase in federal funds sold for that period.

The primary source of funds for earning assets are deposits and borrowings.
Total deposits were up $116.3 million, or 14.4% in 1998; $78.0 million, or 10.6%
in 1997; and up $38.1 million, or 5.5% in 1996. At periods ended December 31,
1998, Money Market and NOW accounts were up $17.2 million, or 14.4% in 1998; up
$24.8 million, or 26.1% in 1997; and up $14.5 million, or 18% in 1996. Savings
deposits were up $18.6 million, or 11.2% in 1998; up $8.1 million, or 5.1% in
1997; and up $4.9 million, or 3.2% in 1996. The category which had the largest
deposit increase for 1998 and 1996 was time deposits, which increased $52.3
million in 1998 or 12.9%; increased $19.5 million, or 5.1% in 1997; and $18.9
million or 5.2% in 1996. A slowing of the growth in deposits in 1997 and 1996,
(as compared to the growth of loans) was planned by management, due to the
slower growth in 1995 of the loan portfolio.



                                      -29-
<PAGE>   34

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued

NET INTEREST INCOME

Net interest income is the Corporation's principal source of revenue and is
comprised of interest income on earning assets, less interest expense on
interest bearing liabilities. The net interest margin is net interest income
expressed as a percent of average earning assets and represents the difference
between the yield on earning assets and the composite interest rate paid on all
sources of funds.

Net interest income is adjusted to a taxable equivalent basis to present income
earned on taxable and tax-exempt assets on a comparable basis. References to net
interest income and net interest margin in this discussion represent taxable
equivalent amounts using a tax rate of 35%, and applies to loans and investments
only.

The asset yields and cost of funds for the Corporation during the last three
years do reflect the level of interest rates as set by the Federal Reserve
Board, but more so the competitive nature of the financial services industry.
For the year 1998, the average yield on earning assets decreased 18 basis
points, and the average cost of interest bearing liabilities decreased 10 basis
points, for a net decrease in the spread of minus 8 basis points. For the year
1997, the average yield on earning assets increased 8 basis points and the
average cost of interest bearing liabilities decreased 10 basis points, for a
net increase in the spread of 18 basis points. For the year 1996, the average
yield on earning assets dropped 11 basis points and the average cost of interest
bearing liabilities dropped 20 basis points. In 1998, management expected a
decrease in the spread due to the prime rate decreases during the year and
increased rate competition from regulated and non-regulated lenders. The major
decrease in earning assets came from the loan portfolio which declined from a
yield of 10.37% in 1997 to a 10.17% yield in 1998. On the deposit side, time
deposits led the way decreasing from a 5.80% yield in 1997, to a 5.72% yield in
1998. In 1997, increased yield on assets was due to an increase in the yield of
the investment portfolio of 10 basis points, increasing from 7.17% in 1996 to
7.27% in 1997. Additionally, the yield on federal funds sold increased from
5.38% to 5.48%, and the yield on total loans remained the same at 10.37%. The
decrease in the cost of funds was due to a decrease in interest bearing deposits
of 10 basis points, decreasing from 4.99% to 4.89% (refer to page 42 for further
detail.) In 1996, rates leveled out and were subject to liquidity adjustments
and competitive factors. The net yield on interest earning assets was 5.69% in
1998, 5.73% in 1997 and 5.49% in 1996. (See "Liquidity and Interest Sensitivity"
in this section.) As noted on page 43 of this report, it was the growth, or
volume, which contributed to the increased net interest earnings of the
Corporation for all three years. The following is a more detailed discussion of
the factors comprising net interest income.

Net interest income is impacted primarily by changes in the volume and mix of
earning assets and funding sources, market rates and asset quality. Tables 1 and
2 of this report present an analysis of the changes in net interest income.
Table 1 (Average Balances) indicates the changes in the average balance of
accounts, and Table 2 (Rate/Volume Analysis) indicates the causes of the changes
in net interest income; whether by changes in the average balance (Volume) or
changes in interest (Rate).

Table 1 indicates that net interest income totaled $56.6 million in 1998 an
increase of $6.7 million, or 13.3% from 1997. In 1997 net interest income
totaled $49.9 million, and increase of $7.0 million, or 16.3% over 1996. In 1996
net interest income totaled $42.9 million, an increase of $4.5 million, or 11.7%
over 1995. Table 2 indicates that of the $6.7 million increase in net interest
income in 1998; there was an increase in interest income of $10.2 million and an
increase in interest expense of $3.5 million which leaves a net increase in net
interest income of $6.7 million. In 1997 there was a $7.0 million increase in
net interest income. There was an increase in interest income of $9.3 million
and an increase in interest expense of $2.3 million, which leaves a net increase
in net interest income of $7.0 million. In 1996 there was a $4.5 million
increase in net interest income. There was an increase in interest income of
$5.5 million and an increase in interest expense of $1.0 million, which left a
net increase in net interest income of $4.5 million.



                                      -30-
<PAGE>   35

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


LOAN PORTFOLIO

Average loans grew $108.6 million, or 15.4% in 1998; $95.1 million, or 15.6% in
1997; and $76.9 million, or 14.5% in 1996. In 1998, average real estate
commercial had the largest dollar growth by increasing $51.3 million, or 18.1%.
This is followed by commercial loans increasing $41.5 million, or 27.9%. In
1997, average real estate commercial loans again had the largest dollar growth
by increasing $56.6 million, or 25%. Real estate construction loans, had the
second largest dollar and percent growth increase of $24.3 million, or 21.4%. In
1996, real estate commercial loans had the largest dollar growth by increasing
$51.4 million, or 29.4%. This was followed by real estate construction loans,
which increased by $18 million, or 18.7%.

The average yield on loans in 1998 slipped to 10.17% from 10.37% the year
before. During 1998, the Corporation decreased its base lending rate three times
from 8.50% at the beginning of the year to 7.75% at year-end. Variable rate
loans make up approximately 30% of the Corporation's loan portfolio. While
one-third of the loan portfolio will adjust immediately to a move in the prime
rate, it takes several months to adjust the deposit side of the balance sheet,
which may never fully adjust to rate decreases due to competitive factors. Along
with base rate decreases, 1998 was a year which saw intensified rate competition
from regulated and non-regulated lenders. At times, the Corporation did not step
up to meet the competition due to safety and soundness reasons, and lost
business. Nonetheless, the Corporation had a record year of loan growth. In
1997, the yield on total loans dropped 1 basis point to 10.37%, from a 1996
average of 10.38%. Although the Corporation raised the prime rate in March of
1997, this was offset by competitive pressures on rates during the year. The
yield on loans eased in 1996, dropping from a 1995 average of 10.73% to 10.38%.
At year-end 1996, 74% of the portfolio was fixed rate and 26% was variable rate.
While it would be desirable to have more variable rate loans if general interest
rates were to increase, it should be recognized that many of the fixed rate
loans are real estate construction loans that have short (less than one year)
maturities. For more information on repricing of assets and liabilities, please
see the section "Interest Rate Risk" later in this report.

Interest and fee income from loans increased $9.5 million, or 13.1% in 1998;
$9.8 million, or 15.6% in 1997; and $6.1 million, or 10.8% in 1996. The earnings
on the $108.6 million increase in the 1998 average balance of loans, resulted in
increased income of $11.2 million, and a decline in rates decreased income $1.6
million. The earnings on the $95.1 million increase in the 1997 average balance
of loans resulted in increased income of $9.9 million, and a decline in rates
was insignificant. The earnings on the $76.9 million increase in the 1996
average balance of loans, resulted in increased income of $8.3 million, while a
decrease in interest rates decreased interest income by $2.2 million.

The Bank has a VISA card department which began operations in 1993. At year-end
1998, the department had $12.7 million in credit lines and $2.3 million in
outstanding balances. At year-end 1997, the department had $7.2 million in
credit lines and outstanding balances of $1.6 million. At year-end 1996, the
department had $5.6 million in credit lines, and $1.2 million in active
balances. The Bank also provides debit cards to customers, and had fifteen ATM's
at year-end 1998.

LOAN LOSS PROVISION

The provision for loan losses decreased $295 thousand in 1998, or 14.1%;
decreased $38 thousand, or 1.8% in 1997 and decreased $512 thousand, or 31.6% in
1996. The Corporation has had excellent loan quality over the last several
years, and excellent recoveries as well. For those reasons, the provision has
declined over the years, while a strong, total allowance has been maintained.



                                      -31-
<PAGE>   36

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


The allowance for loan losses was 2.01% of total loans in 1998; 2.15% of total
loans in 1997 and 2.13% of total loans in 1996. This ratio changes when 1) loans
are charged-off to the reserve; 2) a provision is charged to expense and added
to the reserve; 3) when prior loans charged-off are recovered, or 4) when total
loans increase or decrease. At year-end 1998, 1997, and 1996, management
considered the reserve to be adequate. Please refer to Note 4, page 13 of this
report for details regarding changes in the level of the allowance.

The allowance for loan losses as a percent of impaired loans was 769% in 1998,
275% in 1997, and 335% for year-end 1996. Management evaluates the adequacy of
the allowance for loan losses based upon a number of factors and estimates its
allowance for loan losses in relation to the entire portfolio's estimated losses
over the life of the portfolio. Accordingly, the ratio of the allowance for loan
losses to impaired loans may vary greatly because the timing of certain events
described in the previous paragraph cannot be controlled. General conditions
leading to management's decision to increase the allowance include concerns
about the Northwest's economic environment, regional trends, and adverse effect
of changes in government regulation and taxation.

INVESTMENTS

Total interest income from investments, including federal funds sold, increased
$686 thousand in 1998, or 6.6%; decreased $459 thousand in 1997, or 4.2%; and
decreased $19 thousand in 1996, or .1%. The decrease of $15.5 million in the
average balance of investments in 1998 decreased income by $772 thousand, and a
decrease in yield decreased income by $193 thousand . In 1997 the decrease in
average balances of $5.9 million, decreased interest income by $603 thousand,
while an increase in rates increased interest income by $92 thousand. The
decrease in average balances of $11.3 million in 1996, decreased income by $713
thousand, while and increase in rates increased interest income by $57 thousand.

There were no realized losses in securities during the last three years.

INTEREST EXPENSE

Total interest and borrowing expense for 1998 increased $3.5 million, or 10.2%;
increased $2.3 million, or 7.2% in 1997 and increased $53 thousand, or 3.1% in
1996. The increase of $87.6 million in the average balances of interest bearing
liabilities in 1998, increased interest expense $4.2 million, while a decrease
in the cost of funds lowered interest expense by $712 thousand. In 1997, the
increase of $60.0 million in the average balances of interest bearing
liabilities, contributed $2.8 million to interest expense, while decreased
interest rates reduced interest expense by $.5 million. In 1996, the increase of
$43.9 million in the 1996 average balance of interest bearing liabilities
contributed $2.7 million to expense, while declining interest rates decreased
interest expense by $1.7 million.

In 1998, the increases in the average balances of interest bearing core deposits
increased interest expense by $3.5 million, and decreased interest rates reduced
interest expense by $663 thousand. Increases in the average balances of short
and long-term debt increased interest expense $709 thousand, while dropping
rates reduced interest expense by $49 thousand. In 1997, increases in the
average balance of interest bearing core deposits (Money Market, NOW and savings
accounts) increased interest expense by $2.4 million, and a decrease in rates
reduced interest expense by $.5 million. Increases in the balances of short-term
and long-term debt increased interest expense by $378 thousand, and a net
reduction in the rates of two categories decreased interest expense by $5
thousand. In 1996, increases in the average balance of interest bearing deposits
increased interest expense by $2.0 million, while declining interest rates
decreased interest expense by $1.6 million. Increased balances of short-term
borrowings and long-term debt increased interest expense by $653 thousand, and
decreasing interest rates decreased interest expense by $126 thousand.



                                      -32-
<PAGE>   37

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


OTHER NONINTEREST INCOME

Noninterest income totaled $5.3 million in 1998, up $1 million from 1997, or
22.1%; totaled $4.4 million in 1997, up $203 thousand, or 4.9% and totaled $4.2
million, up $234 thousand, or 6.0% in 1996. In 1998, service charges increased
$43 thousand, or 2.2%; increased $110 thousand, or 5.6%; and decreased $4
thousand, or .2% in 1996. Deposits have grown at a substantially higher rate
than service charges. Management estimates that more customers are maintaining
higher balances to avoid service charges. The number of accounts susceptible to
service charges increased by 1,172, or 5.8% in 1998; increased by 2,248, or
12.5% in 1997; and increased by 532, or 3.0% in 1996.

Other income increased $.9 million in 1998, or 38.2%; increased $93 thousand in
1997, or 4.0%; and decreased $158 thousand in 1996, or 6.8%. The increase in
1998 was due to several factors. Trust department income was up $144 thousand,
or 17.2%; insurance and financial services income was up $38 thousand, or 10.1%;
broker loan fees were up $113 thousand, or 35.6%; and loan servicing fee income
was up $227 thousand. Gain on other real estate owned sold for 1998 was $232
thousand. The increase in 1997 was also due to several factors, but the majority
of the increase was due to an increase in insurance and financial service fees
of $124 thousand, or 81.6%; and an increase in trust department fees of $122
thousand, or 17.0%. Partially offsetting these increases was a decline in gain
on sale of other real estate owned to $195 thousand in 1997 from $346 thousand
in 1996 or a 43.6% decline. The increase in 1996 was due to an increase in trust
department fees of $151 thousand and an increase of $314 thousand on gain on
sale of other real estate owned. In 1996, insurance and financial service fees
decreased $103 thousand, or 40.4% for the year. Broker loan fees, (secondary
market loan origination fees) decreased $119 thousand.

As previously stated, trust department income increased $144 thousand, or 17.2%
in 1998; increased $122 thousand, or 17.0% in 1997 and $151 thousand, or 26.7%
in 1996. The market value of trust assets managed at year-end 1998 was $158.8
million, up $15.6 million, or 10.9%; was $143.2 million, up $23.7 million, or
19.8% in 1997. In 1996 assets increased to $119.5 million, up $12.6 million, or
11.8%.

OTHER NONINTEREST EXPENSE

Total noninterest expenses increased $3.2 million, or 13.4% to $26.7 million in
1998; increased $3.3 million, or 16.2% to $23.5 million in 1997 and increased
$813 thousand to $20.3 million, or 4.2% in 1996.

Salary and employee benefits increased $1.7 million, or 11.8% in 1998; increased
$1.8 million, or 14.7% in 1997 and increased $1.2 million, or 11% in 1996. The
increase in salaries, only, for 1998 was $1.5 million, or 15.2%; 1997 was $1.3
million, up 14.9%; and in 1996 was up $.8 million, or 10.3% over 1995. The
increase in 1998 was due to an increase in staff of 5.6%, and the remaining
increase was due to increases in bonuses and merit raises. The increase in 1997
was attributable to an increase in staff of 9.0%, and the remainder is
attributable to merit raises. In 1996 the increase was attributable to an
increase in staff of 4.4%, and the remainder is attributable to merit raises.

Employee benefits increased $140 thousand, or 3.4% in 1998; increased $512
thousand, or 14.2% in 1997 and increased $405 thousand or 12.7% in 1996. The
increase in 1998 was due to an increase in medical insurance premium of $66
thousand, and an increase in the vacation reserve of $47 thousand. In 1997, the
increase was due to an increase in the profit sharing contributions of $195
thousand, or 10.6%. An increase of 6% is attributable to the increase in staff
in 1997, and increased medical premiums of $102 thousand, or 21.8%. In 1996 this
increase is due, for the most part, to an increase in the profit sharing
contributions of $270 thousand.



                                      -33-
<PAGE>   38

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


Occupancy expense was up $54 thousand in 1998, or 1.7%; up $515 thousand, or
18.8% in 1997 and down $49 thousand or 1.8% in 1996. In 1998, 44% of occupancy
expense was depreciation, which increased $219 thousand, or 17.9%. The remaining
expenses decreased $165 thousand. In 1997, 38% of occupancy expense was
depreciation, which increased $174 thousand, or 16.6%. The remainder of the
increase in 1997 was due to increased building, furniture and equipment expense
of $341thousand. In 1996, 38% of occupancy expense was depreciation. The
remainder of the increase in 1996 was due to an increase in building, furniture
and equipment expense.

Other expense increased $1.2 million in 1998, or 23.9%. Most of the increase is
comprised in four areas. Legal fees increased $395 thousand, or 395% in 1998.
This was almost all due to the merger with Valley Bancorporation. Additionally,
consulting fees of $180 thousand were due to the merger. Also, goodwill
amortization increased $51 thousand and account services fees paid increased $84
thousand. Other expense increased $794 thousand, or 18.7% in 1997. Most of this
increase was attributable to four areas. Marketing expenses increased $94
thousand, or 26.1%, due to product promotions; foreclosure expenses increased
$227 thousand, much of which was due to prior period foreclosures, and self
insurance reserves increased $234 thousand, or 354.5%. Other expenses increased
$344 thousand in 1996, or 8.8%. FDIC insurance premiums dropped to $23 thousand
in 1996, compared with premiums of $692 thousand paid in 1995 and legal expenses
increased $49 thousand, or 158.1%. ATM card expenses increased $14 thousand, or
40% and foreclosure expenses increased $70 thousand.

Many banks and bank holding companies use a computation called the "efficiency
ratio" to measure overhead costs. This ratio is then compared to others in the
industry. The ratio is arrived at by dividing total other noninterest expense by
the sum of net interest income, on a tax equivalent basis, and other noninterest
income, minus non-recurring gains or losses. The lower the number, the more
efficient the organization. The Corporation's efficiency ratio for 1998 was
43.3%, 43.5% for 1997, and 43.3% for 1996. The Corporation's ratio is considered
excellent for the industry.

ASSET AND LIABILITY MANAGEMENT

Assets and liabilities are managed to maximize long-term shareowner returns by
optimizing net interest income within the constraints of maintaining high credit
quality, conservative interest rate risk policies and prudent levels of leverage
and liquidity. The Asset and Liability Committee meets monthly to monitor the
composition of the balance sheet, to assess and project interest rate trends and
to formulate strategies consistent with established objectives for liquidity,
interest rate risk and capital adequacy.

LIQUIDITY

The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for profitable business expansion. Cash flows from operations
contribute significantly. As indicated on page 6 of this report, net income for
1998 contributed $21.6 million to liquidity and in 1997 contributed $18.6
million to liquidity, and $16.0 million to liquidity in 1996. Borrowing
represents an important and manageable source of liquidity based on the
Corporation's ability to raise new funds and renew maturing liabilities in a
variety of markets. Liquidity is also obtained by maintaining assets that are
readily convertible to cash at minimal cost through maturities and sales.




                                      -34-
<PAGE>   39

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


Deposits generated through the Corporation's branch network is the most
important source of liquidity. In 1998, core deposits (Money Market, NOW and
savings accounts) funded $64.4 million of the $158.9 million growth in loans.
Contributing to that growth in loans were cd's which funded $52.3 million.
Federal funds purchased and securities sold under agreements to repurchase also
made a contribution to loan growth of $13.9 million, and FHLB advances
contributed $20.2 million. Other funding for loan growth, and net investment
purchases of $27.1 million, came from Federal funds sold and net profit. In
1997, core deposits funded $47.1 million of the $79.8 million growth in loans.
Contributing to that growth in loans were cd's which funded $16.6 million.
Federal funds sold also made a contribution to loan growth of $35.8 million.
Some of the proceeds from maturing investments funded the growth in loans during
the year. In 1996, core deposits funded $24.8 million of the growth in assets
and net borrowings FHLB funded $20.0 million of the growth. Additional funds of
$13.6 million came from cd's, and $4.4 million came from federal funds purchased
and securities sold under agreements to repurchase. In 1996, maturing securities
totaled $42.7 million and represent a highly accessible source of liquidity. Net
maturities provided $14.9 million in liquidity, with $27.8 million of the total
$42.7 million in maturities being reinvested in the portfolio.

Over the last three years, the financing of investment activities has changed
from mainly cd's to core deposits. In years going forward, core deposits and
FHLB borrowings will become more important in the financing process.

In addition to deposit acquisition and borrowings as a source of liquidity,
maturing loans and investments with maturities of less than one year and
overnight federal funds purchased are considered to be available for liquidity
needs.

The charts below indicate the maturity schedule for earning assets as of
December 31, 1998 and 1997:

MATURITY SCHEDULE FOR EARNING ASSETS
(AMORTIZED COST USED FOR INVESTMENT)


<TABLE>
<CAPTION>
                                                                                                                       Percent
In Thousands                                                                           Total             Total         of Total
                              0-1                1-5                After            Carrying             Fair          Fair
December 31, 1998             Year              Years              5 Years             Cost              Value          Value
                           ----------         ----------         ----------         ----------         ----------      --------
<S>                        <C>                <C>                <C>                <C>                <C>             <C>  
Investments                $   20,453         $   27,141         $   97,045         $  144,639         $  147,224       13.5%

Loans                         334,482            456,797            106,863            898,142            898,441       82.3%

Federal Funds sold             45,712                  -                  -             45,712             45,712        4.2%
                           ----------         ----------         ----------         ----------         ----------      ----- 

       Total               $  400,647         $  483,938         $  203,908         $1,088,493         $1,091,377      100.0%
                           ==========         ==========         ==========         ==========         ==========      ===== 
</TABLE>

<TABLE>
<CAPTION>
                                                                                                                Percent
In Thousands                                                                    Total           Total           of Total
                              0-1             1-5             After           Carrying          Fair              Fair
December 31, 1997            Year            Years           5 Years            Cost            Value            Value
                           --------         --------         --------         --------         --------         --------
<S>                        <C>              <C>              <C>              <C>              <C>               <C>  
Investments                $ 25,187         $ 16,029         $ 74,086         $115,302         $117,510          12.9%

Loans                       284,510          407,872           30,087          736,946          729,390          80.3%

Federal Funds sold           71,885                -                -           71,885           71,885           6.8%
                           --------         --------         --------         --------         --------         ----- 

       Total               $381,582         $423,901         $104,173         $924,133         $918,785         100.0%
                           ========         ========         ========         ========         ========         ===== 
</TABLE>



                                      -35-
<PAGE>   40

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


As indicated in the chart, in 1998, $400.6 million or 36.8% of aggregate assets
were available for liquidity at year-end. In 1997 $381.6 million, or 41.3% in
aggregate assets were available for liquidity at year-end. The Corporation also
has other sources of liquidity not indicated above. For example, at year-end
1998, the bank has a pre-approved credit line up to $172 million from Seattle
FHLB. However, assets must be pledged to secure these borrowings. Currently
borrowings are $50.2 million. AFS securities totaling $111.7 million could be
sold for liquidity purposes. The Corporation could also issue cd's to public
entities exceeding $95 million more than currently issued. Additionally,
participation in the treasury department's short-term note program is available
along with potential borrowings form the Federal Reserve Bank of San Francisco
and other correspondent banks.

INTEREST RATE RISK

Interest rate risk refers to the exposure of earnings and capital arising from
changes in interest rates. Management's objectives are to control interest rate
risk and to ensure predictable and consistent growth of earnings and capital.
Interest rate risk management focuses on fluctuations in net interest income
identified through computer simulations to evaluate volatility varying interest
rate, spread and volume assumptions. The risk is quantified and compared against
tolerance levels.

The simulation model used by the Corporation combines the significant factors
that affect interest rate sensitivity into a comprehensive earnings simulation.
Earning assets and interest-bearing liabilities with longer lives may be subject
to more volatility than those with shorter lives. The model accounts for these
differences in its simulations. At December 31, 1998, the simulation modeled the
impact of assumptions that interest rates would increase or decrease 200 basis
points. Results indicated the Corporation was positioned so equity would not
drop below that point where the Corporation, for regulatory purposes, would
continue to be classified "well capitalized". It should be emphasized that the
model is static in nature and does not take into consideration possible
management actions to minimize the impact on equity. Management also matches
assets and liabilities on a static "gap" report monthly to assist in interest
rate sensitivity measurement.

Interest rate sensitivity is closely related to liquidity because each is
directly affected by the maturity of assets and liabilities. Management
considers any asset or liability which matures, or is subject to repricing over
one year, to be interest sensitive, although continual monitoring is also
performed for other time intervals. The difference between interest-sensitive
assets and liabilities for a defined period of time is known as the
interest-sensitive "gap" and may be either positive or negative. If positive,
more assets reprice before liabilities; if negative, the reverse is true. In
theory, if the gap is positive, a decrease in general interest rates might have
an adverse impact on earnings as interest income decreases faster than interest
expense. This assumes that management adjusts rates equally as general interest
rates fall. Conversely, an increase in interest rates would increase net
interest income as interest income increases faster than interest expense.
However, the exact impact of the gap on future income is uncertain both in
timing and amount because interest rates for the Corporation's assets and
liabilities can change rapidly as a result of market conditions and customer
patterns.

MANAGEMENT DOES NOT USE INTEREST RATE RISK MANAGEMENT PRODUCTS SUCH AS INTEREST
RATE SWAPS, HEDGES, OR DERIVATIVES, NOR DOES MANAGEMENT INTEND TO USE SUCH
PRODUCTS IN THE FUTURE.

The simulation model process provides a dynamic assessment of interest rate
sensitivity, whereas a static interest rate gap table is compiled as of a point
in time. The model simulations differ from a traditional gap analysis because a
traditional gap analysis does not reflect the multiple effects of interest rate
movement on the entire range of assets, liabilities and ignores the future
impact of new business strategies.



                                      -36-
<PAGE>   41

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


The table on the next page gives yet another picture of the assets and
liabilities of the Corporation. The table sets forth the balances of the
Corporation's instruments at the expected maturity dates, as well as the fair
value of those financial instruments as of December 31, 1998. The expected
maturities do not take into consideration contractual principal payments for
loans and securities, or when an asset or liability is susceptible to repricing
as interest rates increase or decrease.

In the table on the next page the expected maturities for financial liabilities
with no stated maturity, reflect assumptions based on historical run-off rate.
The run-off rates for noninterest bearing deposits is 6.4% per year; for NOW and
money market accounts is 7.6% per year; and for savings accounts is 9.1% per
year. The weighted average interest rates for financial instruments presented
are actual for 1998, and are shown on page 42 of this report. Please refer to
Note 17 on page 23 of this report for details regarding estimated fair value
amounts.


                                      -37-

<PAGE>   42

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


The Corporation's interest rate sensitive positions at December 31, 1998 and
1997 are shown in the following tables:

<TABLE>
<CAPTION>
                                                          Expected Maturity Date
                                                          ----------------------                                          Fair
In Thousands                              1999         2000        2001        2002       2003    Thereafter    Total     Value
------------                              ----         ----        ----        ----       ----    ----------    -----     -----
<S>                                     <C>           <C>          <C>       <C>        <C>        <C>        <C>        <C>
FINANCIAL ASSETS
Cash and cash equivalents
        Noninterest bearing             $ 44,233            -            -          -          -          -   $ 44,233   $ 44,233
Federal funds sold
        Variable rate                     45,712            -            -          -          -          -     45,712     45,712
        Weighted average interest rate      5.51%                                                                 5.51%
Securities available for sale
        Fixed Rate                        14,503      $ 3,395      $ 2,979   $  3,807   $ 13,470   $ 74,553    112,707    112,707
        Weighted average interest rate      6.43%        8.33%        8.31%      7.04%      6.60%      7.43%      7.24%
Securities held to maturity
        Fixed Rate                         5,100          155          257      1,018      2,309     24,055     32,894     34,517
        Weighted average interest rate      5.21%        6.15%        6.28%      6.64%      5.91%      5.44%      5.48%
Loans Receivable, net
        Fixed Rate                       124,740       46,936       97,443    104,265    155,487     77,708    606,579    606,794
        Weighted average interest rate      9.00%        9.10%        9.16%      9.24%      8.72%      8.08%      8.88%
        Variable rate                    209,606       23,930        5,391      7,371     16,388     28,864    291,550    291,647
        Weighted average interest rate      9.06%        9.09%        9.28%      8.85%      8.80%      8.43%      8.98%

FINANCIAL LIABILITIES
Noninterest bearing deposits               9,560        8,948        8,375      7,839      7,338    105,921    147,981    147,981
NOW and Money Market accounts             10,412        9,621        8,890      8,214      7,590     92,273    137,000    137,000
        Weighted average interest rate      3.28%        3.28%        3.28%      3.28%      3.28%      3.28%      3.28%
Savings accounts                          16,564       15,239       13,852     12,592     11,446    114,533    184,226    184,226
        Weighted average interest rate      3.69%        3.69%        3.69%      3.69%      3.69%      3.69%      3.69%
Time Certificates
        Fixed Rate                       351,260       28,618       17,433      6,772     13,074      1,717    418,874    421,947
        Weighted average interest rate      5.40%        6.05%        5.73%      5.84%      5.74%      5.71%      5.48%
        Variable rate                     31,580        6,980            -          -          -          -     38,560     38,843
        Weighted average interest rate      5.42%        5.60%                                                    5.45%
Federal funds purchased
        Variable rate                      5,524            -            -          -          -          -      5,524      5,524
        Weighted average interest rate      4.39%                                                                 4.39%
Securities sold under agreement
        to repurchase
        Variable rate                     26,334            -            -          -          -          -     26,334     26,334
        Weighted average interest rate      4.39%                                                                 4.39%  
FHLB advances
        Fixed Rate                         5,000            -        5,028     25,000          -     15,186     50,214     49,641
        Weighted Average interest rate      5.40%                     5.81%      5.81%                 5.09%      5.24%
</TABLE>


                                      -38-
<PAGE>   43

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


CAPITAL

Consolidated capital of the Corporation for financial statement purposes,
increased $21.9 million or 20.4% in 1998 to $129.2 million, increased $19.0
million in 1997, or 21.5% to $107.4 million, and increased $16.2 million in 1996
or 22.4% to $88.4 million. In 1998, $356 thousand of increase came from the
issuance of stock under the Corporation's stock option plan. Almost all of the
remainder came from the net earnings of the Bank. In 1997, almost all of the
increase was attributable to its net income of the Bank. In 1996, $1 million of
the increase was attributable to the investment in Washington Banking Company; a
decrease of $.7 million was attributable to the change in fair market value of
the AFS portfolio, and the remainder was almost all due to net profits to the
Bank.

MARKET FOR FRONTIER FINANCIAL CORPORATION'S COMMON STOCK
AND RELATED SHAREOWNERS' MATTERS

Frontier Financial Corporation's common stock began trading on the National
Association of Securities Dealers' Automated Quotation System (NASDAQ) on April
16, 1998. In 1998, based on the average number of shares outstanding for the
year, stock trades totaled approximately 7% (including the shares issued
pursuant to the merger with Valley Bancorporation. During 1998, the market price
of the common stock ranged from $34.00 to $62.50. The average price, on NASDAQ
trading, was $50.57 for the year.

At December 31, 1998, the total number of shareowners of record of Frontier
Financial Corporation's common stock was 3,617, and there were 8,697,261 shares
outstanding.

Management has established an objective to maximize the rate of internal capital
growth as the means of maintaining capital adequacy. The Corporation has not
paid cash dividends in the past. However, in February 1999, the Board of
Directors of the Corporation declared the first cash dividend since the Bank
opened in 1978 and has had five stock splits over the same period. Annually, the
Board of Directors reviews various methods to distribute the earnings of the
Corporation to the shareowners.

IMPACT OF THE YEAR 2000 ISSUE

The Year 2000. The century date change creates a problem because computer
programs and systems were designed to store calendar years with only two
numbers, rather than four numbers. Because of this design, computer programs and
systems may recognize a date using "00" as 1900 rather than the Year 2000. The
extent of the potential impact of this Year 2000 problem is not yet known and
could affect the global economy and every organization.

Only one thing is certain about the impact of the Year 2000--it is difficult to
predict with any degree of certainty what will happen after December 31, 1999.
The Corporation is committed to address and is addressing these Year 2000 issues
and the uncertainty that is presented by these Year 2000 issues. The total
financial effect that the Year 2000 problem will have on the Corporation is
uncertain and will not be known until the year 2000 arrives. The Corporation is
working to mitigate the Year 2000 problem, the success of Corporation's efforts
will not be known until the year 2000 arrives. The Corporation's Year 2000
progress and efforts continue to be monitored by the banking regulatory
agencies.

The challenges faced by the Corporation. The Year 2000 problem is of particular
concern to the Corporation and other financial institutions because most
financial transactions, such as interest accruals and payments, are date
sensitive. The Year 2000 problem will impact both information technology ("IT")
systems, such as computers, and non-IT systems. Non-IT systems typically include
embedded technology such as microcontrollers, and include automated teller
machines, elevators, alarm systems, and vaults. Non-IT systems are more
difficult to assess and repair than IT systems.



                                      -39-
<PAGE>   44

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


The Corporation's state of readiness. The Corporation established a Year 2000
Committee in February 1997 with representatives from all significant functional
areas which report to the Corporation's Board of Directors. Detailed inventories
for all IT systems and all identified non-IT systems have been conducted to
catalog potential hardware and software problems. The Corporation has identified
certain systems as business-critical systems and testing of those
business-critical systems has commenced. The Corporation has identified the end
of April, 1999 as the projected deadline to complete the Year 2000 testing on
business-critical systems. Additional testing will continue during the year
1999. The Corporation has determined that modifications to certain systems are
required and that such modifications will be conducted to mitigate, but not
eliminate, the risks associated with the Year 2000 problem.

Third party concerns. The Corporation interacts with numerous customers, vendors
and third party service providers whose failure to address the Year 2000 problem
may create significant business disruption and costs to the Corporation. Due to
the interdependence of computer systems today, it is simply impossible for any
one party to eliminate the risks related to the Year 2000 problem. It is even
possible that the Year 2000 problem could disrupt the Corporation's business
through the loss of electric power or phone service, or for other reasons
outside of the Corporation's control. The Corporation has initiated formal
communications with certain significant suppliers and large customers to attempt
to determine the extent to which the Corporation is vulnerable to those third
parties' failure to remediate their own Year 2000 issues. Systems of other
companies on which Corporation's systems rely may not be timely converted, which
might well result in significant costs to the Corporation.

The Corporation is in the process of assessing the incremental credit risk in
loan portfolio relating to individual customers' ability to successfully address
Year 2000 IT and non-IT issues. For those over an established dollar threshold,
credit risk assessments are being performed on each borrower. This process will
be ongoing until the Year 2000.

The Corporation's contingency plans. The Year 2000 Committee is in the process
of developing and implementing contingency plans to handle the most reasonably
likely worst case scenarios. Since these worst case scenarios are difficult or
even impossible to predict at this time, these contingency plans are
particularly challenging. The Corporation intends to develop contingency plans
that are reasonably necessary to address the Year 2000 problem and to revise
those contingency plans on an ongoing basis until the problem is confronted and
resolved.

Estimated costs. It is impossible to predict with any degree of certainty the
costs that the Corporation will incur as a result of the Year 2000 problem. The
Corporation's current estimates for the total Year 2000 testing and remediation
is roughly $550,000, which will be funded through cash flows of operations. The
Corporation has reserved approximately $400,000 addressing the Year 2000
problem. The future financial estimates are just rough estimates, as these are
"forward-looking" statements subject to risks and uncertainties that may cause
future results to differ materially. It is uncertain to what extent the actual
costs of the Year 2000 problem will have on the Corporation's results of
operations, liquidity, and financial condition. Actual lost revenue resulting
from the Year 2000 problem is impossible to predict because of the inherent
uncertainty of the Year 2000 problem. The Corporation, through its Year 2000
Committee, is analyzing and determining how to best handle and mitigate this
uncertainty. The Corporation presently believes that costs associated with
compliance efforts will not have a significant impact on the Corporation's
ongoing operations or financial condition, although there can be no assurance in
this regard. There can be no assurance that there will not be a delay in, or
increased costs associated with, the implementation of the necessary changes to
address the Year 2000 problem, the Corporation's inability to implement such
changes could have an adverse effect on future results of operations. In
addition, the failure of certain Corporation's customers, vendors and third
party service providers to appropriately address the Year 2000 problem could
have a material adverse effect on the Corporation.



                                      -40-
<PAGE>   45

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued


FORWARD LOOKING STATEMENTS

Except for historical financial information contained herein, the matters
discussed in this annual report of the Corporation may be considered
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1993, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended and subject to the safe harbor created by the Securities Litigation
Reform Act of 1995. Forward-looking statements are subject to risks and
uncertainties that may cause actual future results to differ materially. Such
risks and uncertainties with respect to Frontier Financial Corporation include
those related to the economic environment, particularly in the areas in which
Frontier operates, competitive products and pricing, fiscal and monetary
policies of the U.S. government, changes in governmental regulations affecting
financial institutions, including regulatory fees and capital requirements,
changes in prevailing interest rates, acquisitions and the integration of
acquired businesses, credit risk management and asset/liability management, the
financial and securities markets, and the availability of and costs associated
with sources of liquidity.



                                      -41-
<PAGE>   46


FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES Average Balances and
Tax-Equivalent Net Interest Margin - Table 1

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                 --------------------------------------------------------------------------------------------------
                                              1998                            1997                            1996
                                 ------------------------------  ----------------------------- ------------------------------------
In Thousands                                           Average                         Average                             Average
------------                                 Interest  Rates                Interest   Rates                 Interest      Rates
                                 Average     Income/   Earned/   Average    Income/    Earned/   Average     Income/       Earned/
                                 Balance     Expense    Paid     Balance    Expense     Paid     Balance     Expense        Paid
                                 -------     -------    ----     -------    -------     ----     -------     -------      ---------
INTEREST EARNING ASSETS
<S>                           <C>           <C>        <C>      <C>       <C>          <C>     <C>          <C>          <C>  
Taxable investments           $    90,359   $  6,092    6.74%   $ 91,874  $     6,218   6.77%  $   111,330  $     7,409       6.65%
Nontaxable investments(1)          28,557      2,428    8.50%     30,309        2,661   8.78%       31,336        2,814       8.98%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 
        Total                     118,916      8,520    7.16%    122,183        8,879   7.27%      142,666       10,223       7.17%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 
Federal funds sold                 63,962      3,417    5.34%     45,198        2,479   5.48%       30,615        1,646       5.38%
Loans(2)
    Installment                    29,830      2,849    9.55%     27,271        2,651   9.72%       23,973        2,349       9.80%
    Commercial(1)                 190,307     18,938    9.95%    148,786       15,534  10.44%      146,778       15,082      10.28%
    Real estate
        Commercial                334,235     32,228    9.64%    282,904       27,846   9.84%      226,348       22,425       9.91%
        Construction              151,384     17,620   11.64%    138,271       16,233  11.74%      113,939       13,606      11.94%
        Residential               106,110     10,897   10.27%    106,043       10,691  10.08%       97,152        9,661       9.94%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 
        Total                     811,866     82,532   10.17%    703,275       72,955  10.37%      608,190       63,123      10.38%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 
Total earning assets/total
     interest income              994,744   $ 94,469    9.50%    870,656  $    84,313   9.68%      781,471  $    74,992       9.60%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 

Reserve for loan losses           (16,936)                       (14,931)                          (13,252)
Cash and due from banks            39,635                         31,240                            25,077
Other assets                       31,011                         28,183                            25,052
                              -----------                       --------                         ---------
TOTAL ASSETS                  $ 1,048,454                       $915,148                         $ 818,348
                              ===========                       ========                         =========

INTEREST BEARING LIABILITIES
Money Market &
     NOW accounts             $   121,932   $  3,491    2.86%   $102,704  $     3,071   2.99%  $    82,817  $     2,454       2.96%
Savings accounts                  174,311      6,652    3.82%    161,542        6,282   3.89%      155,314        6,081       3.92%
Other time deposits               430,472     24,605    5.72%    388,585       22,554   5.80%      362,037       21,429       5.92%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 
Total interest bearing
     deposits                     726,715     34,748    4.78%    652,831       31,907   4.89%      600,168       29,964       4.99%

Short-term borrowings              24,530      1,196    4.88%     15,198          762   5.01%       11,018          539       4.88%
Long-term debt                     35,565      1,946    5.47%     31,201        1,720   5.51%       28,068        1,560       5.56%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 
Total interest bearing
     liabilities/total
     interest expense             786,810     37,890    4.82%    699,230       34,389   4.92%      639,254       32,063       5.02%
                                  -------   --------    ----     -------  -----------   ----       -------  -----------       ---- 
Noninterest bearing
     deposits                     133,340                        109,340                            91,386
Other liabilities                   9,806                          7,882                             8,253
Shareowners' equity               118,498                         98,696                            79,455
                              -----------                       --------                         ---------

TOTAL LIABILITIES
     AND CAPITAL              $ 1,048,454                       $915,148                         $ 818,348
                              ===========                       ========                         =========

NET INTEREST INCOME                          $56,579                         $49,924                        $  42,929
                                             =======                      ==========                        =========

NET YIELD ON INTEREST
   EARNING ASSETS                                       5.69%                           5.73%                                 5.49%
                                                        ====                            ====                                  ==== 
</TABLE>

--------------

(1) Includes amounts to convert nontaxable amounts to a fully taxable equivalent
    basis at a 35% tax rate.

(2) Includes nonaccruing loans.


                                      -42-
<PAGE>   47


FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

Rate/Volume Analysis of Changes in Net Interest Income - Table 2


<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                            --------------------------------------------------------------------------------------------------
                                    1998 versus 1997                 1997 versus 1996                1996 versus 1995
                            -------------------------------  -------------------------------  --------------------------------
                                 Increase (Decrease) Due           Increase (Decrease) Due        Increase (Decrease) Due
 In Thousands                         to Change in                    to Change in                   to Change in
 ------------               -------------------------------  -------------------------------  --------------------------------
                                                   Total                            Total                            Total
                             Average   Average    Increase     Average   Average   Increase   Average    Average    Increase
                             Volume      Rate    (Decrease)    Volume      Rate    (Decrease)  Volume      Rate     (Decrease)
                            --------   --------  ----------   --------   --------  ---------  --------   --------   ---------
<S>                         <C>        <C>       <C>         <C>        <C>        <C>        <C>        <C>        <C>     
INTEREST INCOME
    Taxable investments     $   (103)  $    (23)  $   (126)  $ (1,295)  $    104   $ (1,191)  $    269   $    312   $    581
    Nontaxable investments      (154)       (79)      (233)       (92)       (61)      (153)      (195)      (108)      (303)
                            --------   --------   --------   --------   --------   --------   --------   --------   --------

            Total               (257)      (102)      (359)    (1,387)        43     (1,344)        74        204        278

    Federal funds sold         1,029        (91)       938        784         49        833       (787)      (147)      (934)

    Loans
        Installment              249        (51)       198        323        (21)       302        207        (45)       162
        Commercial             4,335       (931)     3,404        206        246        452        127       (457)      (330)
        Real estate
            Commercial         5,052       (670)     4,382      5,603       (182)     5,421      5,253       (705)     4,548
            Construction       1,539       (153)     1,386      2,906       (279)     2,627      2,269       (781)     1,488
            Residential            7        199        206        884        147      1,031        430       (165)       265
                            --------   --------   --------   --------   --------   --------   --------   --------   --------

            Total             11,182     (1,606)     9,576      9,922        (89)     9,833      8,286     (2,153)     6,133

TOTAL INTEREST
    INCOME                    11,954     (1,799)    10,155      9,319          3      9,322      7,573     (2,096)     5,477
                            --------   --------   --------   --------   --------   --------   --------   --------   --------

INTEREST EXPENSE
    Money Market &
        NOW accounts             575       (155)       420        589         28        617        166       (133)        33
    Savings accounts             497       (127)       370        244        (43)       201       (344)      (225)      (569)
    Other time deposits        2,431       (381)     2,050      1,571       (445)     1,126      2,216     (1,218)       998
                            --------   --------   --------   --------   --------   --------   --------   --------   --------

            Total interest
                bearing
                deposits       3,503       (663)     2,840      2,404       (460)     1,944      2,038     (1,576)       462

    Short-term borrowings        468        (34)       434        204         19        223        432        (68)       364
    Long-term debt               241        (15)       226        174        (14)       160        221        (58)       163
                            --------   --------   --------   --------   --------   --------   --------   --------   --------

TOTAL INTEREST
    EXPENSE                    4,212       (712)     3,500      2,782       (455)     2,327      2,691     (1,702)       989
                            --------   --------   --------   --------   --------   --------   --------   --------   --------

CHANGE IN NET
     INTEREST INCOME        $  7,742   $ (1,087)  $  6,655   $  6,537   $    458   $  6,995   $  4,882   $   (394)  $  4,488
                            ========   ========   ========   ========   ========   ========   ========   ========   ========
</TABLE>



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