MESSAGE FROM THE CHAIRMAN

The year 2008 saw dramatic change for your company.  In December, Bob Dickson, founder, long-time CEO and Chairman of Frontier Financial Corporation and Frontier Bank, announced his intention to step down from his role as Chairman and to retire from the Board of Directors at year-end.  I accepted the invitation of the Board to become the Chairman and Chief Executive Officer of Frontier Financial Corporation and Chairman of Frontier Bank. I am enthusiastic about the opportunity to work with the experienced and talented staff at Frontier to meet the unprecedented challenges confronting us in this economic environment. My goal is to help realign the business model and direction of our company to address the realities of these times.

Frontier Bank has, for many years, been one of the best performing banks in the entire country. Despite the very severe collapse of the residential real estate markets and the economy, Frontier remains in a strong competitive position with a loyal customer following, thanks to the efforts of our tremendous staff members. To remain strong and improve the Bank’s performance, we have intensified our efforts to diversify our portfolio and risk profile, and preserve capital by significantly increasing our focus on business banking, commercial and industrial lending and consumer banking. We intend to continue our aggressive resolution of problem real estate related loans. As part of these initiatives, we have established a Business Banking Division to coordinate and target our efforts to increase our commercial banking portfolio.

I am pleased that Director and former CEO of the holding company, Mike Clementz, accepted the position as President of Frontier Financial Corporation and CEO of Frontier Bank as part of our leadership team to guide this redirection. John Dickson has assumed the position of President of Frontier Bank, and continues to oversee the core banking business.

While there are many uncertainties and obstacles in this economic environment, unlike anything that any of us have faced, I believe that all of us pulling together will allow us to succeed in accomplishing what needs to be done.

Looking back on 2008, Frontier Bank faced what has been the most challenging 12 months in its 30 years of business. Every one of us is experiencing the effects of a crippled economy and an unprecedented crisis in the entire financial system. Frontier is no exception.

Our goal is to implement a revised business plan that is focused on emphasizing our business banking team, rebalancing the loan portfolio and cultivating core deposits. This presents an exciting opportunity for our organization, and I look forward to working with our dedicated team members to achieve it.

Looking ahead, Frontier Bank cannot control the economic environment, so we will focus on what we can control:

·   We are working with our borrowers on repayment plans and aggressive resolution of problem loans.

·   We are continuing aggressive additions to loan loss reserves.

·   We have suspended the origination of new residential construction and land development loans.

·   We are working to expand our business banking unit, which is comprised of some of the most seasoned and experienced commercial bankers in the Northwest. Over time, we will achieve a balanced asset mix for the Bank.

·   We are strengthening our capital position by selling assets, reducing expenses and seeking outside investors, and have made the difficult decision to suspend the payment of a dividend.

·   We have established new communication channels with our customers, shareholders and employees.

You may recall from previous announcements that the Board eliminated its meeting fees in the third quarter, and the Executive Management Team took reductions in base salary and eliminated bonuses amounting to a 40% reduction in total compensation. Noninterest expenses were reduced by 10%, and that effort continues. This was done to forestall a reduction in staff members who take care of our very loyal customers.

The executive team is committed to successfully managing credit risk while maintaining adequate levels of capital and liquidity. Further, we are committed to leading Frontier Bank with experience and integrity.

We thank our Board for their steadfastness, especially through these unprecedented times. As we continue to fulfill our mission to be “a highly respected and profitable independent community bank and to be widely recognized as a premier provider of financial services,” we are grateful for the dedication, professionalism and loyalty of our staff, and for the continued confidence and trust from our shareholders and customers. We believe that in the worst economic downturn in our lifetime, there is a brighter day for all of us, and we, at Frontier, are working very hard to make it so.

I appreciate your continued support, and thank you for your allegiance to Frontier Bank.

Sincerely,

Patrick M. Fahey

Chairman and CEO

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders of Frontier Financial Corporation

We have audited the accompanying consolidated balance sheets of Frontier Financial Corporation and Subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity and cash flows for the each of the years in the three-year period ended December 31, 2008. We also have audited the Company’s internal control over financial reporting as of December 31, 2008, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also include performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Frontier Financial Corporation and Subsidiaries, as of December 31, 2008, and December 31, 2007, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Frontier Financial Corporation and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework.

/s/ Moss Adams LLP

Everett, Washington

March 10, 2009

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

(In thousands, except for number of shares)

	December 31,
	2008			2007
ASSETS
Cash and due from banks	$	52,022		$	99,102
Federal funds sold		117,740			5
Securities
Available for sale, at fair value		90,606			131,378
Held to maturity (fair value $3,340 and $3,766)		3,085			3,743
Total securities		93,691			135,121
Loans held for resale		6,678			6,227
Loans		3,772,055			3,605,895
Allowance for loan losses		(112,556	)		(53,995	)
Net loans		3,666,177			3,558,127
Premises and equipment, net		51,502			47,293
Intangible assets		794			78,150
Federal Home Loan Bank (FHLB) stock		19,885			18,738
Bank owned life insurance		24,321			23,734
Other real estate owned		10,803			367
Other assets		67,510			35,052
Total assets	$	4,104,445		$	3,995,689
LIABILITIES
Deposits
Noninterest bearing	$	395,451		$	390,526
Interest bearing		2,879,714			2,552,710
Total deposits		3,275,165			2,943,236
Federal funds purchased and securities sold under agreements to repurchase		21,616			258,145
Federal Home Loan Bank advances		429,417			298,636
Junior subordinated debentures		5,156			5,156
Other liabilities		21,048			30,904
Total liabilities		3,752,402			3,536,077
Commitments and Contingent Liabilities (Note 19)
SHAREHOLDERS' EQUITY
Preferred stock, no par value; 10,000,000 shares authorized		-			-
Common stock, no par value; 100,000,000 shares authorized; 47,095,103 and
46,950,878 shares issued and outstanding in 2008 and 2007, respectively		256,137			252,292
Retained earnings		98,020			202,453
Accumulated other comprehensive income (loss), net of tax		(2,114	)		4,867
Total shareholders' equity		352,043			459,612
Total liabilities and shareholders' equity	$	4,104,445		$	3,995,689

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

-1-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME (LOSS)

(In thousands, except for number of shares and per share amounts)

	For the Year Ended December 31,
	2008			2007			2006
INTEREST INCOME
Interest and fees on loans	$	273,392		$	294,099		$	244,493
Interest on federal funds sold		457			958			1,448
Interest on investments
Taxable		4,999			4,475			3,998
Exempt from federal income tax		207			140			205
Total interest income		279,055			299,672			250,144
INTEREST EXPENSE
Interest on deposits		96,091			97,080			73,526
Interest on FHLB advances		14,244			13,402			12,195
Interest on federal funds purchased and securities
sold under agreements to repurchase		1,850			2,559			1,221
Total interest expense		112,185			113,041			86,942
Net interest income		166,870			186,631			163,202
PROVISION FOR LOAN LOSSES		120,000			11,400			7,500
Net interest income after provision for loan losses		46,870			175,231			155,702
NONINTEREST INCOME
Provision for loss on  impairment of securities		(6,430	)		-			-
Gain (loss) on sale of securities		4,570			(937	)		(25	)
Gain on sale of secondary mortgage loans		1,321			1,586			1,491
Gain on sale of premises and equipment		30			24			2,445
Gain on sale of other real estate owned		97			-			-
Service charges on deposit accounts		5,421			4,721			4,214
Other noninterest income		9,821			7,915			7,498
Total noninterest income		14,830			13,309			15,623
NONINTEREST EXPENSE
Salaries and employee benefits		48,403			48,297			42,104
Occupancy expense		11,148			9,956			9,108
State business taxes		2,013			2,066			2,213
FHLB prepayment penalty		-			1,534			-
Other noninterest expense		21,435			15,163			13,621
		82,999			77,016			67,046
Goodwill impairment		77,073			-			-
Total noninterest expense		160,072			77,016			67,046
INCOME (LOSS) BEFORE PROVISION (BENEFIT)
FOR INCOME TAX		(98,372	)		111,524			104,279
PROVISION (BENEFIT) FOR INCOME TAX		(8,635	)		37,586			35,369
NET INCOME (LOSS)	$	(89,737	)	$	73,938		$	68,910
Weighted average number of
shares outstanding for the period		46,991,625			45,265,723			45,009,526
Basic earnings (loss) per share	$	(1.91	)	$	1.63		$	1.53
Weighted average number of diluted shares
outstanding for the period		46,991,625			45,601,066			45,484,897
Diluted earnings (loss) per share	$	(1.91	)	$	1.62		$	1.52

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

-2-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(In thousands, except number of shares)

													Accumulated
													Other
	Common Stock						Comprehensive			Retained			Comprehensive
	Shares			Amount			Income (Loss)			Earnings			Income (Loss)			Total
Balance, December 31, 2005		28,438,150		$	132,598					$	159,075		$	4,424		$	296,097
Comprehensive Income:
Net income for 2006		-			-		$	68,910			68,910			-			68,910
Other comprehensive income,
Unrealized gain on available
for sale securities, net of tax $942		-			-			1,751			-			1,751			1,751
Total comprehensive income							$	70,661
Stock options exercised		275,283			4,218						-			-			4,218
Stock award plan		20,542			1,156						-			-			1,156
Three for two stock split		15,102,634			-						-			-			-
Tax benefit from stock options		-			1,205						-			-			1,205
Merger		1,513,707			46,913						-						46,913
Stock option expense		-			73						-			-			73
Cash dividends declared (50¢ per share)		-			-						(25,040	)		-			(25,040	)
Balance, December 31, 2006		45,350,316			186,163						202,945			6,175			395,283
Comprehensive Income:
Net income for 2007		-			-		$	73,938			73,938			-			73,938
Other comprehensive income,
Unrealized loss on available
for sale securities, net of tax ($699)		-			-			(1,308	)		-			(1,308	)		(1,308	)
Total comprehensive income							$	72,630
Stock options exercised		139,105			1,861						-			-			1,861
Stock award plan		71,994			892						-			-			892
Tax benefit from stock options		-			237						-			-			237
Stock option expense		-			1,691						-			-			1,691
Merger		3,230,795			61,613						-			-			61,613
Fractional shares -  merger		-			-						(1	)		-			(1	)
Stock repurchased		(1,841,332	)		(165	)					(44,219	)		-			(44,384	)
Cash dividends declared (65¢ per share)		-			-						(30,210	)		-			(30,210	)
Balance, December 31, 2007		46,950,878			252,292						202,453			4,867			459,612
Comprehensive Income:
Net loss for 2008		-			-		$	(89,737	)		(89,737	)		-			(89,737	)
Other comprehensive loss,
Unrealized loss on available
for sale securities, net of tax ($4,085)		-			-			(6,981	)		-			(6,981	)		(6,981	)
Total comprehensive loss							$	(96,718	)
Stock options exercised		31,125			391						-			-			391
Stock award plan		130,223			700						-			-			700
Tax benefit from stock options		-			49						-			-			49
Stock option expense		-			2,707						-			-			2,707
Stock repurchased		(17,123	)		(2	)					(70	)		-			(72	)
Cumulative effect of change in
accounting principle, net of tax		-			-						(413	)		-			(413	)
Cash dividends declared (48¢ per share)		-			-						(14,213	)		-			(14,213	)
Balance, December 31, 2008		47,095,103		$	256,137					$	98,020		$	(2,114	)	$	352,043

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

-3-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands)

	For the Year Ended December 31,
	2008			2007			2006
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	(89,737	)	$	73,938		$	68,910
Adjustments to reconcile net income (loss) to net cash provided by operating activities
Depreciation		3,750			2,733			2,851
Amortization		247			64			144
Intangible amortization		283			235			231
Provision for loan losses		120,000			11,400			7,500
Provision for loss on impairment of securities		6,430			-			-
(Gain) loss on sale of securities		(4,570	)		937			25
Gain on sale of premises and equipment		(30	)		(24	)		(2,445	)
Gain on sale of other real estate owned		(97	)		-			-
Gain on sale of secondary market loans		(1,321	)		(1,586	)		(1,491	)
Proceeds from sales of mortgage loans		94,815			158,345			111,720
Origination of mortgage loans held for sale		(93,945	)		(155,766	)		(111,736	)
Goodwill impairment		77,073			-			-
Deferred taxes		(20,431	)		(5,480	)		(1,721	)
Stock award plan compensation		700			892			1,156
Stock option expense		2,707			1,691			73
Excess tax benefits associated with equity-based compensation		(49	)		(237	)		(1,205	)
Increase in cash surrender value of BOLI		(587	)		(1,536	)		(888	)
Changes in operating assets and liabilities
Income taxes receivable		(8,430	)		-			-
Income taxes payable		665			(2,100	)		(1,950	)
Interest receivable		1,254			(2,689	)		(3,780	)
Interest payable		4,332			4,292			4,513
Other operating activities		(6,182	)		(1,161	)		(1,343	)
Net cash provided by operating activities		86,877			83,948			70,564
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in federal funds sold		(117,735	)		18,668			(17,940	)
Purchase of securities available for sale		(306,126	)		(84,724	)		(17,324	)
Proceeds from sales of available for sale securities		45,568			48,039			-
Proceeds from maturities of available for sale securities		288,165			21,390			20,515
Purchase of held to maturity securities		-			(1,019	)		-
Proceeds from maturities of held to maturity securities		650			875			2,114
Purchase of Federal Home Loan Bank stock		(1,147	)		(3,116	)		-
Net cash flows from loan activities		(242,727	)		(510,865	)		(517,267	)
Purchases of premises and equipment		(7,959	)		(16,665	)		(3,927	)
Proceeds from the sale of premises and equipment		30			24			3,443
Proceeds from the sale of other real estate owned		3,208			-			-
Cash acquired in merger		-			1,234			7,121
Other investing activities		-			2,615			(3,069	)
Net cash used in investing activities	$	(338,073	)	$	(523,544	)	$	(526,334	)

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

-4-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)

(In thousands)

	For the Year Ended December 31,
	2008			2007			2006
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in money market, sweep, NOW and savings accounts	$	(304,909	)	$	(35,344	)	$	182,986
Net change in certificates of deposit		636,838			354,906			209,266
Net change in federal funds purchased and securities sold under
agreements to repurchase		(236,529	)		176,472			60,860
Advances from the Federal Home Loan Bank		410,000			324,052			111,756
Repayments to the Federal Home Loan Bank		(279,219	)		(321,023	)		(69,739	)
Stock options exercised		391			1,861			4,218
Excess tax benefits associated with equity-based compensation		49			237			1,205
Purchase of common stock		(72	)		(44,384	)		-
Cash dividends paid		(22,433	)		(29,045	)		(22,358	)
Other financing activities		-			6,744			(3,833	)
Net cash provided by financing activities		204,116			434,476			474,361
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS		(47,080	)		(5,120	)		18,591
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR		99,102			104,222			85,631
CASH AND DUE FROM BANKS AT END OF YEAR	$	52,022		$	99,102		$	104,222
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for interest	$	107,853		$	107,879		$	82,157
Cash paid during the year for income taxes	$	19,700		$	40,000		$	36,595
SUPPLEMENTAL INFORMATION ABOUT NONCASH INVESTING AND FINANCING ACTIVITIES
Transfer of loans to other real estate owned, net of valuation adjustments	$	13,547		$	367		$	-
Change in portion of reserve identified for undisbursed loans and
reclassified as a liability	$	1,581		$	(117	)	$	(276	)
Acquisitions:
Assets aquired	$	-		$	247,078		$	209,600
Liabilities assumed	$	-		$	185,270		$	162,687
Net	$	-		$	61,808		$	46,913

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

-5-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1: Summary of Significant Accounting Policies

Basis of Presentation

Frontier Financial Corporation (together with its subsidiary, “FFC”, the “Corporation”, “us”, “we” or “our”) is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers.  We also provide other services such as trust services and insurance and financial service brokerage activities.  We are subject to competition from other financial institutions and to regulation by certain federal and state agencies and undergo periodic examinations by those regulatory authorities.

The consolidated financial statements include the accounts of Frontier Financial Corporation (the “Corporation” or “FFC”), a bank holding company, and its wholly-owned subsidiary, Frontier Bank (the “Bank”).  Effective December 30, 2008, Frontier Financial Corporation merged its wholly-owned subsidiary, FFP, Inc. (“FFP”) into Frontier Bank in a non-cash transaction.  FFP owned certain real property and leased it to Frontier Bank for use in its operations.  At December 30, 2008, FFP had assets totaling approximately $40.9 million and total equity of approximately $17.6 million.  On a consolidated basis, this transaction had no effect on the financial statements of the Corporation for the year ended December 31, 2008.

We have Trusts that were formed for the exclusive purpose of issuing $5.2 million in trust preferred securities (Note 12).  The Trusts are considered variable interest entities (“VIE”), but have not been consolidated as we are not the primary beneficiary.

Our financial reporting and accounting policies conform to accounting principles generally accepted in the United States of America (“GAAP”).  All significant intercompany transactions and balances have been eliminated in preparing the consolidated financial statements.  Assets held by the Bank in an agency or fiduciary capacity are not included in the accompanying financial statements.

Change in Accounting Principle

In September 2006, the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) reached a final consensus on Issue No. 06-4 (“EITF 06-4”), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.  EITF 06-4 requires employers to recognize a liability for future benefits provided through endorsement split-dollar life insurance arrangements that extend into postretirement periods in accordance with SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions or APB No. 12, Omnibus Opinion – 1967.  We adopted the provisions of EITF 06-4 as of January 1, 2008, as a change in accounting principle through a cumulative-effect adjustment to retained earnings in the statement of financial position in the amount of $413 thousand, net of tax.

Reclassifications

Certain amounts in prior years' financial statements have been reclassified to conform to the current year presentation.  These reclassifications have no effect on the previously reported financial condition or results of operations of the Corporation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and accompanying notes.  Actual results could differ from those estimates.

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

-6-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 1: Summary of Significant Accounting Policies (continued)

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks.  Cash equivalents have an original maturity of three months or less and may exceed federally insured limits.Federal Reserve Board regulations require maintenance of certain minimum reserve balances on deposit with the Federal Reserve Bank.  The average amount of such balances was $9.0 million in 2008 and $15.1 million in 2007.

Securities

Securities are classified into one of three categories: held to maturity (“HTM”), available for sale (“AFS”) or trading.  Securities are categorized as held to maturity when there is positive intent and ability to hold those securities to maturity.  Securities that are held to maturity are stated at cost and adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income.

Securities categorized as available for sale are generally held for investment purposes (to maturity), although unanticipated future events may result in the sale of some securities. Available for sale securities are recorded at estimated fair value, with the net unrealized gain or loss included in comprehensive income (loss), net of the related tax effect. Realized gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of securities sold, using the specific identification method.

We had no trading securities at December 31, 2008 and 2007.

Purchase premiums and discounts are recognized in interest income using the interest method over the term of the security. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Federal Home Loan Bank Stock

Our investment in Federal Home Loan Bank (“FHLB”) stock is carried at par value ($100 per share), which reasonably approximates its fair value.  As a member of the FHLB system, we are required to maintain a minimum level of investment in FHLB stock based on specific percentages of our outstanding FHLB advances.

Bank Owned Life Insurance (“BOLI”)

The carrying amount of BOLI approximates its fair value, net of any surrender charges.  Fair value of BOLI is equivalent to the cash surrender value.

Loans Held for Resale

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

Loans Held in Portfolio and Related Income

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

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

-7-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 1: Summary of Significant Accounting Policies (continued)

Loans Held in Portfolio and Related Income (continued)

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 include standby letter of credit and loan commitment fees.

Allowance for Loan Losses

The allowance for loan losses is established to absorb probable future loan losses through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components.  The specific component relates to loans that are classified as impaired, for which an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers nonclassified loans and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimated specific and general losses in the portfolio.

Reserve for Unfunded Commitments

A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements such as letters or lines of credit. Management determines the adequacy of the reserve for unfunded commitments based upon reviews of individual credit facilities, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are evaluated on a regular basis and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the allowance.  Provisions for unfunded commitment losses, and recoveries on loans previously charged off, are added to the reserve for unfunded commitments, which is included in the Other Liabilities section of the consolidated balance sheets.

Nonaccrual Loans

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

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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 1: Summary of Significant Accounting Policies (continued)

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance, homogeneous loans or leases are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer loans or leases for impairment disclosures, unless such loans are the subject of a restructuring agreement.

Premises and Equipment

Premises, leasehold improvements and equipment are shown at cost and depreciated using the straight-line method. Depreciation expense is computed over the following estimated useful lives:

Premises	7 to 40 years
Furniture, fixtures and equipment	3 to 7 years

Intangible Assets

Intangible assets include goodwill which represents the excess of the purchase price over the fair value of tangible and specifically identifiable intangible net assets acquired in business combinations.  Goodwill is not amortized but is tested for impairment at least annually.  Other intangible assets are amortized, and included in other noninterest expense, over their estimated useful lives.  Additional information on intangible assets is included in Note 7.

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 less selling costs. Losses arising from the acquisition of property, in full or partial satisfaction of loans, are charged to the allowance for loan losses.

Subsequent to the transfer to 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.  The amounts that will ultimately be recovered from foreclosed assets may differ substantially from the carrying value of the assets because of future market factors beyond management’s control.  Additional information on other real estate owned is included in Note 5.

Transfer of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated; (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and (3) we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 1: Summary of Significant Accounting Policies (continued)

Segment Reporting

Our operations are solely in the financial services industry and include providing our customers traditional banking and other financial services.  We operate primarily within western Washington and northwest Oregon.  We make operating decisions and assess performance based on an ongoing review of our consolidated financial results.  We are considered a single operating segment for financial reporting purposes.

Concentrations of Credit Risk

We accept deposits and grant credit primarily within western Washington and northwest Oregon.  Historically, our focus has been on real estate construction lending, but we are in the process of diversifying our loan portfolio.  Due to the downturn in the economy and the negative impact on the local housing market, we are rebalancing our loan portfolio to include more commercial and industrial business and consumer loans.

Advertising Costs

Generally, advertising costs are expenses as incurred.

Income Tax

We report income and expenses using the liability method of accounting and file a consolidated tax return. Deferred taxes are determined using the asset-liability method and are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred taxes result from temporary differences in recognition of certain income and expense amounts between our financial statements and our tax returns.  The principal items giving rise to these differences include depreciation expense, investment income and the allowance for loan losses.

Stock-Based Compensation

Prior to January 1, 2006, we accounted for our stock plans in accordance with the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation (“SFAS 123”).  No stock-based compensation expense was recognized in the Consolidated Statement of Income prior to January 1, 2006, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.  Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, Share-Based Payment (Revised 2004) using the modified-prospective-transition method.  Under the transition method, compensation cost recognized subsequent to January 1, 2006, includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

Prior to adoption of SFAS 123R, we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Consolidated Statement of Cash Flows.  SFAS 123R requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.

Earnings (Loss) per Share

Basic earnings (loss) per share amounts are computed based on the weighted average number of shares outstanding during the period after giving retroactive effect to stock dividends and stock splits.  Diluted earnings (loss) per share are computed by determining the number of additional shares that are deemed outstanding due to stock options and stock awards under the treasury stock method.

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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 1: Summary of Significant Accounting Policies (continued)

Comprehensive Income (Loss)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss).  Certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, and such items, along with net income (loss), are components of comprehensive income (loss).

The components of comprehensive income (loss) and related tax effects are as follows (in thousands):

	Years Ended December 31,
	2008			2007			2006
Unrealized gains (losses) arising during the period on securities available for sale	$	(12,926	)	$	(2,944	)	$	2,668
Reclassification adjustment for losses realized in net income, net of tax
(tax benefit of $651, $328 and $9, respectively)		1,209			609			16
Tax effect		4,736			1,027			(933	)
Net unrealized gains (losses) on securities available for sale	$	(6,981	)	$	(1,308	)	$	1,751

The components of accumulated other comprehensive income (loss), included in shareholders’ equity, are as follows (in thousands):

	Years Ended December 31,
	2008			2007			2006
Unrealized holding gains (losses) on available for sale securities	$	(3,573	)	$	7,493		$	9,500
Tax effect		1,459			(2,626	)		(3,325	)
Accumulated other comprehensive income (loss), net of tax	$	(2,114	)	$	4,867		$	6,175

Recently Adopted Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, Fair Value Measurements (“SFAS 157”).  This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This statement establishes a fair value hierarchy for the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset.  The standard is effective for fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, Effective Date of FASB Statement No. 157.  This FSP delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.  We elected a partial deferral of SFAS 157 under the provisions of FSP 157-2 related to the measurement of fair value used when evaluating goodwill, other intangible assets and other long-lived assets for impairment.  We are currently evaluating the impact of FSP 157-2 on our financial statements. The impact of partially adopting SFAS 157 effective January 1, 2008, was not material to our financial statements.  Please refer to Note 20 for disclosures related to the adoption of SFAS 157.

In October 2008, the FASB issued FSP FAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The FSP clarifies the application of SFAS No. 157, Fair Value Measurements, when the market for a financial asset is not active. The FSP was effective upon issuance, including reporting for prior periods for which financial statements have not been issued. The adoption of the FSP did not have a material impact on our consolidated financial statements.

 In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”).  The standard permits, but does not require, us to measure financial instruments and certain other items at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  As we did not elect to use the fair value option for any of our financial instruments under the provisions of SFAS 159, our adoption of this statement effective January 1, 2008, did not have a material impact on our financial statements.

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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 1: Summary of Significant Accounting Policies (continued)

Recently Adopted Accounting Pronouncements (continued)

In September 2006, the EITF reached a final consensus on Issue No. 06-4 (“EITF 06-4”), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.  EITF 06-4 requires employers to recognize a liability for future benefits provided through endorsement split-dollar life insurance arrangements that extend into postretirement periods in accordance with SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions or APB No. 12, Omnibus Opinion – 1967.  We adopted the provisions of EITF 06-4 as of January 1, 2008, as a change in accounting principle through a cumulative-effect adjustment to retained earnings in the statement of financial position in the amount of $413 thousand, net of tax.

Recently Issued Accounting Pronouncements

In December 2007, the FASB issued Statement No. 141 (revised), Business Combinations (“SFAS 141R”).  SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired.  SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009, and is not expected to have a material impact on our consolidated financial statements.

In March 2008, the Financial Accounting Standards Board (“FASB”) issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), to amend and expand the disclosure requirements of SFAS 133 to provide greater transparency about: (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. SFAS 161 is effective on January 1, 2009, and is not expected to have a material impact on our consolidated financial statements as we currently do not have any derivative instruments.

In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”).  This Statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States.  Any effect of applying the provisions of this Statement shall be reported as a change in accounting principle in accordance with FASB Statement No. 154, AccountingChanges and Error Corrections (“SFAS 154”). An entity shall follow the disclosure requirements of that Statement, and additionally, disclose the accounting principles that were used before and after the application of the provisions of this Statement and the reason why applying this Statement resulted in a change in accounting principle.  SFAS 162 is not expected to have a material impact on our consolidated financial statements as our financial statements are already presented in conformity with GAAP.

-12-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 2: Strategic Plan

Our 2008 financial results reflect continued pressure from an uncertain economy and the negative impact on the local housing market. The ratio of nonperforming assets has increased from 0.53% of total assets at December 31, 2007, to 10.87% at December 31, 2008.   Because of this continued pressure, the provision for loan losses increased from $11.4 million in 2007, to $120.0 million in 2008.

During the fourth quarter 2008, we recorded a non-cash charge of $77.1 million related to the impairment of goodwill.  This write down resulted from goodwill impairment testing that was performed at the end of the fourth quarter due to the quarterly decline in the stock price and the resulting difference between the market capitalization and the book value of the Corporation.  The results of step 1 of the goodwill impairment testing demonstrated that the estimated fair value of the Corporation, or reporting unit, was less than the carrying value.  Step 2 of the impairment test indicated no implied fair value of goodwill resulting in full impairment. This impairment charge had no effect on our cash balances or liquidity.  In addition, because goodwill is not included in the calculation of regulatory capitol, the Corporation’s and Bank’s regulatory ratios were not affected by this non-cash expense.

The Board of Directors, in responding to these challenging and unprecedented times, has taken a number of important steps to strengthen the Corporation.

Change in Management

On December 8, 2008, we announced that Robert J. Dickson, founder, long-time Chief Executive Officer (“CEO”) and current Chairman of the Board of Directors would retire from the Board of Directors on December 31, 2008.  Mr. Dickson was the President and CEO of Frontier Bank since its founding in 1978 until 2003, and President and CEO of Frontier Financial Corporation from 1983 until 2003.

Director Patrick M. Fahey replaced Mr. Dickson as Chairman of the Board of Directors of Frontier Financial Corporation and Frontier Bank.  Mr. Fahey joined the Board in 2006 after retiring as Chairman of Regional Banking at Wells Fargo Bank.  Prior to that, Mr. Fahey was Founder, President and CEO of Pacific Northwest Bank for 16 years.

Additionally, we also announced two important changes to the executive management team.  Mr. Fahey was named CEO of Frontier Financial Corporation and Director Michael J. Clementz was named President of Frontier Financial Corporation and CEO of Frontier Bank.  Mr. Fahey brings significant experience to his role as CEO and will be charged with implementing a revised business plan focused on growing a business banking franchise, rebalancing the loan portfolio and cultivating business banking deposits.  

John J. Dickson assumed the position of President of Frontier Bank, charged primarily with the ongoing operation of Frontier’s core business.  Mr. Dickson will continue in his role as a Director of Frontier Financial Corporation and Frontier Bank.

Having previously served as President and CEO of Frontier Financial Corporation from 2003 until 2006, Mr. Clementz will assist Mr. Fahey and Mr. Dickson in the ongoing operations of the business and the implementation of the new business banking operations.  Mr. Clementz will continue to serve as a Director of Frontier Financial Corporation and Frontier Bank.

Diversifying the Loan Portfolio

Historically, a main focus has been on real estate construction and land development lending.  However, with few exceptions, we are suspended the origination of new relationships for new real estate construction, land development and lot loans.  As current loans in these categories are renewed, the customer’s total relationship is being analyzed and we may require additional collateral or alternative financing.

In addition, due to the downturn in the economy and the negative impact on the local housing market, we are rebalancing our loan portfolio to include more commercial and industrial business and consumer loans. We formed a Business Banking team, consisting of 38 experienced commercial bankers, who are existing employees of the Bank, to focus on generating loans and deposits to small to medium-sized businesses.  Our goal is to rebalance the loan portfolio over the next three years with the use of the Business Banking team and the lack of originations of any new real estate construction, land development and completed lot loans.

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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 2: Strategic Plan (continued)

Asset Quality

During the third quarter of 2008, we expanded our special assets group from 5 to 30 individuals, all from within the company, to focus on reducing nonperforming assets.  This group is split into two teams.  One team’s focus is on identifying emerging problem loans with the other team handling legal issues, liquidations and the ultimate sale of foreclosed assets. This structure has enhanced our ability to manage our portfolio of troubled loans.

We have implemented several strategies to reduce our troubled loans.  We are encouraging our builders and developers to present all offers to us for consideration.  Many of our builders have rented completed homes or sold them on a lease to own basis.  These loans are typically amortized over 30 years with a two to three year maturity.  In addition, we have established an internal loan program for financing home purchases for credit worthy buyers who may not be able to obtain a traditional mortgage.  Due to the volatility of the real estate market future recoveries on these loans are uncertain at this time.

In the event that our nonperforming assets continue to increase, this could have an adverse effect on the Bank, causing total capital to drop below levels that may result in regulatory actions or constraints.

Capital Preservation

To preserve capital, the third quarter 2008 quarterly cash dividend was reduced to $0.06 per share, down from $0.18 in the previous quarter.  Additionally, in December of 2008, the Board of Directors voted to suspend the payment of the quarterly cash dividend, beginning in the first quarter 2009.  We are also taking steps to strengthen our capital position.  We have sold assets and reduced expenses and we are looking at adding capital through a private equity investment.  We have engaged an investment banking firm to help facilitate this process.  A Form S-3, Shelf Registration Statement, was filed on November 14, 2008, in anticipation of this action.  We have applied for TARP funds; however, our application has neither been approved nor denied.  Our capital ratios continue to be above the established minimum regulatory capital levels.

While we are taking action to preserve and/or grow capital, there is no assurance that the preservation efforts will be successful or whether we will be successful in raising capital through private investment under acceptable terms, or at all.  In the event capital levels continue to decline, this could have an adverse effect on the Bank causing the capital to drop below levels that may cause regulatory actions or constraints.

Expense Reduction Measures

As part of our strategy to reduce noninterest expense, there were no performance bonuses paid or discretionary profit sharing contributions made to the Employee Benefit Plan for the year ended December 31, 2008.  The Board of Directors of Frontier Bank also elected to forego their director meeting fees indefinitely beginning in the fourth quarter 2008.  Effective January 1, 2009, executive management took a reduction in their base salaries, and as a group, total executive compensation for 2009 will be reduced by approximately 40% from 2008 total compensation.   

Deposit Growth

Deposit growth continues to be a strong focus for the Corporation.  We are anticipating further deposit growth in 2009, from the Business Banking team as discussed above.  In addition, management has introduced a new employee incentive program based on deposit growth.

Our liquidity position continues to be strong.  At December 31, 2008, we had $169.8 million in cash and federal funds sold.  In addition, we have $93.7 million in our security portfolio that could be used to support liquidity.

In the event that our efforts to retain a strong liquidity position are not successful, this could have an adverse effect on the Bank causing regulatory actions or constraints.

-14-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 2: Strategic Plan (continued)

Possible Regulatory Constraints

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

In the event our regulators deem us to be less than well-capitalized, they have the ability to place constraints on our operating practices. Those constraints may include, but are not limited to, regulatory approval to accept brokered deposits, restrictions on capital distributions, expansion, asset growth, management changes, rates paid on deposits and other items.

Note 3: Business Combinations

On November 30, 2007, we acquired 100 percent of the outstanding shares of Bank of Salem.  The results of Bank of Salem’s operations have been included in the consolidated financial statements since the date of acquisition.  Bank of Salem was an Oregon chartered commercial bank headquartered in Salem, Oregon that provided commercial real estate and business lending products and related services through 3 locations in Portland, Salem and Tigard, Oregon.    The merger with Bank of Salem allows us to expand our commercial banking franchise into the state of Oregon and into the Salem and Portland metropolitan areas in particular. This is consistent with our strategy to expand into major business communities along the Washington and Oregon Interstate 5 corridor.

Bank of Salem shareholders received 0.99 shares of Frontier common stock for each share of Bank of Salem common stock.  The value of the 3,230,886 common shares (including fractional shares) issued was determined in accordance with the Merger Agreement at $19.07 per share.  The aggregate purchase price was $61.8 million, which included $195 thousand of direct merger related costs.

This acquisition was accounted for under the purchase method of accounting in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”).  Accordingly, the purchase price was allocated to the assets acquired and the liabilities assumed based on their estimated fair values at the date of acquisition, with the difference between the purchase price and the fair value of the net assets acquired recorded as goodwill.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

Total value of common stock exchanged	$	61,613
Direct merger related expenses		195
Total purchase price		61,808
Allocation of purchase price:
Bank of Salem shareowners' equity		26,981
Adjustments to reflect assets acquired and liabilities assumed at fair value
Loans		(4,162	)
Buildings and land		1,347
Certificates of deposit		(570	)
Core deposit intangible asset		373
Deferred tax asset		1,054
Fair value of net assets acquired		25,023
Goodwill	$	36,785

The acquired core deposit intangible asset has an estimated useful life of approximately 7.1 years.  Goodwill is not deductible for tax purposes.

-15-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 3: Business Combinations (continued)

The fair value of assets acquired and liabilities assumed of Bank of Salem, at the date of acquisition, are presented below (in thousands):

	November 30, 2007
Cash and due from banks	$	1,234
Securities available for sale		8,581
Loans, net of allowance for loan loss of $2,983		192,671
Premises and equipment, net		3,341
Goodwill		36,785
Other assets		4,466
Total assets		247,078
Deposits		170,042
FHLB advances		13,590
Other liabilities		1,638
Total liabilities		185,270
Net assets acquired	$	61,808

The following unaudited pro forma condensed consolidated financial information presents the results of operations had the acquisition taken place on January 1, 2007 and 2006, respectively (in thousands).  Any cost savings realized as a result of the merger are not reflected in the proforma condensed consolidated statements of income.  The proforma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2007 and 2006, respectively.

	Years Ended December 31,
	2007		2006
Net interest income	$	196,022	$	173,665
Provision for loan losses		12,662		8,152
Noninterest income		13,659		15,988
Noninterest expense		83,616		70,896
Income before income tax		113,403		110,605
Net income	$	74,846	$	72,783
Basic earnings per share	$	1.65	$	1.51
Diluted earnings per share	$	1.64	$	1.49
Weighted average common shares issued and outstanding		45,265,723		48,240,321
Weighted average diluted common shares issued and outstanding		45,601,066		48,715,692

-16-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 4: Securities

The following table presents the amortized cost, unrealized gains, unrealized losses and fair value of available for sale and held to maturity securities as of December 31, 2008 and 2007 (in thousands).  For the years ended December 31, 2008 and 2007, there were no securities classified as trading.

2008
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses (less than 12 months)			Gross Unrealized Losses (12 months or more)			Aggregate Fair Value
AFS Securities
Equities	$	6,107	$	61	$	(4,057	)	$	(181	)	$	1,930
U.S. Treasuries		6,304		153		-			-			6,457
U.S. Agencies		51,594		461		-			-			52,055
Corporate securities		4,528		153		-			(242	)		4,439
Mortgage-backed securities		22,791		-		-			-			22,791
Municipal securities		2,855		81		-			(2	)		2,934
		94,179		909		(4,057	)		(425	)		90,606
HTM Securities
Corporate securities		1,524		229		-			-			1,753
Municipal securities		1,561		26		-			-			1,587
		3,085		255		-			-			3,340
Total	$	97,264	$	1,164	$	(4,057	)	$	(425	)	$	93,946

2007
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses (less than 12 months)			Gross Unrealized Losses (12 months or more)			Aggregate Fair Value
AFS Securities
Equities	$	27,606	$	9,255	$	(922	)	$	(1,364	)	$	34,575
U.S. Treasuries		6,223		88		-			-			6,311
U.S. Agencies		71,385		782		-			-			72,167
Corporate securities		15,537		87		(320	)		(124	)		15,180
Mortgage-backed securities		-		-		-			-			-
Municipal securities		3,134		14		-			(3	)		3,145
		123,885		10,226		(1,242	)		(1,491	)		131,378
HTM Securities
Corporate securities		1,525		-		(1	)		-			1,524
Municipal securities		2,218		27		(3	)		-			2,242
		3,743		27		(4	)		-			3,766
Total	$	127,628	$	10,253	$	(1,246	)	$	(1,491	)	$	135,144

-17-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 4: Securities (continued)

The following table shows gross unrealized losses and fair value of securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2008 and 2007 (in thousands):

2008	Less Than 12 Months					12 Months or More					Total
	Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value
AFS Securities
Equities	$	(4,057	)	$	923	$	(181	)	$	425	$	(4,238	)	$	1,348
U.S. Treasuries		-			-		-			-		-			-
U.S. Agencies		-			-		-			-		-			-
Corporate securities		-			-		(242	)		1,769		(242	)		1,769
Mortgage-backed securities		-			-		-			-		-			-
Municipal securities		-			-		(2	)		23		(2	)		23
	$	(4,057	)	$	923	$	(425	)	$	2,217	$	(4,482	)	$	3,140

2007	Less Than 12 Months					12 Months or More					Total
	Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value
AFS Securities
Equities	$	(922	)	$	7,190	$	(1,364	)	$	3,561	$	(2,286	)	$	10,751
U.S. Treasuries		-			-		-			-		-			-
U.S. Agencies		-			-		-			-		-			-
Corporate securities		(320	)		5,722		(124	)		5,867		(444	)		11,589
Mortgage-backed securities		-			-		-			-		-			-
Municipal securities		-			-		(3	)		22		(3	)		22
		(1,242	)		12,912		(1,491	)		9,450		(2,733	)		22,362
HTM Securities
Corporate securities		(1	)		1,524		-			-		(1	)		1,524
Municipal securities		(3	)		1,016		-			-		(3	)		1,016
		(4	)		2,540		-			-		(4	)		2,540
Total	$	(1,246	)	$	15,452	$	(1,491	)	$	9,450	$	(2,737	)	$	24,902

Management has the ability and intent to hold securities classified as held to maturity until they mature, at which time we expect to receive full value for the securities.  Furthermore, management also has the ability and intent to hold the securities classified as available for sale for a period of time sufficient for a recovery of cost.

-18-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 4: Securities (continued)

Management evaluates securities for other-than-temporary impairment at least on an annual basis, and more frequently when economic or market concerns warrant such evaluation.  Consideration is given to: (1) the length of time and extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer and (3) our intent and ability to retain a security for a period of time sufficient to allow for any anticipated recovery in fair value.  Declines in the fair value of available for sale and held to maturity securities below their cost that are deemed to be other-than- temporary are reflected in earnings as realized losses.  For the year ended December 31, 2008, we recognized other-than-temporary impairment losses of $6.4 million (pre-tax), related to our holdings in Fannie Mae and Freddie Mac preferred stock and a Lehman Brothers bond and preferred stock.

Certain securities shown above currently have fair values less than amortized cost, and therefore, contain unrealized losses.  We have evaluated these securities and have determined that the decline in value is temporary.  There are six securities with unrealized losses at December 31, 2008.

Contractual maturities of securities as of December 31, 2008, are shown below (in thousands).  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties.

	Available for sale				Held to maturity
Maturity	Amortized Cost		Fair Value		Amortized Cost		Fair Value
0 - 1 years	$	11,223	$	11,291	$	574	$	579
1 - 5 years		48,940		49,163		987		1,008
5 - 10 years		1,625		1,731		-		-
Over 10 years		32,391		28,421		1,524		1,753
	$	94,179	$	90,606	$	3,085	$	3,340

Proceeds from the sale of available for sale securities totaled $45.6 million for year ended December 31, 2008, and $48.0 million for the year ended December 31, 2007.  Realized gains on sale of securities totaled $4.6 million in 2008, and realized losses totaled $937 thousand in 2007 and $25 thousand in 2006.

The following table shows securities, which were pledged to secure borrowings, public deposits, repurchase agreements and other items, as permitted or required by law, at December 31, 2008 (in thousands):

	Amortized Cost		Fair Value
To the Federal Home Loan Bank to secure borrowings	$	502	$	517
To state government to secure public deposits		25,213		25,303
To Federal Reserve to secure repurchase agreements		26,069		26,319
To Federal Reserve to secure customer tax payments		4,000		4,080
Other securities pledged		7,004		7,178
Total pledged securities	$	62,788	$	63,397

Securities with an amortized cost of $81.7 million and fair values of $82.6 million were pledged at December 31, 2007.

-19-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 5: Loans and Allowance for Loan Losses

The major classifications of loans, excluding loans held for resale, at December 31 are as follows (in thousands):

	2008			2007
Commercial and industrial	$	458,263		$	403,511
Real Estate:
Commercial		1,048,431			1,007,152
Construction		952,619			1,068,196
Land development		581,683			540,419
Completed lots		250,405			250,738
Residential 1-4 family		425,874			283,470
Installment and other loans		65,490			67,460
		3,782,765			3,620,946
Unearned fee income		(10,710	)		(15,051	)
Total loans	$	3,772,055		$	3,605,895

Contractual maturities of loans, excluding loans held for resale and net of deferred fees, as of December 31, 2008, are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to prepay loans with or without prepayment penalties.

	Within 1 Year		1 -5 Years		After 5 Years		Total
Commercial and industrial	$	272,955	$	154,565	$	29,695	$	457,215
Real Estate:
Commercial		124,502		630,986		289,345		1,044,833
Construction		861,079		84,970		3,860		949,909
Land development		544,019		36,434		-		580,453
Completed lots		207,124		40,819		1,742		249,685
Residential 1-4 family		164,406		203,399		56,687		424,492
Installment and other loans		15,883		15,384		34,201		65,468
Total loans	$	2,189,968	$	1,166,557	$	415,530	$	3,772,055
			1 -5 Years		After 5 Years
Fixed rates			$	818,792	$	79,270
Variable rates				347,765		336,260
			$	1,166,557	$	415,530

At December 31, 2008, loans totaling $942.3 million were pledged to secure borrowings.

-20-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 5: Loans and Allowance for Loan Losses (continued)

Allowance for Loan Losses

Changes in the allowance for loan losses for the years ended December 31 are summarized below (in thousands):

	2008			2007			2006
Beginning balance	$	57,658		$	44,195		$	37,075
Provision for loan losses		120,000			11,400			7,500
Charge-offs		(63,526	)		(1,906	)		(3,294	)
Recoveries		506			986			413
Merger		-			2,983			2,501
Balance before portion identified for undisbursed loans		114,638			57,658			44,195
Portion of reserve identified for undisbursed
loans and reclassified as a liability		(2,082	)		(3,663	)		(3,546	)
Balance at end of period	$	112,556		$	53,995		$	40,649

The allowance for loan losses totaled $112.6 million, or 2.98%, of total loans outstanding at December 31, 2008.  This compares to the allowance for loan losses of $54.0 million, or 1.49%, of total loans outstanding at December 31, 2007, and $40.6 million, or 1.40%, at December 31, 2006.  The increase in the allowance for loan loss for 2008, as compared to 2007 and 2006, is primarily attributable to the downturn in the economy and the negative impact on the local housing market, which significantly affected our real estate construction, land development and completed lot portfolios.

Nonperforming Assets

Loans delinquent 90 days or more or other nonaccruing, restructured and other real estate owned (“OREO”), on which the accrual of interest has been discontinued at December 31 are as follows (in thousands):

	2008			2007			2006
Commercial and industrial	$	12,908		$	159		$	574
Real estate:
Commercial		10,937			-			-
Construction		181,905			19,842			47
Land development		177,139			-			7,143
Completed lots		34,005			804			-
Residential 1-4 family		17,686			93			889
Installment and other		645			10			-
Total nonaccruing loans		435,225			20,908			8,653
Other real estate owned		10,803			367			-
Total nonperforming assets	$	446,028		$	21,275		$	8,653
Restructured loans	$	-		$	-		$	-
Total loans at end of period (1)	$	3,778,733		$	3,612,122		$	2,908,000
Total assets at end of period	$	4,104,445		$	3,995,689		$	3,238,464
Total nonperforming loans to total loans		11.52	%		0.58	%		0.30	%
Total nonperforming assets to total assets		10.87	%		0.53	%		0.27	%
(1) Includes loans held for resale

-21-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 5: Loans and Allowance for Loan Losses (continued)

Nonaccrual Loans

At December 31, 2008, nonaccruing loans totaled $435.2 million, compared to $20.9 million at December 31, 2007, and $8.7 million at December 31, 2006.  Average balances of these loans were $468.5 million, $15.4 million and $8.7 million, for the years ended December 31, 2008, 2007 and 2006, respectively.  The allowance for loan losses related to these loans was approximately $12.9 million in 2008, $1.6 million in 2007 and $914 thousand in 2006.

For the years ended December 31, there are certain amounts of interest collected on nonaccrual loans that are included in income and amounts that have not been accrued, which are indicated in the following table (in thousands):

	2008		2007		2006
Additional interest income which
would have been recorded during the
period under original loan terms	$	18,915	$	757	$	761
Interest collected and included in
net income for the period	$	21,004	$	1,131	$	344
Commitments for additional funds
related to loans above	$	-	$	-	$	-

Other Real Estate Owned

The following table presents the activity related to OREO (in thousands):

	December 31, 2008						December 31, 2007
	Amount			Number			Amount		Number
Beginning balance	$	367			1		$	-		-
Additions to OREO		12,992			76			367		1
Capitalized improvements		623						-
Valuation adjustments		(68	)					-
Disposition of OREO		(3,111	)		(13	)		-		-
Ending balance	$	10,803			64		$	367		1

At December 31, 2008, OREO totaled $10.8 million and consisted of 64 properties in Washington (53) and Oregon (11), with balances ranging from $76 thousand to $478 thousand.  At December 31, 2007, we had one OREO property totaling $367 thousand.

Note 6: Premises and Equipment

Premises and equipment at December 31 are comprised of the following (in thousands):

	2008			2007
Premises	$	44,440		$	31,032
Furniture, fixtures and equipment		25,676			21,180
Land		15,593			15,597
Construction in process		1,155			11,403
		86,864			79,212
Accumulated depreciation		(35,362	)		(31,919	)
Premises and equipment, net	$	51,502		$	47,293

For the years ended December 31, 2008, 2007 and 2006, depreciation expense on premises and equipment totaled $3.8 million, $2.7 million and $2.9 million, respectively.

-22-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 7: Intangible Assets

The changes in the carrying amount of goodwill for the years ended December 31 are as follows (in thousands):

	2008			2007
Beginning balance	$	77,073		$	40,288
Goodwill acquired during the year		-			36,785
Impairment losses		(77,073	)		-
Ending balance	$	-		$	77,073

During the fourth quarter of 2008, we recorded a non-cash charge of $77.1 million related to the impairment of goodwill.  This write down resulted from goodwill impairment testing that was performed at the end of the fourth quarter due to the quarterly decline in the stock price and the resulting difference between the market capitalization and book value of the Corporation.  The results of the goodwill impairment testing demonstrated that the estimated fair value of the Corporation, or reporting unit, was less than the book value, resulting in full impairment.  This impairment charge had no effect on our cash balances or liquidity.  In addition, because goodwill is not included in the calculation of regulatory capital, the Corporation’s and Bank’s regulatory ratios were not affected by this non-cash expense.

The gross carrying amount, accumulated amortization and net carrying amount of amortized intangible assets for the years ended December 31 are as follows (in thousands):

2008
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Core deposit intangible	$	1,054	$	(434	)	$	620
Other		489		(315	)		174
Total amortized intangible assets	$	1,543	$	(749	)	$	794

2007
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Core deposit intangible	$	1,054	$	(256	)	$	798
Other		489		(210	)		279
Total amortized intangible assets	$	1,543	$	(466	)	$	1,077

Intangible amortization expense of $283 thousand, $235 thousand and $231 thousand was included in other noninterest expense for the years ended December 31, 2008, 2007 and 2006, respectively.

-23-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 8: Interest Bearing Deposits

The major classifications of interest bearing deposits at December 31 are as follows (in thousands):

	2008		2007
Money market, sweep and NOW accounts	$	325,554	$	745,780
Savings		365,114		254,722
Time deposits, $100,000 and over		1,430,685		832,373
Other time deposits		758,361		719,835
Total interest bearing deposits	$	2,879,714	$	2,552,710

At December 31, 2008, the scheduled maturities of time deposits are as follows (in thousands):

Year Ending December 31,	2009	$	1,882,705
	2010		211,022
	2011		31,951
	2012		41,469
	2013		19,664
	Thereafter		2,235
		$	2,189,046

Note 9: Credit Arrangements

We are a member of the Federal Home Loan Bank (“FHLB”) of Seattle. As a member, we have a committed line of credit up to approximately 15% of total Bank assets, or $617.2 million, at December 31, 2008.

At December 31, 2008, committed lines of credit agreements totaling approximately $12.0 million were available to us from an unaffiliated bank.  There were no outstanding balances related to this line of credit at December 31, 2008.  Such lines generally provide for interest at the lending bank's federal funds rate or other money market rates.  Subsequent to December 31, 2008, we were notified that this unsecured credit agreement has been suspended.

Note 10: Federal Home Loan Bank Advances

Contractual maturities of FHLB advances as of December 31, 2008 are shown below (in thousands).  Expected maturities may differ from contractual maturities because FHLB has the right to call without penalties.

		Amount		Interest Rates
Year Ending December 31,	2009	$	68,146		2.44% - 4.49	%
	2010		65,786		3.03% - 4.93	%
	2011		-		-
	2012		100,485		3.87% - 4.97	%
	2013		100,000		3.04	%
	Thereafter		95,000		3.71% - 4.66	%
		$	429,417

Advances from FHLB are collateralized by qualifying first mortgage loans, qualifying commercial real estate and government agency securities, as required by the agreement with FHLB.

-24-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 10: Federal Home Loan Bank Advances (continued)

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

	2008			2007
Maximum outstanding at any month end	$	429,417		$	341,704
Average outstanding		340,350			294,169
Weighted average interest rates
Annual		4.09	%		4.15	%
End of year		3.91	%		4.43	%

Note 11: Securities Sold Under Agreements to Repurchase

We have sold certain securities of the U.S. Government and its agencies and other approved investments under agreements to repurchase on a short-term basis. The securities underlying the agreements were held by a safekeeping agent and had an amortized cost of $26.1 million and fair values of $26.3 million as of December 31, 2008 (see Note 4).  Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction.  We may be required to provide additional collateral based on the fair value of the underlying securities.

Securities sold under agreement to repurchase were $14.8 million at December 31, 2008, and $34.6 million at December 31, 2007.  The average daily balance of outstanding agreements during the period was $28.8 million in 2008 and $11.5 million in 2007, with maximum outstanding agreements at any month end of $40.1 million and $34.6 million, respectively.

Note 12: Junior Subordinated Debentures

On February 1, 2006, we acquired 100 percent of the outstanding shares of NorthStar Financial Corporation.  As part of the transaction, we acquired two statutory business trusts which had been formed in December of 2004.  NorthStar Financial Corporation Statutory Trust I (“Trust I”) and NorthStar Financial Corporation Statutory Trust II (“Trust II”), collectively the Trusts, were formed for the exclusive purposes of issuing and selling capital securities and utilizing the proceeds to acquire junior subordinated debt.

The Trusts raised $5.2 million in cash through the issuance of $5.0 million of trust preferred securities and $156 thousand of common stock. The trust preferred securities are owned by third parties and the common stock is owned by the Corporation.  The proceeds from the sale of the trust preferred securities and the common stock were invested by the Trusts in $5.2 million of junior subordinated debentures issued by NorthStar Financial Corporation and assumed by us in the acquisition.  On the December 31, 2008, balance sheet, the $5.2 million of junior subordinated debentures is reflected as a liability and the $156 thousand of common stock of the Trusts is included in other assets.  There were $5.0 million in trust preferred securities outstanding at December 31, 2008.

The Trusts accrue interest and make cash distributions on the trust preferred securities periodically at rates specified in the trust agreement.  The interest rate on Trust I trust preferred securities is fixed at 6.0%.  The interest rate on Trust II trust preferred securities is the Three-Month Libor rate plus 2%, and is adjusted quarterly.  As of December 31, 2008, the interest rate on Trust II trust preferred securities was 4.15%.  We pay interest on the junior subordinated debentures to the Trusts equal to the rate at which the Trusts accrue and pay interest on their trust preferred securities.  Interest expense incurred on the junior subordinated debentures totaled $288 thousand for the year ended December 31, 2008.

The junior subordinated debentures mature in February 2035.  The Trust’s trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures.  In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Trust’s trust preferred securities are redeemable by us in whole before February 23, 2010, at 100% of the liquidation amount.  Upon approval of the Federal Reserve, we may redeem the Trust’s trust preferred securities in whole or in part on or after February 23, 2010, at 100% of the liquidation amount.  We fully and unconditionally guarantee the Trust’s trust preferred securities.  As of December 31, 2008, $5.0 million of the Trust’s preferred securities qualify as Tier I capital under the guidelines of the Federal Reserve.

-25-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 13: Income Taxes

The components of the provision for income tax for the years ended December 31, are as follows (in thousands):

	2008			2007			2006
Current	$	11,796		$	43,066		$	37,090
Deferred		(20,431	)		(5,480	)		(1,721	)
Provision (benefit) for income tax	$	(8,635	)	$	37,586		$	35,369

The following table shows the nature and components of the net deferred tax assets, established at an estimated tax rate of 35%, at December 31 (in thousands):

	2008			2007
Deferred tax assets
Allowance for possible loan losses, in excess of tax reserves	$	40,260		$	20,159
Intangible assets		900			1,468
Unrealized loss on available for sale securities		1,459			-
Other deferred tax assets		2,097			892
Total deferred tax assets		44,716			22,519
Deferred tax liabilities
FHLB stock dividends		(2,589	)		(2,574	)
Deferred loan fees		(2,239	)		(1,964	)
Unrealized gain on available for sale securities		-			(2,626	)
Other deferred tax liabilities		(1,892	)		(1,875	)
Total deferred tax liabilities		(6,720	)		(9,039	)
Net deferred tax assets	$	37,996		$	13,480

We believe, based upon 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 for the years ended December 31 is as follows (in thousands):

	2008						2007						2006
	Amount			Rate			Amount			Rate			Amount			Rate
Income tax provision (benefit) at statutory rate	$	(34,627	)		(35	%)	$	39,034			35	%	$	36,498			35	%
Effect of nontaxable interest income		(1,123	)		(1	%)		(1,085	)		(1	%)		(1,129	)		(1	%)
Goodwill		27,131			27	%		-			-			-			-
Other		(16	)		-			(363	)		-			-			-
Income tax provision (benefit) at effective rate	$	(8,635	)		(9	%)	$	37,586			34	%	$	35,369			34	%

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007 (“FIN 48”).  ThisInterpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  We had no unrecognized tax benefits which would require an adjustment to the January 1, 2007, beginning balance of retained earnings.  We had no unrecognized tax benefits at January 1, 2007, December 31, 2007 or December 31, 2008.

We recognize interest accrued and penalties related to unrecognized tax benefits in tax expense.  During the years ended December 31, 2008, and 2007, we recognized no interest or penalties.

We file federal and various state and local income tax returns.  With few exceptions, we are no longer subject to U.S. federal or state/local income tax examinations by tax authorities for years before 2006.             

-26-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 14: Shareholders’ Equity and Regulatory Matters

We are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The minimum ratios and the actual capital ratios for the year ended December 31, 2008 and 2007 are set forth in the table below (in thousands).

						To Be Well
						Capitalized Under
						Prompt Corrective					For Capital
	Actual					Action Provisions					Adequacy Purposes
2008	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to risk
weighted assets)
Consolidated	$	402,612		10.91	%		N/A		N/A		$	295,126		8.00	%
Frontier Bank		390,260		10.55	%		370,006		10.00	%		296,005		8.00	%
Tier I Capital (to risk
weighted assets)
Consolidated		355,653		9.64	%		N/A		N/A			147,563		4.00	%
Frontier Bank		343,165		9.27	%		222,003		6.00	%		148,002		4.00	%
Tier I Capital (to
average assets)
Consolidated		355,653		8.62	%		N/A		N/A			164,981		4.00	%
Frontier Bank		343,165		8.53	%		201,146		5.00	%		160,917		4.00	%

2007
Total Capital (to risk
weighted assets)
Consolidated	$	429,227	11.38	%	N/A	N/A		$	301,664	8.00	%
Frontier Bank		397,844	10.62	%	374,529	10.00	%		299,623	8.00	%
Tier I Capital (to risk
weighted assets)
Consolidated		381,962	10.13	%	N/A	N/A			150,833	4.00	%
Frontier Bank		350,935	9.37	%	224,718	6.00	%		149,812	4.00	%
Tier I Capital (to
average assets)
Consolidated		381,962	10.55	%	N/A	N/A			144,841	4.00	%
Frontier Bank		350,935	9.74	%	180,136	5.00	%		144,109	4.00	%

-27-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 14: Shareholders’ Equity and Regulatory Matters (continued)

During the third quarter of 2008, the Board of Directors reduced the quarterly cash dividend to $0.06 per share from $0.18 per share, the rate paid in the second quarter of 2008, in an effort to preserve capital.  For the year ended December 31, 2008, we paid cash dividends totaling $22.4 million, compared to $29.0 million for the year ended December 31, 2007.  In an effort to further preserve capital, the Board of Directors voted to suspend the quarterly cash dividend, beginning with the first quarter of 2009.

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 (approximately $10.0 million at December 31, 2008, and $8.6 million at December 31, 2007).

Note 15: Share-Based Compensation Plans

Stock Incentive Plan

In 2006, Shareholders approved a Stock Incentive Plan (the “Plan”) to promote the best interest of the Corporation, our subsidiaries and our shareholders, by providing an incentive to those key employees who contribute to our success.  The Plan allows for incentive stock options, stock grants and stock appreciation rights to be awarded.  The maximum number of shares that may be issued under the Plan is 5,250,000 common shares.  At December 31, 2008, 4,378,358 common shares were available for grant.  Shares issued and outstanding are adjusted to reflect common stock dividends, splits, recapitalization or reorganization. The Board of Directors make available sufficient shares for each award granted.  Options are granted at fair market value, generally vest over three years and expire ten years from the date of grant.  Dividends are paid on stock grants but not on incentive stock options.  Certain options provide for accelerated vesting if there is a change in control.

We use the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The expected term of the options is developed by considering the historical share option exercise experience, historical share retention practices of employees and assumptions about their propensity for early exercise in the future.  Expected volatility is estimated using daily historical volatility. We believe that historical volatility is currently the best estimate of expected volatility.  The dividend yield is the annualized yield on our common stock on the date of grant. The risk free interest rate is the yield on the grant date of U.S. Treasury zero coupon issues with a maturity comparable to theexpected term of the option. The assumptions used in the Black-Scholes pricing model and the weighted average grant date fair value of options granted for  the  years ended December 31, 2008, 2007 and 2006, were as follows:

	Years Ended December 31,
	2008			2007			2006
Risk-free interest rate		1.53	%		3.41	%		4.60	%
Expected dividends		3.63	%		2.45	%		1.68	%
Expected volatility		50.72	%		36.50	%		35.61	%
Expected term (in years)		6.1			5.7			3.2
Weighted average grant date fair value	$	1.05		$	5.79		$	8.06

-28-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 15: Share-Based Compensation Plans (continued)

A summary of option activity under the Plan, as of December 31, 2008, and changes during the year then ended are as follows:

						Weighted		Aggregate
						Average		Intrinsic
	Options			Weighted Average		Contractual		Value
	Outstanding			Exercise Price		Term		(Thousands)
Outstanding, January 1, 2008		1,331,490		$	18.24
Granted		150,750			3.02
Exercised		(31,125	)		12.55
Forfeited/Expired		(76,381	)		18.50
Outstanding, December 31, 2008		1,374,734		$	16.69		6.3	$	198
Exercisable at December 31, 2008		1,009,946		$	16.93		5.3	$	18

A summary of the status of the nonvested stock awards, as of December 31, 2008, and changes during the year then ended, are presented below:

				Weighted Average
				Grant-Date
	Shares			Fair Value
Nonvested at January 1, 2008		231,799		$	22.64
Awarded		183,150			6.11
Released		(128,753	)		21.93
Forfeited		(16,434	)		22.67
Nonvested at December 31, 2008		269,762		$	11.74

As of December 31, 2008, there was $4.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over a weighted-average period of 1.7 years.  The total compensation cost that has been charged against income for the Plan was $3.4 million in 2008, $2.6 million in 2007 and $1.2 million in 2006.  The total income tax benefit recognized in the income statement for share-based compensation arrangements was $1.2 million in 2008, $904 thousand in 2007 and $430 thousand in 2006.

The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006, was $160 thousand, $1.6 million and $4.8 million, respectively.  Cash received from option exercises under all share-based payment arrangements for the years ended December 31, 2008, 2007 and 2006 was $391 thousand, $1.9 million and $4.2 million, respectively.  The actual tax benefit realized for the tax deductions from option exercises of the share-based payment arrangements totaled $ 49 thousand, $237 thousand and $1.2 million, respectively, for the years ended December 31, 2008, 2007 and 2006.

1999 Employee Stock Award Plan

In 1999, we adopted the 1999 Employee Stock Award Plan to recognize, motivate and reward eligible employees for longstanding performance with us and our subsidiaries.  Employees eligible to receive stock awards under this Plan must have been employees for at least 20 years, or some other tenure as determined from time to time by the Board of Directors.  The maximum number of shares that may be issued is 45,000 and is adjusted to reflect future common share dividends, splits, recapitalization or reorganization.  The stock awards vest immediately when granted.  In 2008, there were 1,470 shares with a fair value of $25 thousand awarded and vested to employees.  In 2007 and 2006, there were 564 and 813 shares with fair values of $15 thousand and $17 thousand, respectively, awarded and vested under this Plan.  At December 31, 2008, there have been 9,256 shares issued under this Plan, with 35,744 shares remaining.  The Plan is effective for ten years from adoption.

-29-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 16: Employee Benefit Plan

We have a profit sharing and salary deferral plan that covers eligible employees.  Contributions to the plan were $1.5 million in 2008, $4.7 million in 2007, and $4.3 million in 2006.  Contributions to the profit sharing plan are discretionary, with a minimum of 6% of employee compensation.  For the year ended December 31, 2008, the Board of Directors elected not to make a contribution to the profit sharing plan as a result of the 2008 reported net loss.  Employer contributions are funded during the period in which it is committed by the Board of Directors.

Note 17: Earnings (Loss) per Share

The numerators and denominators of basic and fully diluted earnings (loss) per share are as follows (in thousands, except for number of shares and per share amounts):

	2008			2007		2006
Net income (loss)	$	(89,737	)	$	73,938	$	68,910
Shares used in the calculation
Weighted average shares outstanding		46,991,625			45,265,723		45,009,526
Effect of dilutive stock options		-			335,343		475,461
Diluted shares		46,991,625			45,601,066		45,484,987
Basic earnings (loss) per share	$	(1.91	)	$	1.63	$	1.53
Diluted earnings (loss) per share	$	(1.91	)	$	1.62	$	1.52

Note 18: Related Party Transactions

Loans to directors, executive officers and their affiliates are subject to regulatory limitations.  Such loans had aggregate balances and activity during 2008, 2007 and 2006, as follows (in thousands), and were within regulatory limitations:

	2008			2007			2006
Balance at beginning of year	$	52,649		$	85,277		$	72,700
New loans or advances		6,471			10,089			23,342
Repayments		(2,132	)		(42,717	)		(10,765	)
Balance at end of year	$	56,988		$	52,649		$	85,277

Total deposits beneficially owned by related parties were $3.2 million, $4.2 million and $6.4 million at December 31, 2008, 2007 and 2006, respectively.

-30-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 19: Commitments and Contingent Liabilities

We lease various branch offices under agreements, which expire between 2009 and 2034. The agreements contain various renewal options and generally require us to maintain the properties.

The total future minimum lease commitments through 2013, and thereafter, are as follows (in thousands):

Year ending December 31,	2009	$	1,900
	2010		1,633
	2011		1,346
	2012		886
	2013		845
	Thereafter		1,064
		$	7,674

Rental expense charged to operations was $2.1 million in 2008, $2.3 million in 2007 and $1.9 million in 2006.

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

Our exposure to credit loss in the event of nonperformance by the other party to the instrument for commitments to extend credit, standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Our 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. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income-producing commercial properties.

Standby letters of credit and financial guarantees written are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, bond financing and similar transactions. We underwrite our standby letters of credit using our policies and procedures applicable to loans in general. Standby letters of credit are made on an unsecured and secured basis. We have not been required to perform on any financial guarantees during the past two years. We have not incurred any material losses on our commitments in 2008, 2007 or 2006.

A summary of the notional amount of financial instruments with off-balance sheet risk at December 31, 2008, is as follows (in thousands):

	Amount
Commitments to extend credit	$	484,407
Credit card arrangements		44,537
Standby and commercial letters of credit		18,133
	$	547,077

We are a defendant in certain claims and legal actions arising in the ordinary course of business.  In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on our financial condition or results of operations.

-31-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 20: Fair Value Measurements

As discussed in Note 1, SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active exchange markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following is a description of the valuation methodologies used to measure and report fair value of financial assets and liabilities on a recurring or nonrecurring basis:

Securities

Securities available for sale are recorded at fair value on a recurring basis.  Fair value is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1), through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily available (Level 2) or by using a discounted cash flow model (Level 3).

Loans Held for Resale

Mortgage loans originated and designated as held for resale are carried at the lower of cost or estimated fair value, as determined by quoted market prices, where applicable, or the prices for other mortgage loans with similar characteristics, in aggregate, and are measured on a nonrecurring basis (Level 2).  At December 31, 2008, loans held for resale were carried at cost.

Impaired Loans

From time to time, and on a nonrecurring basis, fair value adjustments to collateral dependent loans are recorded to reflect partial write-downs based on the current appraised value of the collateral or internally developed models which contain management’s assumptions.

-32-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 20: Fair Value Measurements (continued)

Other Real Estate Owned

Other real estate owned (“OREO”) consists principally of properties acquired through foreclosure and are carried at the lower of cost or estimated market value less selling costs.  Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell.

The following table presents the balances of assets measured at fair value on a recurring basis at December 31, 2008 (in thousands):

	Fair Value at December 31, 2008
	Level 1		Level 2		Level 3		Total
Available for sale securities
Equities	$	1,327	$	603	$	-	$	1,930
U.S. Treasuries		-		6,457		-		6,457
U.S. Agencies		-		52,055		-		52,055
Corporate securities		-		2,939		1,500		4,439
Mortgage-backed securities		-		22,791		-		22,791
Municipal securities		-		2,934		-		2,934
Total	$	1,327	$	87,779	$	1,500	$	90,606

The following table presents the fair value adjustments using significant unobservable inputs (Level 3) for the year ended December 31, 2008 (in thousand):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Beginning balance	$	-
Total gains or losses recognized		-
Purchases		-
Transfers in and/or out of Level 3		1,500
Ending balance	$	1,500

At December 31, 2008, we valued investments in a single issuer trust preferred security at par value.  As a result of unprecedented disruptions of certain financial markets, we determined that there were insufficient transactions or other market indicators to accurately determine the fair value of this security.  This determination is considered a Level 3 input.

-33-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 20: Fair Value Measurements (continued)

The following table presents the balance of assets measured at fair value on a nonrecurring basis at December 31, 2008, and the total losses resulting from these fair value adjustments for the year ended December 31, 2008 (in thousands):

	Fair Value at December 31, 2008								For the Year Ended December 31, 2008
	Level 1		Level 2		Level 3		Total		Total Losses
Impaired loans (1)	$	-	$	-	$	268,193	$	268,193	$	60,828
OREO (2)		-		-		10,803		10,803		3,880
	$	-	$	-	$	278,996	$	278,996	$	64,708

(1)   The loss represents charge offs or impairments on collateral dependent loans for fair value adjustments based on the fair value of the collateral.

(2)   The loss represents charge offs or impairments on other real estate owned for fair value adjustments based on the fair value of the real estate.

There were no material liabilities carried at fair value, measured on a recurring or nonrecurring basis, at December 31, 2008.

Note 21: 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.  We determined the estimated fair value amounts using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data in the development of the estimates of fair value. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.  The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value.

Cash Equivalents and Federal Funds Sold - For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities - Securities fair values 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.

Loans Held for Resale - For loans held for resale, carrying value approximates fair value.

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.

Bank Owned Life Insurance - The fair value of Bank owned life insurance policies are based on cash surrender value of the insurance contract.

Deposits and Federal Funds Purchased - The fair value of demand deposits, savings accounts, certain money market deposits, and federal funds purchased, is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

FHLB Advances and Securities Sold Under Agreements to Repurchase- Fair value is determined by discounting future cash flows using rates currently available to the Bank for debt with similar terms and remaining maturities.

Junior Subordinated Debentures - The fair value of junior subordinated debentures is estimated using a discounted cash flow model.

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 19). The fair value of these commitments is not material.

-34-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 21: Fair Value of Financial Instruments (continued)

The estimated fair values at December 31 are as follows (in thousands):

	2008				2007
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Assets
Cash and due from banks	$	52,022	$	52,022	$	99,102	$	99,102
Federal funds sold		117,740		117,740		5		5
Securities
Available for sale		90,606		90,606		131,378		131,378
Held to maturity		3,085		3,340		3,743		3,766
Loans held for resale		6,678		6,678		6,227		6,227
Loans, net		3,666,177		3,714,492		3,558,127		3,639,120
Bank owned life insurance		24,321		24,321		23,734		23,734
Liabilities
Noninterest bearing deposits		395,451		395,451		390,526		390,526
Interest bearing deposits		2,879,714		2,909,730		2,552,710		2,574,268
Federal funds purchased and securities
sold under agreements to repurchase		21,616		21,616		258,145		258,145
FHLB Advances		429,417		444,441		298,636		298,105
Junior subordinated debentures		5,156		1,676		5,156		4,976

Note 22: Parent Company (Only) Financial Information

Condensed balance sheets for Frontier Financial Corporation (only) at December 31 are as follows (in thousands):

	2008			2007
ASSETS
Cash	$	5,702		$	-
Investment in subsidiaries
Bank		346,336			350,717
Nonbank		-			16,539
Available for sale securities, at fair value		2,847			32,315
Other assets		2,343			73,754
Total assets	$	357,228		$	473,325
LIABILITIES
Other liabilities	$	5,185		$	13,713
SHAREHOLDERS' EQUITY
Common stock		256,137			252,292
Retained earnings		98,020			202,453
Accumulated other comprehensive income, net of tax		(2,114	)		4,867
Total shareholders' equity		352,043			459,612
Total liabilities and shareholders' equity	$	357,228		$	473,325

-35-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 22: Parent Company (Only) Financial Information (continued)

Condensed statements of income for Frontier Financial Corporation (only) for the years ended December 31 are as follows (in thousands):

	2008			2007		2006
Income
Dividends from Bank	$	9,471		$	70,769	$	23,846
Dividends from FFP		414			800		1,100
Other dividends		332			819		526
Interest		174			177		186
Provision for loss on  impairment of securities		(460	)		-		-
Gain on sale of securities		4,575			-		-
Other income		-			21		32
Total income		14,506			72,586		25,690
Expenses
Personnel		3,399			2,523		677
Depreciation and amortization		238			260		267
Goodwill impairment		77,073			-		-
Other		1,881			2,457		1,934
Total expenses		82,591			5,240		2,878
Income (loss) before equity in undistributed income
of subsidiaries and benefit equivalent to income tax		(68,085	)		67,346		22,812
Income tax benefit		342			1,566		800
Income (loss) before equity in undistributed income
of subsidiaries		(67,743	)		68,912		23,612
Equity in undistributed income (loss) of subsidiaries		(21,994	)		5,026		45,298
Net income (loss)	$	(89,737	)	$	73,938	$	68,910

-36-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 22: Parent Company (Only) Financial Information (continued)

Condensed statements of cash flows for the years ended December 31 (in thousands):

	2008			2007			2006
Cash flows from operating activities
Net income (loss)	$	(89,737	)	$	73,938		$	68,910
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Equity in undistributed (income) loss of subsidiaries		21,994			(5,026	)		(45,298	)
Depreciation and amortization		238			260			267
Provision for loss on impairment of securities		460			-			-
Gain on sale of available for sale securities		(4,575	)		-			-
Stock option expense		2,707			1,691			73
Stock award plan compensation		700			892			1,156
Excess tax benefits associated with stock-based
compensation		(49	)		(237	)		(1,205	)
Goodwill impairment		77,073			-			-
Other operating activities		229			(1,940	)		(743	)
Net cash flows provided by operating activities		9,040			69,578			23,160
Cash flows from investing activities
Purchase of available for sale securities		-			-			(5,496	)
Proceeds from sale of available for sale securities		20,941			-			-
Proceeds from maturity of available for sale securities		-			460			-
Other investment activities		(2,214	)		(139	)		(390	)
Net cash flows provided by (used in)
investing activities		18,727			321			(5,886	)
Cash flows from financing activities
Stock options exercised		391			1,861			4,218
Cash dividends paid to shareholders		(22,433	)		(29,045	)		(22,358	)
Repurchase of common stock		-			(44,384	)		-
Excess tax benefits associated with stock-based
compensation		49			237			1,205
Other financing activities		(72	)		75			712
Net cash flows used in financing activities	$	(22,065	)	$	(71,256	)	$	(16,223	)
Increase (decrease) in cash	$	5,702		$	(1,357	)	$	1,051
Cash at beginning of year		-			1,357			306
Cash at end of year	$	5,702		$	-		$	1,357

-37-

FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 23: Unaudited Quarterly Financial Data - Condensed Consolidated Statement of Income

(In thousands)	2008 Quarter Ended
	(Unaudited)
	December 31			September 30			June 30		March 31
Interest income	$	60,392		$	68,821		$	72,342	$	77,500
Interest expense		26,537			28,095			27,451		30,102
Net interest income		33,855			40,726			44,891		47,398
Provision for loan losses		44,400			42,100			24,500		9,000
Net interest income (loss) after provision
for loan losses		(10,545	)		(1,374	)		20,391		38,398
Non interest income		7,502			(3,173	)		4,198		6,303
Non interest expense		94,937			22,057			21,533		21,545
Income (loss) before income tax		(97,980	)		(26,604	)		3,056		23,156
Provision (benefit) for income tax		(8,464	)		(8,808	)		982		7,655
Net income (loss)	$	(89,516	)	$	(17,796	)	$	2,074	$	15,501
Basic earnings (losses) per share	$	(1.90	)	$	(0.38	)	$	0.04	$	0.33
Diluted earnings (losses) per share	$	(1.90	)	$	(0.38	)	$	0.04	$	0.33
Weighted average basic shares outstanding		47,038,400			47,010,944			47,006,729		46,985,320
Weighted average diluted shares outstanding		47,038,400			47,010,944			47,069,136		47,098,645

	2007 Quarter Ended
	(Unaudited)
	December 31		September 30		June 30		March 31
Interest income	$	79,404	$	77,748	$	73,997	$	68,523
Interest expense		29,883		29,566		27,788		25,804
Net interest income		49,521		48,182		46,209		42,719
Provision for loan losses		6,000		2,100		1,850		1,450
Net interest income after provision
for loan losses		43,521		46,082		44,359		41,269
Non interest income		3,802		3,538		2,562		3,407
Non interest expense		20,226		19,137		19,506		18,147
Income before income tax		27,097		30,483		27,415		26,529
Provision for income tax		9,080		10,256		9,244		9,006
Net income	$	18,017	$	20,227	$	18,171	$	17,523
Basic earnings per share	$	0.40	$	0.46	$	0.41	$	0.39
Diluted earnings per share	$	0.40	$	0.46	$	0.40	$	0.38
Weighted average basic shares outstanding		44,645,895		44,033,951		44,635,972		45,176,326
Weighted average diluted shares outstanding		44,871,141		44,332,276		44,991,139		45,624,490

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