UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2015

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 000-29829

 

PACIFIC FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Washington		91-1815009
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

 

1101 S. Boone Street

Aberdeen, Washington 98520-5244

(Address of principal executive offices) (Zip Code)

 

(360) 533-8870

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨

Accelerated filer  ¨

Non-accelerated filer ¨

Smaller Reporting Company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

The number of shares outstanding of Registrant's common stock as of April 30, 2015 was 10,380,492.

 

 

Form 10-Q

Table of Contents

 

Part I	FINANCIAL INFORMATION
Item I.	FINANCIAL STATEMENTS (UNAUDITED)	2
	CONDENSED CONSOLIDATED BALANCE SHEETS MARCH 31, 2015 AND DECEMBER 31, 2014	2
	CONDENSED CONSOLIDATED STATEMENTS OF INCOME THREE MONTHS ENDED MARCH 31, 2015 AND 2014	3
	CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME THREE MARCH 31, 2015 AND 2014	4
	CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY THREE MONTHS ENDED MARCH 31, 2015 AND 2014	5
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 2015 AND 2014	6
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	7
Item 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	33
Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	46
Item 4.	CONTROLS AND PROCEDURES	46
Part II	OTHER INFORMATION
Item 1.	LEGAL PROCEEDINGS	47
Item 1A.	RISK FACTORS	47
Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	47
Item 3.	DEFAULTS UPON SENIOR SECURITIES	47
Item 4.	MINE SAFETY DISCLOSURES	47
Item 5.	OTHER INFORMATION	47
Item 6.	EXHIBITS	48
SIGNATURES		49

 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, except per share data)

(UNAUDITED)

 

		March 31,				December 31,
		2015				2014
ASSETS
Cash and cash equivalents:
Cash and due from banks		$	15,321			$	14,782
Interest-bearing deposits in banks			12,282				16,255
Total cash and cash equivalents			27,603				31,037
Interest-bearing certificates of deposit (original maturities greater than 90 days)			2,727				2,727
Federal Home Loan Bank stock, at cost			2,865				2,896
Pacific Coast Bankers' Bank stock, at cost			1,000				1,000
Investment securities:
Investment securities available-for-sale, at fair market value (amortized cost of $91,982 and 86,907)			93,194				87,440
Investment securities held-to-maturity, at amortized cost (fair value of $1,832 and $1,852)			1,815				1,829
Total investment securities			95,009				89,269
Loans held-for-sale			10,780				5,786
Loans, net of deferred loan fees			572,783				563,099
Allowance for loan losses			(8,254	)			(8,353	)
Loans, net			564,529				554,746
Premises and equipment, net of accumulated depreciation and amortization			16,165				16,303
Other real estate owned and foreclosed assets			1,124				999
Accrued interest receivable			2,524				2,348
Cash surrender value of life insurance			18,863				18,742
Goodwill			12,168				12,168
Other intangible assets			1,430				1,439
Other assets			5,309				5,347
TOTAL ASSETS		$	762,096			$	744,807
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand		$	167,264			$	165,760
Interest-bearing demand and savings			374,429				354,611
Time deposits			115,419				118,683
Total deposits			657,112				639,054
Accrued interest payable			140				145
Long-term borrowings			11,416				11,453
Junior subordinated debentures			13,403				13,403
Other liabilities			5,888				8,269
Total liabilities			687,959				672,324
Preferred Stock, par value none 5,000,000 shares authorized, none outstanding			-				-
Common Stock, par value $1 25,000,000 shares authorized, 10,380,492 shares issued and outstanding at 03/31/2015 and 10,371,460 at 12/31/2014			10,380				10,371
Additional paid-in-capital			43,056				42,991
Retained earnings			20,352				19,256
Accumulated other comprehensive income (loss)			349				(135	)
Total shareholders' equity			74,137				72,483
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	762,096			$	744,807

 

See accompanying notes.

 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except per Share Data)

(UNAUDITED)

 

		For the Three Months Ended
		March 31,				March 31,
		2015				2014
INTEREST AND DIVIDEND INCOME
Loans		$	6,923			$	6,495
Deposits in banks and federal funds sold			20				21
Securities available for sale:
Taxable			301				337
Tax-exempt			166				207
Securities held to maturity:
Taxable			2				2
Tax-exempt			19				22
FHLB & PCBB dividends			1				1
Total interest and dividend income			7,432				7,085
INTEREST EXPENSE
Deposits:
Interest-bearing demand and savings			151				141
Time			242				276
Long-term borrowings			56				53
Junior subordinated debentures			60				60
Total interest expense			509				530
Net interest income			6,923				6,555
LOAN LOSS PROVISION			30				-
Net interest income after loan loss provision			6,893				6,555
NON-INTEREST INCOME
Service charges on deposit accounts			426				435
Net loss on sale of other real estate owned			(6	)			(36	)
Net gains from sales of loans			954				627
Net gains on sales of securities available for sale			-				52
Net other-than-temporary impairment			-				(45	)
Earnings on bank owned life insurance			121				111
Other operating income			478				464
Total non-interest income			1,973				1,608
NON-INTEREST EXPENSE
Salaries and employee benefits			4,578				4,055
Occupancy			522				506
Equipment			267				252
Data processing			513				468
Professional services			168				196
Other real estate owned write-downs			31				12
Other real estate owned operating costs			17				61
State taxes			102				97
FDIC and state assessments			133				134
Other non-interest expense			1,153				1,049
Total non-interest expense			7,484				6,830
INCOME BEFORE PROVISION FOR INCOME TAXES			1,382				1,333
PROVISION FOR INCOME TAXES			286				305
Effective Tax Rate			20.69	%			22.88	%
NET INCOME APPLICABLE TO COMMON SHAREHOLDERS		$	1,096			$	1,028
EARNINGS PER COMMON SHARE:
BASIC		$	0.11			$	0.10
DILUTED		$	0.10			$	0.10
WEIGHTED AVERAGE SHARES OUTSTANDING:
BASIC			10,373,563				10,182,083
DILUTED			10,505,901				10,272,341

 

See accompanying notes.

 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(UNAUDITED)

 

		For the Three Months Ended
		March 31,				March 31,
		2015				2014
NET INCOME		$	1,096			$	1,028
OTHER COMPREHENSIVE INCOME, NET OF TAX:
Change in fair value of securities available-for-sale			449				366
Defined benefit plan			35				29
Total other comprehensive income, net of tax			484				395
COMPREHENSIVE INCOME		$	1,580			$	1,423

 

See accompanying notes.

 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(Dollars in Thousands, Except Share Amounts)

(UNAUDITED)

 

																		Accumulated
		Common Stock								Additional				Retained				Other Comprehensive				Total Shareholders'
		Shares				Amount				Paid-in Capital				Earnings				Income/(Loss)				Equity
BALANCE - December 31, 2013			10,182,083			$	10,182			$	41,817			$	16,507			$	(1,369	)		$	67,137
Net income			-				-				-				1,028				-				1,028
Other comprehensive income, net of tax
Unrealized holding loss on securities less reclassification adjustments for net gains included in net income			-				-				-				-				366				366
Amortization of unrecognized prior service costs and net gains			-				-				-				-				29				29
Stock-based compensation expense			-				-				35				-				-				35
BALANCE - March 31, 2014			10,182,083			$	10,182			$	41,852			$	17,535			$	(974	)		$	68,595
BALANCE - December 31, 2014			10,371,460			$	10,371			$	42,991			$	19,256			$	(135	)		$	72,483
Net income			-				-				-				1,096				-				1,096
Other comprehensive income, net of tax
Unrealized holding gain on securities less reclassification adjustments for net gains included in net income			-				-				-				-				449				449
Amortization of unrecognized prior service costs and net gains			-				-				-				-				35				35
Issuance of common stock			9,032				9				32				-				-				41
Stock-based compensation expense			-				-				33				-				-				33
BALANCE - March 31, 2015			10,380,492			$	10,380			$	43,056			$	20,352			$	349			$	74,137

 

See accompanying notes.

 

 

PACIFIC FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(UNAUDITED)

 

		March 31,				March 31,
		2015				2014
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income		$	1,096			$	1,028
Adjustments to reconcile net income to net cash from operating activities
Loan loss provision			30				-
Depreciation and amortization			684				467
Originations of loans held for sale			(42,706	)			(27,065	)
Proceeds from sales of loans held for sale			38,666				27,460
Net gain on sales of loans			(954	)			(627	)
Net gain on sales of securities available for sale			-				(52	)
Net OTTI recognized in earnings			-				45
Loss on sales of other real estate owned			6				36
Gain on sale of premises and equipment			-				(11	)
Earnings on bank owned life insurance			(121	)			(111	)
Increase in accrued interest receivable			(176	)			(116	)
Decrease in accrued interest payable			(4	)			(1	)
Other real estate owned write-downs			31				12
Increase in prepaid expenses			(74	)			(159	)
Other operating activities			(315	)			(39	)
Net cash (used in) provided by operating activities			(3,837	)			867
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease in interest bearing balances with banks			3,973				3,862
Activity in securities available for sale:
Sales			-				4,849
Maturities, prepayments and calls			1,828				2,237
Purchases			(7,158	)			(5,741	)
Activity in securities held to maturity:
Maturities, prepayments and calls			13				22
Purchases			-				-
Increase in loans made to customers, net of principal collections			(10,002	)			(13,959	)
Purchases of premises and equipment			(218	)			(81	)
Proceeds from sales of other real estate owned			57				396
Proceeds from sales of premises and equipment			-				8
Net cash used in investing activities			(11,507	)			(8,407	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits			18,058				13,109
Repayments of long-term debt			(38	)			-
Issuance of common stock			41				-
Cash dividends paid			(2,178	)			(2,036	)
Net cash provided by financing activities			15,883				11,073
NET INCREASE IN CASH AND CASH EQUIVALENTS			539				3,533
CASH AND DUE FROM BANKS - BEGINNING OF THE PERIOD			14,782				12,214
CASH AND DUE FROM BANKS - END OF THE PERIOD		$	15,321			$	15,747
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest		$	513			$	531
Cash paid for taxes		$	-			$	330
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES
Change in fair value of securities available-for-sale, net of tax		$	449			$	366
Other real estate owned acquired in settlement of loans		$	219			$	(111	)
Financed sale of other real estate owned		$	-			$	52

 

See accompanying notes.

 

 

PACIFIC FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

As of and for the three months ended March 31, 2015

(Unaudited)

(Dollars in thousands, except per share amounts)

 

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Organization – Pacific Financial Corporation (the “Company” or “Pacific”) is a bank holding company headquartered in Aberdeen, Washington. The Company owns one bank, Bank of the Pacific (the “Bank”), which is also headquartered in Washington. The Company was incorporated in the State of Washington in February, 1997, pursuant to a holding company reorganization of the Bank.

 

The Company conducts its banking business through the Bank, which operates 17 branches located in communities in Grays Harbor, Pacific, Whatcom, Clark, Skagit and Wahkiakum counties in the state of Washington and three in Clatsop County, Oregon. In addition, the Bank operates loan production offices in Burlington and Dupont, Washington and Salem, Oregon. The Bank also operates a residential real estate mortgage department.

 

The accompanying unaudited condensed consolidated financial statements have been prepared by Pacific Financial Corporation ("Pacific" or the "Company") in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with instructions to Form 10-Q. Accordingly, these financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of Management, adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2015, are not necessarily indicative of the results anticipated for the year ending December 31, 2015. Certain information and footnote disclosures included in the Company's consolidated financial statements for the year ended December 31, 2014, have been condensed or omitted from this report. Accordingly, these statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Annual Report”).

 

On April 28, 2015, the Company, relying on Section 12(g)(4) of the Securities Exchange Act of 1934, as amended by the Jumpstart Our Business Startups Act (the "Exchange Act"), filed Form 15 to terminate the registration of its common stock under Section 12(g) of the Exchange Act. The Company intends to seek suspension or termination of its obligations to file with the Securities and Exchange Commission ("SEC") periodic and current reports under the Exchange Act, and believes that a termination or suspension will be achieved within 90 days after filing of the Form 15. Upon the effectiveness of its deregistration, the Company’s obligations to comply with the periodic and current reporting requirements of, and the proxy rules , under the Exchange Act will be terminated, as will the obligations of the Company's officers and directors to file reports under Section 16 of the Exchange Act. The Company anticipates that its common stock will continue to trade on the OTCQB exchange under its existing stock symbol “PFLC.”

 

Basis of presentation – The consolidated financial statements include the accounts of Bank of the Pacific and its wholly-owned subsidiary. All intercompany accounts and transactions have been eliminated in consolidation.

 

The interim consolidated financial statements are not audited, but include all adjustments that Management considers necessary for a fair presentation of consolidated financial condition and results of operations for the interim periods presented.

 

Method of accounting and use of estimates – The Company prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. This requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made by Management involve the calculation of the allowance for loan losses, impaired loans, the fair value of available-for-sale investment securities, deferred tax assets, and the value of other real estate owned and foreclosed assets.

 

The Company utilizes the accrual method of accounting, which recognizes income when earned and expenses when incurred.

 

In preparing these financial statements, the Company has evaluated events and transactions subsequent to March 31, 2015, for potential recognition or disclosure in the financial statements. In Management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations of the Company on the accompanying financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation.

 

 

 

Cash dividends – No cash dividends were declared in the quarter ended March 31, 2015.

 

NOTE 2 – EARNINGS PER SHARE

 

The Company’s basic earnings per common share is computed by dividing net income available to common shareholders (net income less dividends declared) by the weighted average number of common shares outstanding during the period. The Company’s diluted earnings per common share is computed similar to basic earnings per common share except that the numerator is equal to net income available to common shareholders and the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Included in the denominator are the dilutive effects of stock options computed under the treasury stock method and warrants outstanding in the first quarter 2014.

 

The following table illustrates the computation of basic and diluted earnings per share.

 

		For the Three Months Ended
		March 31,
		2015				2014
Basic:
Net income (numerator)		$	1,096			$	1,028
Weighted average shares outstanding (denominator)			10,373,563				10,182,083
Basic earnings per share		$	0.11			$	0.10
Diluted:
Net income (numerator)		$	1,096			$	1,028
Weighted average shares outstanding			10,373,563				10,182,083
Effect of dilutive stock options			132,338				90,258
Weighted average shares outstanding assuming dilution (denominator)			10,505,901				10,272,341
Diluted earnings per share		$	0.10			$	0.10
		March 31,  2015				March 31,  2014
Shares subject to outstanding options			271,800				395,895
Shares subject to outstanding warrants			-				638,920

 

As of March 31, 2015 and 2014, certain outstanding options and for March 31. 2014, warrants, had exercise prices in excess of the current market value of the underlying shares. All of these shares are not included in the table above, as exercise of these options and warrants would not be dilutive to shareholders.

 

 

NOTE 3 – INVESTMENT SECURITIES

 

Investment securities consist principally of short and intermediate term debt instruments issued by the U.S. Treasury, other U.S. government agencies, state and local government units, other corporations, and mortgage backed securities (MBS).

 

Investment securities at March 31, 2015 and December 31, 2014 consisted of the following:

(Dollars in Thousands)

 

		March 31, 2015
						Gross				Gross
		Amortized				unrealized				unrealized				Fair
		cost				gains				losses				value
Available-for-sale:
Collateralized mortgage obligations: agency issued		$	41,985			$	338			$	(215	)		$	42,108
Collateralized mortgage obligations: non-agency			514				-				(10	)			504
Mortgage-backed securities: agency issued			12,041				64				(86	)			12,019
U.S. Government and agency securities			9,944				175				(5	)			10,114
State and municipal securities			27,498				961				(10	)			28,449
Total available-for-sale		$	91,982			$	1,538			$	(326	)		$	93,194
Held-to-maturity:
Mortgage-backed securities: agency issued		$	117			$	13			$	-			$	130
State and municipal securities			1,698				4				-				1,702
Total held-to-maturity		$	1,815			$	17			$	-			$	1,832

 

		December 31, 2014
						Gross				Gross
		Amortized				unrealized				unrealized				Fair
		cost				gains				losses				value
Available-for-sale:
Collateralized mortgage obligations: agency issued		$	38,949			$	236			$	(418	)		$	38,767
Collateralized mortgage obligations: non agency			535				-				(8	)			527
Mortgage-backed securities: agency issued			12,325				39				(165	)			12,199
U.S. Government agency securities			7,977				111				(32	)			8,056
State and municipal securities			27,121				850				(80	)			27,891
Total available-for-sale		$	86,907			$	1,236			$	(703	)		$	87,440
Held-to-maturity:
Mortgage-backed securities: agency issued		$	123			$	12			$	-			$	135
State and municipal securities			1,706				11				-				1,717
Total held-to-maturity		$	1,829			$	23			$	-			$	1,852

 

 

Unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, as of March 31, 2015, and December 31, 2014, are summarized as follows:

 

(Dollars in Thousands)
		Less than 12 months								12 months or more								Total
						Unrealized								Unrealized								Unrealized
At March 31, 2015		Fair Value				Losses				Fair Value				Losses				Fair Value				Losses
Available-for-sale:
Collateralized mortgage obligations: agency issued		$	10,649			$	64			$	11,306			$	151			$	21,955			$	215
Collateralized mortgage obligations: non agency			317				2				186				8				503				10
Mortgage-backed securities: agency issued			3,068				59				4,314				27				7,382				86
U.S. Government agency securities			-				-				2,617				5				2,617				5
State and municipal securities			2,097				9				805				1				2,902				10
Total		$	16,131			$	134			$	19,228			$	192			$	35,359			$	326

 

		Less than 12 months								12 months or more								Total
						Unrealized								Unrealized								Unrealized
At December 31, 2014		Fair Value				Losses				Fair Value				Losses				Fair Value				Losses
Available-for-sale:
Collateralized mortgage obligations: agency issued		$	5,836			$	27			$	17,446			$	391			$	23,282			$	418
Collateralized mortgage obligations: non agency			335				2				192				6				527				8
Mortgage-backed securities: agency issued			2,883				80				6,888				85				9,771				165
U.S. Government agency securities			-				-				3,615				32				3,615				32
State and municipal securities			5,123				41				3,054				39				8,177				80
Total		$	14,177			$	150			$	31,195			$	553			$	45,372			$	703

 

At March 31, 2015, there were 41 investment securities in an unrealized loss position, of which 23 were in a continuous loss position for 12 months or more. The unrealized losses on these securities were caused by changes in interest rates, widening pricing spreads and market illiquidity, leading to a decline in the fair value subsequent to their purchase. The Company has evaluated the securities shown above and anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market environment. Based on management’s evaluation, and because the Company does not have the intent to sell these securities and it is not more likely than not that it will have to sell the securities before recovery of cost basis, the Company does not consider these investments to be other-than-temporarily impaired at March 31, 2015.

 

For non-agency MBS the Company estimates expected future cash flows of the underlying collateral, together with any credit enhancements. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which considers current delinquencies, future expected default rates and collateral value by vintage) and prepayments. The expected cash flows of the security are then discounted to arrive at a present value amount. For the three months ended March 31, 2015, no non-agency MBS was determined to be other-than-temporarily-impaired. For the three months ended March 31, 2014, one non-agency MBS was determined to be other-than-temporarily-impaired. This security was sold in second quarter 2014, incurring a loss of $69,000. The Company recorded $0 and $45,000 in impairments related to credit losses through earnings for the three months ended March 31, 2015 and 2014, respectively.

 

The following table presents the cash proceeds from the sales of securities and their associated gross realized gains and gross realized losses that are included in earnings for the three months ended March 31, 2015 and 2014:

 

(Dollars in Thousands)
		For the Three Months Ended
		March 31, 2015				March 31, 2014
Gross realized gain on sale of securities		$	-			$	62
Gross realized loss on sale of securities			-				(10	)
Net realized gain on sale of securities		$	-			$	52
Proceeds from sale of securities		$	-			$	4,849

 

 

The Company did not engage in originating subprime mortgage loans, and it does not believe that it has material exposure to subprime mortgage loans or subprime mortgage backed securities. Additionally, the Company does not own any sovereign debt of Eurozone nations or structured financial products, such as collateralized debt obligations or structured investment vehicles, which are known by the Company to have elevated risk characteristics.

 

The amortized cost and estimated fair value of investment securities at March 31, 2015 are shown below by contractual maturity, except collateralized mortgage obligations and mortgage-backed securities. These securities are presented by expected average life, rather than contractual maturity.  Expected maturities may differ from contractual maturities because borrowers may have the right to prepay underlying loans without prepayment penalties.

 

(Dollars in Thousands)
		Held-to-maturity								Available-for-sale
		Amortized								Amortized
		Cost				Fair Value				Cost				Fair Value
Due in one year or less		$	-			$	-			$	325			$	327
Due after one year through five years			-				-				10,605				10,656
Due after five years through ten years			1,115				1,119				13,342				13,734
Due after ten years			583				583				13,170				13,846
Declining Balance Securities			117				130				54,540				54,631
Total investment securities		$	1,815			$	1,832			$	91,982			$	93,194

 

At March 31, 2015, investment securities with an estimated fair value of $92.2 million were pledged to secure public deposits, certain nonpublic deposits and borrowings.

 

As required of all members of the Federal Home Loan Bank (FHLB) system, the Company maintains an investment in the capital stock of the FHLB in an amount equal to the greater of $500,000 or 0.5% of home mortgage loans and pass-through securities plus 5.0% of the outstanding balance of mortgage home loans sold to FHLB under the Mortgage Purchase Program. The FHLB system, the largest government sponsored entity in the United States, is made up of 12 regional banks, including the FHLB of Seattle. Participating banks record the value of FHLB stock equal to its par value at $100 per share. At March 31, 2015, the Company held approximately $2.9 million in FHLB stock.

 

The Company is required to hold FHLB’s stock in order to receive advances and views this investment as long-term. Thus, when evaluating it for impairment, the value is determined based on the recovery of the par value through redemption by the FHLB or from the sale to another member, rather than by recognizing temporary declines in value. The FHLB of Seattle disclosed that it reported net income for the twelve month period ended December 31, 2014, at which time it declared a cash dividend. The Federal Home Loan Bank of Des Moines and the FHLB of Seattle announced on February 27, 2015, that the members of both banks have ratified a Merger Agreement approved by their respective boards of directors in September 25, 2014. The merger is expected to close as of May 31, 2015, contingent on satisfaction of the conditions of the Federal Housing Finance Agency’s (FHFA) December 22, 2014, approval of the merger. The Company has concluded that its investment in FHLB is not impaired as of March 31, 2015, and believes that it will ultimately recover the par value of its investment in this stock.

 

The Company owns $1.0 million in common stock in Pacific Coast Bankers’ Bancshares (PCBB), from which the Company receives a variety of corresponding banking services through its banking subsidiary Pacific Coast Bankers’ Bank. An investment by the Company in such an entity is permissible under 12 CFR 362.3(a)(2)(iv). When evaluating this investment for impairment, the value is determined based on valuation supported by an outside consulting firm. PCBB disclosed that it reported net income for the twelve month period ended December 31, 2014 and maintains capital ratios that exceed “well capitalized” standards for regulatory purposes. Our investment in PCBB is not considered to be other-than-temporarily impaired as of March 31, 2015.

 

 

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY

 

Loans

 

Loans held in the portfolio at March 31, 2015 and December 31, 2014, are as follows:

 

(Dollars in Thousands)		March 31, 2015				December 31, 2014
Commercial and agricultural		$	119,095			$	120,517
Real estate:
Construction and development			28,831				26,711
Residential 1-4 family			91,865				92,965
Multi-family			20,287				18,541
Commercial real estate — owner occupied			130,486				125,632
Commercial real estate — non owner occupied			116,095				117,137
Farmland			21,898				22,245
Consumer			45,411				40,565
Gross loans			573,968				564,313
Less:  deferred fees			(1,185	)			(1,214	)
Portfolio Loans		$	572,783			$	563,099

 

Allowance for losses and credit quality

 

The allowance for loan losses represents the Company’s estimate as to the probable credit losses inherent in its loan portfolio. The allowance for loan losses is increased through periodic charges to earnings through provision for loan losses and represents the aggregate amount, net of loans charged-off and recoveries on previously charged-off loans, that is needed to establish an appropriate reserve for credit losses. The allowance is estimated based on a variety of factors and using a methodology as described below:

 

·

The Company classifies loans into relatively homogeneous pools by loan type in accordance with regulatory guidelines for regulatory reporting purposes. The Company regularly reviews all loans within each loan category to establish risk ratings for them that include Pass, Watch, Special Mention, Substandard, Doubtful and Loss. Pursuant to ASC 310 “Accounting by Creditors for Impairment of a Loan”, the impaired portion of collateral dependent loans is charged-off. Other risk-related loans not considered impaired have loss factors applied to the various loan pool balances to establish loss potential for provisioning purposes.

  

·

Analyses are performed to establish the loss factors based on historical experience, as well as expected losses based on qualitative evaluations of such factors as the economic trends and conditions, industry conditions, levels and trends in delinquencies and impaired loans, levels and trends in charge-offs and recoveries, among others. The loss factors are applied to loan category pools segregated by risk classification to estimate the loss inherent in the Company’s loan portfolio pursuant to ASC 450 “Accounting for Contingencies.”

 

·

Additionally, impaired loans are evaluated for loss potential on an individual basis in accordance with ASC 310 “Accounting by Creditors for Impairment of a Loan,” and specific reserves are established based on thorough analysis of collateral values where loss potential exists. When an impaired loan is collateral dependent and a deficiency exists in the fair value of collateral securing the loan in comparison to the associated loan balance, the deficiency is charged-off at that time or a specific reserve is established. Impaired loans are reviewed no less frequently than quarterly.

  

·

In the event that a current appraisal to support the fair value of the real estate collateral underlying an impaired loan has not yet been received, and the Company believes that the collateral value is insufficient to support the loan amount, an impairment reserve is recorded. In these instances, the receipt of a current appraisal triggers an updated review of the collateral support for the loan and any deficiency is charged-off or reserved at that time. In those instances where a current appraisal is not available in a timely manner in relation to a financial reporting cut-off date, the Company discounts the most recent third-party appraisal depending on a number of factors including, but not limited to, property location, local price volatility, local economic conditions, and recent comparable sales. In all cases, the costs to sell the subject property are deducted in arriving at the fair value of the collateral.

 

 

Changes in the allowance for loan losses for the three months ended March 31, 2015 are as follows:

 

Allowance for Loan Losses

 

Dollars in Thousands						Commercial Real				Residential
		Commercial				Estate ("CRE")				Real Estate				Consumer				Unallocated				Total
For the three months ended March 31, 2015
Beginning balance		$	1,022			$	3,419			$	701			$	979			$	2,232			$	8,353
Charge-offs and concessions			-				(8	)			(86	)			(64	)			-				(158	)
Recoveries			6				3				9				11				-				29
Provision / (recapture)			(74	)			(293	)			131				130				136				30
Ending balance		$	954			$	3,121			$	755			$	1,056			$	2,368			$	8,254

 

Changes in the allowance for loan losses for the year ended December 31, 2014 are as follows:

 

Allowance for Loan Losses

 

Dollars in Thousands						Commercial Real				Residential
		Commercial				Estate ("CRE")				Real Estate				Consumer				Unallocated				Total
For the twelve months ended December 31, 2014
Beginning balance		$	775			$	3,506			$	675			$	744			$	2,659			$	8,359
Charge-offs and concessions			(26	)			(533	)			(129	)			(79	)			-				(767	)
Recoveries			11				425				22				3				-				461
Provision / (recapture)			262				21				133				311				(427	)			300
Ending balance		$	1,022			$	3,419			$	701			$	979			$	2,232			$	8,353

 

Recorded investments in loans as of March 31, 2015 are as follows:

 

Dollars in Thousands						Commercial Real				Residential
		Commercial				Estate ("CRE")				Real Estate				Consumer				Unallocated				Total
As of March 31, 2015
Allowance for Loan Losses:
Ending balance: individually evaluated for impairment		$	3			$	249			$	36			$	-			$	-			$	288
Ending balance: collectively evaluated for impairment			951				2,872				719				1,056				2,368				7,966
Total allowance for loan losses		$	954			$	3,121			$	755			$	1,056			$	2,368			$	8,254
Loans:
Ending balance: individually evaluated for impairment		$	369			$	8,047			$	1,046			$	27			$	-			$	9,489
Ending balance: collectively evaluated for impairment		$	118,726			$	289,263			$	111,106			$	45,384			$	-			$	564,479
Ending balance		$	119,095			$	297,310			$	112,152			$	45,411			$	-			$	573,968
Less deferred fees																						$	(1,185	)
Ending balance total loans																						$	572,783

 

 

Recorded investments in loans as of December 31, 2014 are as follows:

 

Dollars in Thousands						Commercial Real				Residential
		Commercial				Estate ("CRE")				Real Estate				Consumer				Unallocated				Total
As of December 31, 2014
Allowance for Loan Losses:
Ending balance: individually evaluated for impairment		$	-			$	249			$	-			$	-			$	-			$	249
Ending balance: collectively evaluated for impairment			1,022				3,170				701				979				2,232				8,104
Total allowance for loan losses		$	1,022			$	3,419			$	701			$	979			$	2,232			$	8,353
Loans:
Ending balance: individually evaluated for impairment		$	380			$	9,864			$	1,067			$	-			$	-			$	11,311
Ending balance: collectively evaluated for impairment		$	120,137			$	281,861			$	110,439			$	40,565			$	-			$	553,002
Ending balance		$	120,517			$	291,725			$	111,506			$	40,565			$	-			$	564,313
Less deferred fees																						$	(1,214	)
Ending balance total loans																						$	563,099

 

Credit Quality Indicators

 

Federal regulations require that the Bank periodically evaluate the risks inherent in its loan portfolios. In addition, the Washington Division of Banks and the Federal Deposit Insurance Corporation (“FDIC”) have authority to identify problem loans and, if appropriate, require them to be reclassified. There are three classifications for problem loans: Substandard, Doubtful, and Loss. These terms are used as follows:

 

·

“Substandard” loans have one or more defined weaknesses and are characterized by the distinct possibility some loss will be sustained if the deficiencies are not corrected.

 

·

“Doubtful” loans have the weaknesses of loans classified as "Substandard," with additional characteristics that suggest the weaknesses make collection or recovery in full after liquidation of collateral questionable on the basis of currently existing facts, conditions, and values. There is a high possibility of loss in loans classified as "Doubtful."

 

·

“Loss” loans are considered uncollectible and of such little value that continued classification of the credit as a loan is not warranted. If a loan or a portion thereof is classified as "Loss," it must be charged-off; meaning the amount of the loss is charged against the allowance for credit losses, thereby reducing that reserve.

 

The Bank also classifies some loans as “Pass” or Other Loans Especially Mentioned (“OLEM”). Within the Pass classification, certain loans are “Watch” rated because they have elements of risk that require more monitoring than other performing loans. Pass grade loans include a range of loans from very high credit quality to acceptable credit quality. These borrowers generally have strong to acceptable capital levels and consistent earnings and debt service capacity. Loans with higher grades within the Pass category may include borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Overall, loans with a Pass grade show no immediate loss exposure. Loans classified as OLEM continue to perform but have shown deterioration in credit quality and require closer monitoring.

 

 

Credit quality indicators as of March 31, 2015 are as follows:

 

						Other Loans
						Especially
		Pass				Mentioned				Substandard				Doubtful				Total
Commercial and agricultural		$	110,518			$	6,239			$	2,338			$	-			$	119,095
Real estate:
Construction and development			27,954				47				830				-				28,831
Residential 1-4 family			87,740				676				3,449				-				91,865
Multi-family			20,022				265				-				-				20,287
Commercial real estate — owner occupied			122,353				1,698				6,435				-				130,486
Commercial real estate — non owner occupied			101,461				9,194				5,191				249				116,095
Farmland			19,846				1,846				206				-				21,898
Total real estate			379,376				13,726				16,111				249				409,462
Consumer			45,280				75				56				-				45,411
Less deferred fees			-				-				-				-				(1,185	)
Total loans		$	535,174			$	20,040			$	18,505			$	249			$	572,783

 

Credit quality indicators as of December 31, 2014 are as follows:

 

						Other Loans
						Especially
		Pass				Mentioned				Substandard				Doubtful				Total
Commercial and agricultural		$	111,800			$	6,354			$	2,363			$	-			$	120,517
Real estate:
Construction and development			25,696				50				965				-				26,711
Residential 1-4 family			89,183				684				3,098				-				92,965
Multi-family			18,274				267				-				-				18,541
Commercial real estate — owner occupied			117,444				1,717				6,471				-				125,632
Commercial real estate — non owner occupied			94,068				17,587				5,233				249				117,137
Farmland			20,130				1,862				253				-				22,245
Total real estate			364,795				22,167				16,020				249				403,231
Consumer			40,436				82				47				-				40,565
Less deferred fees			-				-				-				-				(1,214	)
Total loans		$	517,031			$	28,603			$	18,430			$	249			$	563,099

 

 

Impaired Loans

 

Impaired loans by type as of March 31, 2015, and interest income recognized for the three months ended March 31, 2015, were as follows:

 

(Dollars in Thousands)														3 Month				3 Month
		Unpaid												Average				Interest
		Principal				Recorded				Related				Recorded				Income
		Balance				Investment				Allowance				Investment				Recognized
With no Related Allowance:
Commercial		$	404			$	366			$	-			$	373			$	3
Consumer			27				27				-				13				-
Residential real estate			1,315				1,010				-				1,038				14
Commercial real estate:
CRE — owner occupied			1,174				1,174				-				1,277				-
CRE — non owner occupied			5,960				5,588				-				6,430				17
Farmland			-				-				-				-				-
Construction and development			1,315				1,036				-				1,001				-
Total		$	10,195			$	9,201			$	-			$	10,132			$	34
With a Related Allowance:
Commercial		$	3			$	3			$	3			$	1			$	-
Residential real estate			36				36				36				18				-
CRE — non owner occupied			249				249				249				249				-
Total		$	288			$	288			$	288			$	268			$	-
Total Impaired Loans:
Commercial		$	407			$	369			$	3			$	374			$	3
Consumer			27				27				-				13				-
Residential real estate			1,351				1,046				36				1,056				14
Commercial real estate:
CRE — owner occupied			1,174				1,174				-				1,277				-
CRE — non owner occupied			6,209				5,837				249				6,679				17
Farmland			-				-				-				-				-
Construction and development			1,315				1,036				-				1,001				-
Total Impaired Loans		$	10,483			$	9,489			$	288			$	10,400			$	34

 

 

Impaired loans by type as of December 31, 2014, and interest income recognized for the twelve months ended December 31, 2014, were as follows:

 

(Dollars in Thousands)
		Unpaid												Average				Interest
		Principal				Recorded				Related				Recorded				Income
		Balance				Investment				Allowance				Investment				Recognized
With no Related Allowance:
Commercial		$	418			$	380			$	-			$	439			$	19
Consumer			-				-				-				53				-
Residential real estate			1,359				1,067				-				866				58
Commercial real estate:
CRE — owner occupied			1,381				1,379				-				1,662				-
CRE — non owner occupied			7,642				7,271				-				4,705				45
Farmland			-				-				-				716				225
Construction and development			3,023				965				-				1,201				57
Total		$	13,823			$	11,062			$	-			$	9,642			$	404
With a Related Allowance:
CRE — non owner occupied			249				249				249				83				-
Total		$	249			$	249			$	249			$	83			$	-
Total Impaired Loans:
Commercial		$	418			$	380			$	-			$	439			$	19
Consumer			-				-				-				53				-
Residential real estate			1,359				1,067				-				866				58
Commercial real estate:
CRE — owner occupied			1,381				1,379				-				1,662				-
CRE — non owner occupied			7,891				7,520				249				4,788				45
Farmland			-				-				-				716				225
Construction and development			3,023				965				-				1,201				57
Total Impaired Loans		$	14,072			$	11,311			$	249			$	9,725			$	404

 

Aging Analysis

 

The following tables summarize the Company’s loans past due, both accruing and nonaccruing, by type as of March 31, 2015.

 

(Dollars in Thousands)

										Greater
		30-59 Days				60-89 Days				Than				Total Past				Non-accrual								Total
		Past Due				Past Due				90 Days				Due				Loans				Current				Loans
Commercial and agricultural		$	253			$	-			$	-			$	253			$	90			$	118,752			$	119,095
Real estate:
Construction and development			-				-				-				-				1,035				27,796				28,831
Residential 1-4 family			163				279				-				442				828				90,595				91,865
Multi-family			-				-				-				-				-				20,287				20,287
Commercial real estate — owner occupied			-				-				-				-				1,116				129,370				130,486
Commercial real estate — non owner occupied			-				-				-				-				3,804				112,291				116,095
Farmland			-				-				-				-				-				21,898				21,898
Total real estate			163				279								442				6,783				402,237				409,462
Consumer			-				10				-				10				27				45,374				45,411
Less deferred fees			-				-				-				-				-				(1,185	)			(1,185	)
Total		$	416			$	289			$	-			$	705			$	6,900			$	565,178			$	572,783

 

 

The following tables summarize the Company’s loans past due, both accruing and nonaccruing, by type as of December 31, 2014.

 

(Dollars in Thousands)

										Greater
		30-59 Days				60-89 Days				Than				Total Past				Non-accrual								Total
		Past Due				Past Due				90 Days				Due				Loans				Current				Loans
Commercial and agricultural		$	-			$	-			$	-			$	-			$	96			$	120,421			$	120,517
Real estate:
Construction and development			18				-				-				18				965				25,728				26,711
Residential 1-4 family			537				68				-				605				848				91,512				92,965
Multi-family			-				-				-				-				-				18,541				18,541
Commercial real estate — owner occupied			-				-				409				409				1,325				123,898				125,632
Commercial real estate — non owner occupied			-				-				-				-				5,482				111,655				117,137
Farmland			46				-				-				46				-				22,199				22,245
Total real estate			601				68				409				1,078				8,620				393,533				403,231
Consumer			170				2				-				172				-				40,393				40,565
Less deferred fees			-				-				-				-				-				(1,214	)			(1,214	)
Total		$	771			$	70			$	409			$	1,250			$	8,716			$	553,133			$	563,099

 

Modifications

 

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession.  There are various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted by the Company.  Commercial and industrial loans modified in a TDR may involve term extensions, below market interest rates and/or interest-only payments wherein the delay in the repayment of principal is determined to be significant when all elements of the loan and circumstances are considered.  Additional collateral, a co-borrower, or a guarantor is often required. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor.  Construction loans modified in a TDR may also involve extending the interest-only payment period.  Residential mortgage loans modified in a TDR are primarily comprised of loans where monthly payments are lowered to accommodate the borrowers’ financial needs. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity.  Land loans modified in a TDR typically involve extending the balloon payment by one to three years, and providing an interest rate concession. Home equity modifications are made infrequently and are uniquely designed to meet the specific needs of each borrower. 

 

Loans modified in a TDR are considered impaired loans and typically already on non-accrual status. Partial charge-offs have in some cases already been taken against the outstanding loan balance.  Loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan.  An allowance for impaired loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent.  The Company’s practice is to re-appraise collateral dependent loans every six to nine months. During the three months ended March 31, 2015, there was no impact on the allowance from TDRs during the period, as the loans classified as TDRs during the period did not have a specific reserve. Loans classified as TDRs were already considered impaired loans at the time of modification and no further impairment was required upon modification. The Company had no commitments to lend additional funds for loans classified as TDRs at March 31, 2015.

 

The Company closely monitors the performance of modified loans for delinquency, as delinquency is considered an early indicator of possible future default. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan.

 

 

The following table presents TDRs for the three months ended March 31, 2015 and 2014, all of which were modified due to financial stress of the borrower. There were not any subsequent defaulted TDRs as of March 31, 2015 and 2014.

 

Restructured loans by type current and subsequently defaulted

(Dollars in Thousands)

 

		March 31, 2015
		Current Restructured Loans
		Number of Loans				Pre-TDR Outstanding Recorded  Investment				Post-TDR Outstanding Recorded  Investment
Commercial and agriculture			1			$	335			$	279
Construction and development			1				920				829
Residential real estate			2				272				218
CRE — owner occupied			1				59				58
CRE — non owner occupied			1				2,180				2,034
Total restructured loans (1)			6			$	3,766			$	3,418
		March 31, 2014
		Current Restructured Loans
		Number of Loans				Pre-TDR Outstanding Recorded Investment				Post-TDR Outstanding Recorded Investment
Commercial and agriculture			1			$	335			$	297
Construction and development			3				2,972				1,278
Residential real estate			2				272				224
CRE — owner occupied			1				59				54
CRE — non owner occupied			1				2,180				2,080
Total restructured loans (1)			8			$	5,818			$	3,933

 

(1) The period end balances are inclusive of all partial paydowns and charge-offs since the modification date.

 

The following table summarizes the Company’s TDR loans by type and geographic region as of March 31, 2015:

 

Restructured loans by type and geographic region

(Dollars in Thousands)

		March 31, 2015
		Restructured Loans
		Central Western Washington				Southwestern Washington				Northern Washington				Oregon				Totals				Number of  Loans
Commercial and agriculture		$	-			$	-			$	279			$	-			$	279				1
Construction and development			-				-				829				-				829				1
Residential real estate			-				-				-				218				218				2
CRE — owner occupied			58				-				-				-				58				1
CRE — non owner occupied			-				-				2,034				-				2,034				1
Total restructured loans		$	58			$	-			$	3,142			$	218			$	3,418				6

 

 

The following table presents troubled debt restructurings by accrual or nonaccrual status as of March 31, 2015:

 

Restructured loans by accrual or nonaccrual status
(Dollars in Thousands)
		March 31, 2015
		Restructured loans
		Accrual Status				Non-accrual  Status				Total Modifications
Commercial and agriculture		$	279			$	-			$	279
Construction and development			-				829				829
Residential real estate			218				-				218
CRE — owner occupied			58				-				58
CRE — non owner occupied			2,034				-				2,034
Total restructured loans		$	2,589			$	829			$	3,418

 

NOTE 5 – ACCUMULATED OTHER COMPREHENSIVE INCOME

 

The following table presents the changes in each component of accumulated other comprehensive income/(loss), net of tax, for the three months ended March 31, 2015:

 

(Dollars in Thousands)		Net Unrealized
		Gains and Losses
		On Investment				Defined Benefit
		Securities				Plans				Total
Balance, January 1, 2015		$	350			$	(485	)		$	(135	)
Other comprehensive gain (loss) before reclassifications			449				35				484
Amounts reclassified from AOCI			-				-				-
Net Current period other comprehensive income (loss)			449				35				484
Balance, March 31, 2015		$	799			$	(450	)		$	349

 

The following table presents the changes in each component of accumulated other comprehensive income/(loss), net of tax, for the three months ended March 31, 2014:

 

		Net Unrealized
		Gains and Losses
		On Investment				Defined Benefit
		Securities				Plans				Total
Balance, January 1, 2014		$	(919	)		$	(450	)		$	(1,369	)
Other comprehensive gain (loss) before reclassifications			371				29				400
Amounts reclassified from AOCI			(5	)			-				(5	)
Net Current period other comprehensive income (loss)			366				29				395
Balance, March 31, 2014		$	(553	)		$	(421	)		$	(974	)

 

There were no amounts reclassified out of accumulated other comprehensive income (“AOCI”) for the three months ended March 31, 2015.

 

 

The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (“AOCI”) for the three months ended March 31, 2014:

 

(Dollars in Thousands)
Details about Accumulated Other Comprehensive Income Components						Affected Line Item in the Statement Where Net  Income is Presented
		For the Three
		Months Ended
		March 31, 2014
Net Unrealized Gains and Losses		$	(52	)		(Gain) on sales of investments available for sale
on Investment Securities			45			Net OTTI losses
			2			Income tax expense
		$	(5	)		Unrealized gain on investment securities net of tax

 

The following table presents the components of other comprehensive income for the three months ended March 31, 2015:

 

(Dollars in Thousands)
		Before Tax				Tax Effect				Net of Tax
Three months ended March 31, 2015
Net unrealized losses on investment securities:
Net unrealized gains arising during the period		$	680			$	231			$	449
Less: reclassification adjustments for net gains realized in net income			-				-				-
Net unrealized losses on investment securities		$	680			$	231			$	449
Defined benefit plans:
Amortization of unrecognized prior service costs and net actuarial gains/losses		$	53			$	18			$	35
Other Comprehensive Income		$	733			$	249			$	484

 

The following table presents the components of other comprehensive income for the three months ended March 31, 2014:

 

(Dollars in Thousands)
		Before Tax				Tax Effect				Net of Tax
Three months ended March 31, 2014
Net unrealized losses on investment securities:
Net unrealized losses arising during the period		$	562			$	191			$	371
Less: reclassification adjustments for net gains realized in net income			(7	)			(2	)			(5	)
Net unrealized losses on investment securities		$	555			$	189			$	366
Defined benefit plans:
Amortization of unrecognized prior service costs and net actuarial gains/losses		$	44			$	15			$	29
Other Comprehensive Income		$	599			$	204			$	395

 

 

NOTE 6 – STOCK BASED COMPENSATION

 

The Company’s 2011 Equity Incentive Plan, as amended (the “2011 Plan”), provides for the issuance of up to 900,000 shares in connection with incentive and nonqualified stock options, restricted stock, restricted stock units and other equity-based awards. Prior to adoption of the 2011 Plan, the Company made equity-based awards under the Company’s 2000 Stock Incentive Plan, which expired January 1, 2011.

 

Stock Options

 

The 2011 Plan authorizes the issuance of incentive and non-qualified stock options, as defined under current tax laws, to key personnel. Options granted under the 2011 Plan either become exercisable ratably over five years or in a single installment five years from the date of grant.

 

The Company uses the Black-Scholes option pricing model to calculate the fair value of stock option awards based on assumptions in the following table. Expected volatility is based on historical volatility of the Company’s common stock. The expected term of stock options granted is based on the simplified method, which is the simple average between contractual term and vesting period. The risk-free rate is based on the expected term of stock options and the applicable U.S. Treasury yield in effect at the time of grant.

 

Grant period ended		Expected  Life		Risk Free Interest Rate				Expected Volatility				Dividend  Yield				Average Fair Value
March 31, 2015		6.5 years			1.49	%			23.04	%			3.11	%		$	1.06

 

There were no options granted during the three months ended March 31, 2014.

 

A summary of stock option activity as of March 31, 2015, and changes during the three months then ended are presented below:

 

March 31, 2015		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (Years)				Aggregate Intrinsic Value
Outstanding beginning of period			566,945			$	8.75
Granted			-				-
Exercised			(4,000	)			5.00
Forfeited			(10,750	)			9.35
Expired			(76,395	)			14.77
Outstanding end of period			475,800			$	7.81				5.34				316,430
Exercisable end of period			334,000			$	8.90				4.22				107,180

 

 

A summary of stock option activity as of March 31, 2014, and changes during the three months then ended are presented below:

March 31, 2014		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (Years)				Aggregate Intrinsic Value
Outstanding beginning of period			625,495			$	9.53
Granted			-				-
Exercised			-				-
Forfeited			-				-
Expired			(39,600	)			14.04
Outstanding end of period			585,895			$	9.19				5.20				265,650
Exercisable end of period			323,345			$	11.91				3.40				51,520

 

A summary of the status of the Company’s non-vested options as of March 31, 2015 and 2014 and changes during the three months then ended, are presented below:

		March 31, 2015								March 31, 2014
		Shares				Weighted Average Fair Value				Shares				Weighted Average Fair Value
Non-vested beginning of period			178,600			$	0.65				296,650			$	0.47
Granted			-				-				-				-
Vested			(33,400	)			0.56				(34,100	)			0.56
Forfeited			(3,400	)			0.24				-				-
Non-vested end of period			141,800			$	0.68				262,550			$	0.46

 

The Company accounts for stock based compensation in accordance with GAAP, which requires measurement of compensation cost for all stock-based awards based on grant date fair value and recognition of compensation cost over the service period of each award.

 

Stock-based compensation expense
(Unaudited)
(Dollars in Thousands)
Three months ended March 31, 2015		Before Tax				Tax Effect				Net of Tax
Recognized compensation expense		$	8			$	4			$	4
Three months ended March 31, 2014		Before Tax				Tax Effect				Net of Tax
Recognized compensation expense		$	10			$	3			$	7

 

		March 31,  2015				March 31,  2014
Future compensation expense (1)		$	108			$	70
Weighted Average Remaining Contractual Term (Years)			1.6				1.7

 

(1) related to non-vested stock options

 

  

Restricted Stock Units

 

The Company grants restricted stock units (“RSU”) to employees qualifying for awards under the Company’s Annual Incentive Compensation Plan. Recipients of RSUs will be issued a specified number of shares of common stock under the 2011 Plan upon the lapse of applicable restrictions. Outstanding RSUs are subject to forfeiture if the recipient’s employment terminates prior to the expiration of three years from the date of grant.

 

The following table summarizes RSU activity during the three months ended March 31, 2015 and 2014:

 

		March 31, 2015
		Shares				Weighted Average Grant Price				Weighted Average Remaining Contractual terms (in years)
Outstanding, January 1, 2015			61,233
Granted			44,966			$	6.75
Converted			(5,032	)
Outstanding end of period			101,167								1.9

 

		March 31, 2014
		Shares				Weighted Average Grant Price				Weighted Average Remaining Contractual terms (in years)
Outstanding, January 1, 2014			50,024
Granted			11,444			$	6.46
Forfeited			-
Outstanding end of period			61,468								1.9

 

The following table summarizes RSU compensation expense during the three months ended March 31, 2015 and 2014:

 

RSU compensation expense
(Unaudited)
(Dollars in Thousands)
Three months ended March 31, 2015		Before Tax				Tax Effect				Net of Tax
RSU recognized compensation expense		$	46			$	17			$	29
Three months ended March 31, 2014		Before Tax				Tax Effect				Net of Tax
RSU recognized compensation expense		$	25			$	8			$	17
		March 31,  2015				March 31,  2014
Future compensation expense (1)		$	104			$	221

 

(1) related to non-vested RSU's

 

  

NOTE 7 – COMMITMENTS AND CONTINGENCIES

 

The Company’s wholly owned subsidiary, the Bank of the Pacific (the “Bank”), is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, and involve, to varying degrees, elements of credit risk in excess of the amount recognized on the consolidated balance sheets.

 

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments. A summary of the Bank’s off-balance sheet commitments at March 31, 2015 and December 31, 2014 is as follows:

 

(Dollars in Thousands)
		March 31, 2015				December 31, 2014
Commitments to extend credit		$	118,004			$	109,545
Standby letters of credit		$	1,351			$	1,351

 

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. Many of the commitments expire without being drawn upon; therefore total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.

 

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

 

In connection with certain loans held for sale, the Bank typically makes representations and warranties that the underlying loans conform to specified guidelines. If the underlying loans do not conform to the specifications, the Bank may have an obligation to repurchase the loans or indemnify the purchaser against loss. The Bank believes that the potential for loss under these arrangements is remote. Accordingly, no contingent liability is recorded in the condensed consolidated financial statements.

 

The Company is currently not party to any material pending litigation. However, because of the nature of its activities, the Company may be subject to or threatened with legal actions in the ordinary course of business. In the opinion of management, liabilities arising from these claims, if any, will not have a material effect on the results of operations or financial condition of the Company.

 

 

NOTE 8 – FAIR VALUE MEASUREMENTS

 

Fair Value Hierarchy

 

The Company uses an established hierarchy for measuring fair value that is intended to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

 

Level 1 – Valuations based on quoted prices in active exchange markets for identical assets or liabilities; also includes certain corporate debt securities actively traded in over-the-counter markets.

 

Level 2 – Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and model–derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services. This category generally includes certain U.S. Government, agency and non-agency securities, state and municipal securities, mortgage-backed securities, corporate securities, and residential mortgage loans held for sale.

 

Level 3 – Valuation based on unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, yield curves and similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external data, which may include third-party pricing services.

 

Investment Securities Available-for-Sale

 

The Company uses an independent pricing service to assist management in determining fair values of investment securities available-for-sale. This service provides pricing information by utilizing evaluated pricing models supported with market based information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, credit ratings, bids and offers, relative credit information and reference data from market research publications. Investment securities that are deemed to have been trading in illiquid or inactive markets may require the use of significant unobservable inputs.

 

The pricing service provides quoted market prices when available. Quoted prices are not always available due to bond market inactivity. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. Additionally, the pricing service may obtain a broker quote when sufficient information is not available to produce a valuation. Valuations and broker quotes are non-binding and do not represent quotes on which one may execute the disposition of the assets.

 

The Company generally obtains one value from its primary external third-party pricing service. The Company’s third-party pricing service has established processes for us to submit inquiries regarding quoted prices. The Company’s third-party pricing service will review the inputs to the evaluation in light of any new market data presented by us. The Company’s third-party pricing service may then affirm the original quoted price or may update the evaluation on a going forward basis.

 

On a quarterly basis, management reviews the pricing information received from the third party-pricing service through a combination of procedures that include an evaluation of methodologies used by the pricing service, analytical reviews and performance analyses of the prices against statistics and trends and maintenance of an investment watch list. Based on this review, management determines whether the current placement of the security in the fair value hierarchy is appropriate or whether transfers may be warranted. As necessary, the Company compares prices received from the pricing service to discounted cash flow models or through performing independent valuations of inputs and assumptions similar to those used by the pricing service in order to ensure prices represent a reasonable estimate of fair value. Although the Company does identify differences from time to time as a result of these validation procedures, the Company did not make any significant adjustments as of March 31, 2015 or December 31, 2014.

 

  

The following table presents the balances of assets measured at fair value on a recurring basis at March 31, 2015 and December 31, 2014.

 

		Fair Value Measurements
(Dollars in Thousands)		At March 31, 2015
Description		Fair Value  03/31/2015				Quoted Prices in Active Markets for Identical Assets (Level 1)				Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available-for-sale securities:
Collateralized mortgage obligations: agency issued		$	42,108			$	-			$	42,108			$	-
Collateralized mortgage obligations: non agency			504				-				504				-
Mortgage-backed securities: agency issued			12,019				-				12,019				-
U.S. Government agency securities			10,114				-				10,114				-
State and municipal securities			28,449				-				26,308				2,141
Total assets measured at fair value		$	93,194			$	-			$	91,053			$	2,141

 

		Fair Value Measurements
		At December 31, 2014
Description		Fair Value  12/31/2014				Quoted Prices in Active Markets for Identical Assets (Level 1)				Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available-for-sale securities:
Collateralized mortgage obligations: agency issued		$	38,767			$	-			$	38,767			$	-
Collateralized mortgage obligations: non agency			527				-				527				-
Mortgage-backed securities: agency issued			12,199				-				12,199				-
U.S. Government agency securities			8,056				-				8,056				-
State and municipal securities			27,891				-				25,741				2,150
Total assets measured at fair value		$	87,440			$	-			$	85,290			$	2,150

 

As of March 31, 2015 and December 31, 2014, the Company had four investments classified as Level 3 investments which consist of local non-rated municipal bonds for which the Company is the sole owner of the entire bond issue. The valuation of these securities is supported by analysis prepared by an independent third party. Their approach to determining fair value involves using recently executed transactions and market quotations for similar securities. As these securities are not rated by the rating agencies and there is no trading volume, Management determined that these securities should be classified as Level 3 within the fair value hierarchy. Additionally, these securities are considered to have more sensitivity to changes in credit given the unobserved assumed credit ratings.

 

The following table presents a reconciliation of assets that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2015 and 2014, respectively. There were no transfers of assets into or out of Level 1, 2 or 3 for the three months ended March 31, 2015.

 

(Dollars in Thousands)		Three months ending March 31,
		2015				2014
Balance beginning of period		$	2,150			$	1,419
Change in FV (included in other comprehensive income)			(9	)			(18	)
Balance end of period		$	2,141			$	1,401

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans measured for impairment and other real estate owned (“OREO”). The following methods were used to estimate the fair value of each such class of financial instrument:

 

  

Impaired loans – A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Impaired loans are classified as Level 3 in the fair value hierarchy and are measured based on the present value of expected future cash flows or by the net realizable value of the collateral if the loan is collateral dependent. In determining the net realizable value of the underlying collateral, we consider third party appraisals by qualified licensed appraisers, less estimated costs to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

 

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available and include consideration for variations in location, size, and income production capacity of the property. The income approach commonly utilizes a discount or cap rate to determine the present value of expected future cash flows. Additionally, the appraisals are periodically further adjusted by the Company in consideration of charges that may be incurred in the event of foreclosure and are based on management’s historical knowledge, changes in business factors and changes in market conditions. Such discounts are typically significant, and may range from 10% to 30%.

 

Impaired loans are reviewed and evaluated quarterly for additional impairment and adjusted accordingly, based on the same factors identified above. Because of the high degree of judgment required in estimating the fair value of collateral underlying impaired loans and because of the relationship between fair value and general economic conditions, we consider the fair value of impaired loans to be highly sensitive to changes in market conditions.

 

Other real estate owned – OREO is initially recorded at the fair value of the property less estimated costs to sell. This amount becomes the property’s new basis. Management considers third party appraisals in determining the fair value of particular properties. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

 

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available and include consideration for variations in location, size, and income production capacity of the property. Additionally, the appraisals are periodically further adjusted by the Company based on management’s historical knowledge, changes in business factors and changes in market conditions. Such discounts are typically significant, and may range from 10% to 25%.

 

Any write-downs based on the property fair value less estimated costs to sell at the date of acquisition are charged to the allowance for credit losses. Management periodically reviews OREO to ensure the property is carried at the lower of its new basis or fair value, net of estimated costs to sell. Any additional write-downs based on re-evaluation of the property fair value are charged to non-interest expense. Because of the high degree of judgment required in estimating the fair value of OREO and because of the relationship between fair value and general economic conditions, we consider the fair value of OREO to be highly sensitive to changes in market conditions.

 

The following table presents the Company’s assets that were held at the end of each period that were measured at fair value on a nonrecurring basis during the three months ended March 31, 2015 and year ended December 31, 2014:

 

(Dollars in Thousands)		Fair Value Measurements
		As of March 31, 2015
Description		Fair Value 03/31/2015				Quoted Prices in Active Markets for Identical Assets (Level 1)				Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Other real estate owned and foreclosed assets		$	35			$	-			$	-			$	35
Loans measured for impairment, net of specific reserves			67				-				-				67
Total impaired assets measured at fair value		$	102			$	-			$	-			$	102

 

		Fair Value Measurements
		As of December 31, 2014
Description		Fair Value 12/31/2014				Quoted Prices in Active Markets for Identical Assets (Level 1)				Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Other real estate owned and foreclosed assets		$	139			$	-			$	-			$	139
Loans measured for impairment, net of specific reserves			231				-				-				231
Total impaired assets measured at fair value		$	370			$	-			$	-			$	370

 

  

Other real estate owned with a pre-foreclosure loan balance of $219,000 was acquired during the three months ended March 31, 2015. Upon foreclosure, there were no write downs applied to the allowance for credit losses during the period related to those assets. During the three months ended March 31, 2015, there were write downs totaling $31,000 applied to the allowance for credit losses related to other properties.

 

The following table presents quantitative information about Level 3 inputs for financial instruments measured at fair value on a nonrecurring basis at March 31, 2015:

 

(Dollars in Thousands)
Description		Fair Value 03/31/2015				Valuation Technique		Significant Unobservable Inputs		Range (Weighted Average)
Other real estate owned and foreclosed assets		$	35			Appraised value		Adjustment for market conditions			0	%
Loans measured for impairment, net of specific reserves		$	67			Appraised value		Adjustment for  market conditions			0	%

  

Fair Value of Financial Instruments

 

The following methods and assumptions were used by the Company in estimating the fair values of financial instruments disclosed in these consolidated financial statements:

 

Cash and due from banks, interest bearing deposits in banks, and certificates held for investment

The carrying amounts of cash, interest bearing deposits at other financial institutions, and certificates approximate their fair value.

 

Investment Securities Available-for-Sale and Held-to-Maturity

The fair value of all investment securities are based upon the assumptions market participants would use in pricing the security. Such assumptions include observable and unobservable inputs such as quoted market prices, dealer quotes and analysis of discounted cash flows.

 

Federal Home Loan Bank Stock

FHLB stock is carried at cost which approximates fair value and equals its par value because the shares can only be redeemed with the FHLB at par.

 

Pacific Coast Bankers’ Bancshares Stock

PCBB stock is carried at cost which approximates fair value and equals its par value based on valuation supported by an outside consulting firm.

 

Loans, net and Loans held for sale

The fair value of loans is estimated based on comparable market statistics for loans with similar credit ratings. An additional liquidity discount is also incorporated to more closely align the fair value with observed market prices. Fair values of loans held for sale are based on a discounted cash flow calculation using interest rates currently available on similar loans. The fair value was based on an aggregate loan basis.

 

Deposits

The fair value of deposits with no stated maturity date is included at the amount payable on demand. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation calculated on interest rates currently offered on similar certificates.

 

Short-term borrowings

The fair value of the Company’s short-term borrowings are estimated using discounted cash flow analysis based on the Company’s incremental borrowing rates for similar types of borrowing arrangements.

 

 

Long-term borrowings

The fair values of the Company’s long-term borrowings is estimated using discounted cash flow analysis based on the Company’s incremental borrowing rates for similar types of borrowing arrangements.

 

Junior subordinated debentures

The fair value of the junior subordinated debentures and trust preferred securities is estimated using discounted cash flow analysis based on interest rates currently available for junior subordinated debentures.

 

Off-Balance-Sheet Instruments

The fair value of commitments to extend credit and standby letters of credit was estimated using the rates currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the customers. Since the majority of the Company’s off-balance-sheet instruments consist of non-fee producing, variable-rate commitments, the Company has determined they do not have a material fair value.

 

The estimated fair value of the Company’s financial instruments at March 31, 2015 and December 31, 2014 is as follows:

 

(Dollars in Thousands)
		As of March 31, 2015
		Carrying Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total Fair Value
Financial assets:
Cash and cash equivalents		$	27,603			$	27,603			$	-			$	-			$	27,603
Interest-bearing certificates of deposit (original maturities greater than 90 days)			2,727				2,727				-				-				2,727
Investment securities available-for-sale			93,194				-				91,053				2,141				93,194
Investment securities held-to-maturity			1,815				-				1,832				-				1,832
Federal Home Loan Bank stock			2,865				-				2,865				-				2,865
Pacific Coast Bankers Bank stock			1,000				-				1,000				-				1,000
Loans held-for-sale			10,780				-				10,780				-				10,780
Loans			564,529				-				-				538,409				538,409
Financial liabilities:
Deposits		$	657,112			$	-			$	657,612			$	-			$	657,612
Long-term borrowings			11,416				-				11,598				-				11,598
Junior subordinated debentures			13,403				-				-				7,811				7,811

 

		As of December 31, 2014
		Carrying Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Other Observable Inputs (Level 2)				Significant Unobservable  Inputs (Level 3)				Total Fair Value
Financial assets:
Cash and cash equivalents		$	31,037			$	31,037			$	-			$	-			$	31,037
Interest-bearing certificates of deposit  (original maturities greater than 90 days)			2,727				2,727				-				-				2,727
Investment securities available-for-sale			87,440				-				85,290				2,150				87,440
Investment securities held-to-maturity			1,829				-				1,852				-				1,852
Federal Home Loan Bank stock			2,896				-				2,896				-				2,896
Pacific Coast Bankers Bank stock			1,000				-				1,000				-				1,000
Loans held-for-sale			5,786				-				5,786				-				5,786
Loans			554,746				-				-				527,510				527,510
Financial liabilities:
Deposits		$	639,054			$	-			$	639,537			$	-			$	639,537
Long-term borrowings			11,453				-				11,583				-				11,583
Junior subordinated debentures			13,403				-				-				7,644				7,644

 

  

NOTE 9 – JUNIOR SUBORDINATED DEBENTURES

 

At March 31, 2015, two wholly-owned subsidiary grantor trusts established by the Company had outstanding $13.0 million of Trust Preferred Securities (“trust preferred securities”). Trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in the indentures. The trusts used the net proceeds from the offering of trust preferred securities to purchase a like amount of Junior Subordinated Debentures (the “Debentures”) of the Company. The Debentures are the sole assets of the trusts. The Company’s obligations under the Debentures and the related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole or in part, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date.

 

The Debentures issued by the Company to the grantor trusts totaling $13.0 million are reflected in the consolidated balance sheet in the liabilities section under the caption “junior subordinated debentures.” The Company records interest expense on the corresponding junior subordinated debentures in the consolidated statements of income. The Company also recorded $403,000 in the consolidated balance sheet at March 31, 2015 and December 31, 2014 for the common capital securities issued by the issuer trusts.

 

As of March 31, 2015, regular accrued interest on junior subordinated debentures totaled $39,000 and is included in accrued interest payable on the balance sheet.

 

Following are the terms of the junior subordinated debentures as of March 31, 2015.

 

(Dollars in Thousands)

Issued

Maturity

Trust Name

Issue Date

Amount

Rate

Date

Pacific Financial Corporation Statutory Trust I

December 2005

$

5,000

LIBOR + 1.45% (1)

March 2036

Pacific Financial Corporation Statutory Trust II

June 2006

8,000

LIBOR + 1.60% (2)

July 2036

$

13,000

 

⁽¹⁾ Pacific Financial Corporation Statutory Trust I securities incurred interest at the fixed rate of 6.39% until mid March 2011, at which the rate changed to a variable rate of 3-month LIBOR (0.27% at March 16, 2015) plus 1.45% or 1.72%, adjusted quarterly, through the final maturity date in March 2036.

⁽²⁾ Pacific Financial Corporation Statutory Trust II securities incur interest at a variable rate of 3-month LIBOR (0.253% at January 7, 2015) plus 1.60% or 1.85%, adjusted quarterly, through the final maturity date in July 2036.

 

NOTE 10 – RECENTLY ISSUED ACCOUNTING STANDARDS

 

In June 2014, the FASB issued ASU No. 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. ASU 2014-11 changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements. It also requires additional disclosures about repurchase agreements and other similar transactions. The new guidance aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. The ASU also requires new and expanded disclosures. This ASU is effective for the first interim or annual period beginning after December 15, 2014. The adoption of ASU No. 2014-11 did not have a material impact on the Company's consolidated financial statements as of March 31, 2015.

 

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718, Compensation - Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU can be applied prospectively or retrospectively and are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015 with early adoption permitted. The Company is currently reviewing the requirements of ASU No. 2014-12, but does not expect the ASU to have a material impact on the Company's consolidated financial statements.

 

  

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.

 

NOTE 11 – INCOME TAXES

 

The Company recorded an income tax provision for the three months ended March 31, 2015 and 2014. The amount of the provision for each period was commensurate with the estimated tax liability associated with the net income earned during the period. As of March 31, 2015, the Company maintained a deferred tax asset balance of $2.9 million. The Company believes it will be fully utilized in the normal course of business, thus no valuation allowance is maintained against this asset.

 

The Company's provision for income taxes includes both federal and state income taxes and reflects the application of federal and state statutory rates to the Company's income before taxes. The principal difference between statutory tax rates and the Company's effective tax rate is the benefit derived from investing in tax-exempt securities and bank owned life insurance.

 

Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized.

 

The Company applies the provisions of FASB ASC 740, Income Taxes, relating to the accounting for uncertainty in income taxes. The Company periodically reviews its income tax positions based on tax laws and regulations, and financial reporting considerations, and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations of the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment. The Company’s uncertain tax positions were nominal in amount as of March 31, 2015.

 

  

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with the audited consolidated financial statements and related notes to those statements of Pacific Financial Corporation (“Company”) that appear under the heading “Financial Statements and Supplementary Data” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 (“2014 10-K”), as well as the unaudited consolidated financial statements for the current quarter found under Item 1 above.

 

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

 

This document contains forward-looking statements that are subject to risks and uncertainties. These statements are based on the present beliefs and assumptions of our management, and on information currently available to them. Forward-looking statements include the information concerning our possible future results of operations set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and statements preceded by, followed by or that include the words "believes," “will”, "expects," "anticipates," "intends," "plans," "estimates" or similar expressions.

 

Any forward-looking statements in this document are subject to the risks of our business, including risk factors described in our 2014 10-K, as well as risks relating to, among other things, the following:

 

·

changing laws, regulations, standards, and government programs and policies, that may limit our revenue sources, significantly increase our costs, including compliance and insurance costs, cause or contribute to rising interest rates, and place additional burdens on our limited management resources;

 

·

economic or business conditions, nationally and in the regions in which we do business, that have resulted in, and may continue to result in, among other things, challenges with respect to credit quality and/or reduced demand for credit and other banking services due to the dependency of repayment of our loans on the cash flows of the borrower and additional workout and other real estate owned expenses;

 

·

decreases in real estate and other asset prices, whether or not due to changes in economic conditions, that may reduce the value of the assets that serve as collateral for many of our loans;

 

·

competitive pressures among depository and other financial institutions that may impede our ability to attract and retain depositors, borrowers and other customers, retain our key employees, and/or maintain and improve our net interest margin and income and non-interest income, such as fee income;

 

·

a lack of liquidity in the market for our common stock that may make it difficult or impossible for you to liquidate your investment in our stock or lead to distortions in the market price of our stock; and

 

·

integration and other risks relating to the opening of our Salem, Oregon loan production office that may cost more or be less beneficial to us than expected.

 

Our management believes the forward-looking statements in this report are reasonable; however, you should not place undue reliance on them. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Many of the factors that will determine our future results and share value are beyond our ability to control or predict. We undertake no obligation to update forward-looking statements.

 

First Quarter 2015 Highlights (as of, or for the period ended March 31, 2015, except as noted):

 

·

Basic earnings per share (EPS) were $0.11 for both the first quarter of 2015 and the fourth quarter of 2014, and increased 10% from $0.10 for the first quarter of 2014.

 

·

Net interest income grew 2% to $6.9 million for the first quarter of 2015, compared to $6.8 million for the fourth quarter of 2014, and grew 6% from $6.6 million for the first quarter a year ago.

 

  

·

Net interest margin (NIM) expanded 14 basis points to 4.15% from 4.01% in the preceding quarter and declined 12 basis points compared to 4.27% for the first quarter of 2014. The expansion in NIM reflects greater levels of higher yielding loans. First quarter 2014 included one-time collection of interest from non-accrual loans.

 

·

Total assets increased 2% to $762.1 million at March 31, 2015, compared to $744.8 million at December 31, 2014, and 6% from $717.4 million at March 31, 2014.

 

·

Gross loans increased 2% to $572.8 million at March 31, 2015, compared to $563.1 million at December 31, 2014, and grew 11% from $518.6 million at March 31, 2014.

 

·

Nonperforming assets (NPAs) declined to $8.0 million, or 1.05% of total assets, at March 31, 2015, compared to $10.1 million, or 1.36% of total assets in the preceding quarter, and $9.7 million, or 1.35% of total assets at March 31, 2014.

 

·

Classified loans remained unchanged at $18.8 million, or 3.27% of gross loans, at March 31, 2015. Classified loans totaled $18.7 million, or 3.31% of gross loans at December 31, 2014, compared to $16.8 million, or 3.23% of gross loans at March 31, 2014.

 

·

Net charge-offs totaled $129,000 for the first quarter 2015, compared to $2,000 in the preceding quarter and $71,000 for first quarter 2014. The ratio of loans on accruing status 30 – 89 days delinquent to total loans remained low at 0.12%, at March 31, 2015, compared to 0.23% for the preceding quarter and 0.15% for March 31, 2014.

 

·

Allowance for loan losses (“ALLL”) was 1.44% of gross loans at March 31, 2015, compared to 1.48% of gross loans at December 31, 2014, and 1.59% of gross loans at March 31, 2014. The decline in ALLL from the year ago quarter reflects the general improvement in credit metrics.

 

·

The average cost of deposits and borrowings fell 1 basis point to 0.31% from the 0.32% in fourth quarter 2014, and dropped 3 basis points from 0.34% in first quarter 2014.

 

·

Capital levels exceeded regulatory requirements for a well-capitalized financial institution, with a total risk-based capital ratio of 13.28%, a tier 1 leverage ratio of 10.01% and a common equity tier 1 ratio of 9.91% at quarter end.

 

OPERATING RESULTS

 

Net interest income for first quarter 2015 increased 2% from fourth quarter 2014 and grew 6% from first quarter 2014. First quarter 2015 results were affected by a number of seasonal factors, particularly the slowdown of the tourism business in coastal communities in Western Washington and Oregon during the winter months. In addition, the current quarter included two fewer days of interest accruals than fourth quarter 2014, which impacted net interest income.

 

This increase was primarily due to the growth in earning assets, which increased interest income. Changes in the balance sheet mix also contributed to increases in interest income during the period. Loan balances increased due to production generated predominately within the Company’s primary market area of Western Washington and Oregon. Investment securities and fed funds sold continued to decline as a proportion of the balance sheet in first quarter 2015 due to strong loan demand during the period. Funding costs declined further due to a continued shift in deposit mix toward non-interest bearing and lower-cost deposits. As a result, NIM improved from fourth quarter 2014.

 

Non-interest income was virtually unchanged from fourth quarter 2014, but up significantly from first quarter in the prior year. The increase over the prior year quarter was primarily due to an increase in income associated with residential real estate lending due to stronger residential real estate sales and recent increase in refinancing activity.

 

  

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, except per share data)

(UNAUDITED)

  

														Sequential				Year over
		March 31,				December 31,				March 31,				Quarter				Year
		2015				2014				2014				% Change				% Change
ASSETS
Cash and cash equivalents:
Cash and due from banks		$	15,321			$	14,782			$	15,747				4	%			-3	%
Interest-bearing deposits in banks			12,282				16,255				19,872				-24	%			-38	%
Total cash and cash equivalents			27,603				31,037				35,619				-11	%			-23	%
Interest-bearing certificates of deposit (original maturities greater than 90 days)			2,727				2,727				2,727				0	%			0	%
Federal Home Loan Bank stock, at cost			2,865				2,896				2,985				-1	%			-4	%
Pacific Coast Bankers' Bank stock, at cost			1,000				1,000				-				0	%			100	%
Investment securities:
Investment securities available-for-sale, at fair market value (amortized cost of $91,982, 86,907 and $95,966)			93,194				87,440				95,129				7	%			-2	%
Investment securities held-to-maturity, at amortized cost (fair value of $1,832, $1,852 and $2,128)			1,815				1,829				2,110				-1	%			-14	%
Total investment securities			95,009				89,269				97,239				6	%			-2	%
Loans held-for-sale			10,780				5,786				7,997				86	%			35	%
Loans, net of deferred loan fees			572,783				563,099				518,552				2	%			10	%
Allowance for loan losses			(8,254	)			(8,353	)			(8,288	)			-1	%			0	%
Loans, net			564,529				554,746				510,264				2	%			11	%
Premises and equipment, net of accumulated depreciation and amortization			16,165				16,303				16,706				-1	%			-3	%
Other real estate owned and foreclosed assets			1,124				999				2,386				13	%			-53	%
Accrued interest receivable			2,524				2,348				2,423				7	%			4	%
Cash surrender value of life insurance			18,863				18,742				18,349				1	%			3	%
Goodwill			12,168				12,168				12,168				0	%			0	%
Other intangible assets			1,430				1,439				1,471				-1	%			-3	%
Other assets			5,309				5,347				7,106				-1	%			-25	%
TOTAL ASSETS		$	762,096			$	744,807			$	717,440				2	%			6	%
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand		$	167,264			$	165,760			$	152,916				1	%			9	%
Interest-bearing demand and savings			374,429				354,611				342,008				6	%			9	%
Time deposits			115,419				118,683				125,532				-3	%			-8	%
Total deposits			657,112				639,054				620,456				3	%			6	%
Accrued interest payable			140				145				166				-3	%			-16	%
Long-term borrowings			11,416				11,453				10,000				0	%			14	%
Junior subordinated debentures			13,403				13,403				13,403				0	%			0	%
Other liabilities			5,888				8,269				4,820				-29	%			22	%
Total liabilities			687,959				672,324				648,845				2	%			6	%
Preferred Stock, par value none 5,000,000 shares authorized, none outstanding			-				-				-				0	%			0	%
Common Stock, par value $1 25,000,000 shares authorized, 10,380,492 shares issued and outstanding at 03/31/2015, 10,371,460 at 12/31/2014, and 10,182,083 at 03/31/2014			10,380				10,371				10,182				0	%			2	%
Additional paid-in-capital			43,056				42,991				41,852				0	%			3	%
Retained earnings			20,352				19,256				17,535				6	%			16	%
Accumulated other comprehensive income (loss)			349				(135	)			(974	)			359	%			136	%
Total shareholders' equity			74,137				72,483				68,595				2	%			8	%
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	762,096			$	744,807			$	717,440				2	%			6	%

 

  

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except per Share Data)

(UNAUDITED)

 

		For the Three Months Ended												Sequential				Year over
		March 31,				December 31,				March 31,				Quarter				Year
		2015				2014				2014				% Change				% Change
INTEREST AND DIVIDEND INCOME
Loans		$	6,923			$	6,805			$	6,495				2	%			7	%
Deposits in banks and federal funds sold			20				26				21				-23	%			-5	%
Securities available for sale:
Taxable			301				287				337				5	%			-11	%
Tax-exempt			166				166				207				0	%			-20	%
Securities held to maturity:
Taxable			2				2				2				0	%			0	%
Tax-exempt			19				19				22				0	%			-14	%
FHLB & PCBB dividends			1				31				1				-97	%			0	%
Total interest and dividend income			7,432				7,336				7,085				1	%			5	%
INTEREST EXPENSE
Deposits:
Interest-bearing demand and savings			151				166				141				-9	%			7	%
Time			242				252				276				-4	%			-12	%
Long-term borrowings			56				57				53				-2	%			6	%
Junior subordinated debentures			60				61				60				-2	%			0	%
Total interest expense			509				536				530				-5	%			-4	%
Net interest income			6,923				6,800				6,555				2	%			6	%
LOAN LOSS PROVISION			30				100				-				-70	%			100	%
Net interest income after loan loss provision			6,893				6,700				6,555				3	%			5	%
NON-INTEREST INCOME
Service charges on deposit accounts			426				450				435				-5	%			-2	%
Net loss on sale of other real estate owned			(6	)			(28	)			(36	)			79	%			83	%
Net gains from sales of loans			954				970				627				-2	%			52	%
Net gains on sales of securities available for sale			-				-				52				0	%			-100	%
Net other-than-temporary impairment			-				-				(45	)			0	%			100	%
Earnings on bank owned life insurance			121				126				111				-4	%			9	%
Other operating income			478				503				464				-5	%			3	%
Total non-interest income			1,973				2,021				1,608				-2	%			23	%
NON-INTEREST EXPENSE
Salaries and employee benefits			4,578				4,494				4,055				2	%			13	%
Occupancy			522				512				506				2	%			3	%
Equipment			267				274				252				-3	%			6	%
Data processing			513				509				468				1	%			10	%
Professional services			168				108				196				56	%			-14	%
Other real estate owned write-downs			31				-				12				100	%			158	%
Other real estate owned operating costs			17				48				61				-65	%			-72	%
State taxes			102				103				97				-1	%			5	%
FDIC and state assessments			133				110				134				21	%			-1	%
Other non-interest expense			1,153				969				1,049				19	%			10	%
Total non-interest expense			7,484				7,127				6,830				5	%			10	%
INCOME BEFORE PROVISION FOR INCOME TAXES			1,382				1,594				1,333				-13	%			4	%
PROVISION FOR INCOME TAXES			286				473				305				-40	%			-6	%
Effective Tax Rate			20.69	%			29.67	%			22.88	%
NET INCOME APPLICABLE TO COMMON SHAREHOLDERS		$	1,096			$	1,121			$	1,028				-2	%			7	%
EARNINGS PER COMMON SHARE:
BASIC		$	0.11			$	0.11			$	0.10				0	%			10	%
DILUTED		$	0.10			$	0.11			$	0.10				-9	%			0	%
WEIGHTED AVERAGE SHARES OUTSTANDING:
BASIC			10,373,563				10,369,417				10,182,083
DILUTED			10,505,901				10,459,808				10,272,341

  

  

Noninterest Income

 

The slight decrease in noninterest income from fourth quarter 2014 was due to a variety of factors, including slight declines in service charge income on deposit accounts, along with other miscellaneous sources of fee income, arising out of seasonal declines in economic activity. Gains on sale of residential mortgage loans were unchanged in the current quarter compared to the linked quarter, but up significantly when compared to first quarter 2014. In addition, gains on sales of securities were taken in the first quarter of 2014 for the purpose of adjusting the mix of securities to mitigate the impact of potential changes in market rates on the value of the portfolio. A small OTTI impairment charge was expensed during first quarter 2014 to reflect a reduction in fair value of a private-label CMO investment security.

 

Noninterest income
(Unaudited)
(Dollars in Thousands)
For The Three Months Ended
		March 31,  2015				December 31, 2014				$ Change				% Change				March 31, 2014				$ Change				% Change
Service charges on deposit accounts		$	426			$	450			$	(24	)			-5	%		$	435			$	(9	)			-2	%
Net (loss) on sale of other real estate owned			(6	)			(28	)			22				79	%			(36	)			30				83	%
Net gains from sales of loans			954				970				(16	)			-2	%			628				326				52	%
Net gains on sales of securities available for sale			-				-				-				0	%			52				(52	)			-100	%
Net other-than-temporary impairment			-				-				-				0	%			(45	)			45				100	%
Earnings on bank owned life insurance			121				126				(5	)			-4	%			111				10				9	%
Other operating income
Fee income			439				405				34				8	%			364				75				21	%
Annuity sales income			32				81				(49	)			-60	%			82				(50	)			-61	%
Other non-interest income			7				17				(10	)			-59	%			17				(10	)			-59	%
Total non-interest income		$	1,973			$	2,021			$	(48	)			-2	%		$	1,608			$	365				23	%

 

Noninterest Expense

 

Noninterest expense for the three months ended March 31, 2015 was up compared to fourth quarter 2014. These increases were primarily due to annual increases in salary and health benefit plan expenses and other noninterest expense related to establishment of a reserve for unfunded commitments of $120,000. Professional services expenses increased due to a $70,000 one-time adjustment to accruals in fourth quarter 2014 related to an expected reduction in fees due to a change in external auditors. Noninterest expense for first quarter 2015 also increased versus the three months ended March 31, 2014. This increase was primarily due to additional salary and benefit expense associated with the opening of our Salem, OR loan production office in the current quarter, increased commissions paid to residential real estate mortgage lenders reflecting higher production volume, and annual merit increases in salary and health benefit plan expenses.

 

Noninterest expense
(Unaudited)
(Dollars in Thousands)
For The Three Months Ended
		March 31,  2015				December 31, 2014				$ Change				% Change				March 31, 2014				$ Change				% Change
Salaries and employee benefits		$	4,578			$	4,494			$	84				2	%		$	4,055			$	523				13	%
Occupancy			522				512				10				2	%			506				16				3	%
Equipment			267				274				(7	)			-3	%			252				15				6	%
Data processing			513				509				4				1	%			468				45				10	%
Professional services			168				108				60				56	%			196				(28	)			-14	%
Other real estate owned write-downs			31				-				31				100	%			12				19				158	%
Other real estate owned operating costs			17				48				(31	)			-65	%			61				(44	)			-72	%
State taxes			102				103				(1	)			-1	%			97				5				5	%
FDIC and state assessments			133				110				23				21	%			134				(1	)			-1	%
Other non-interest expense:
Director fees			71				79				(8	)			-10	%			56				15				27	%
Communication			61				53				8				15	%			37				24				65	%
Advertising			96				104				(8	)			-8	%			78				18				23	%
Professional liability insurance			22				20				2				10	%			23				(1	)			-4	%
Amortization			83				95				(12	)			-13	%			95				(12	)			-13	%
Other non-interest expense			820				618				202				33	%			760				60				8	%
Total non-interest expense		$	7,484			$	7,127			$	357				5	%		$	6,830			$	654				10	%

 

  

Income Taxes

 

The Company recorded an income tax provision for the three months ended March 31, 2015, December 31, 2014, and March 31, 2014. The amount of the provision for each period was commensurate with the estimated tax liability associated with the net income earned during the period.

 

As of March 31, 2015, the Company maintained a deferred tax asset balance of $2.9 million. The Company believes it will be fully utilized in the normal course of business, thus no valuation allowance is maintained against this asset.

 

LIQUIDITY

 

Cash and Cash Equivalents and Investment Securities

(Unaudited)

(Dollars in Thousands)

		March 31, 2015				% of Total				December 31, 2014				% of Total				$ Change				% Change				March 31, 2014				% of Total				$ Change				% Change
Cash and due from banks		$	15,321				11	%		$	14,782				12	%		$	539				4	%		$	15,747				11	%		$	(426	)			-3	%
Cash equivalents:
Interest-bearing deposits			12,282				10	%			16,255				13	%			(3,973	)			-24	%			19,872				15	%			(7,590	)			-38	%
Interest-bearing certificates of deposit			2,727				2	%			2,727				2	%			-				0	%			2,727				2	%			-				0	%
Total cash equivalents and certificate of deposits			30,330				23	%			33,764				27	%			(3,434	)			-10	%			38,346				28	%			(8,016	)			-21	%
Investment securities:
Collateralized mortgage obligations: agency issued			42,108				34	%			38,767				31	%			3,341				9	%			37,567				27	%			4,541				12	%
Collateralized mortgage obligations: non-agency issued			504				0	%			527				0	%			(23	)			-4	%			1,974				1	%			(1,470	)			-74	%
Mortgage-backed securities: agency issued			12,136				9	%			12,322				10	%			(186	)			-2	%			13,182				10	%			(1,046	)			-8	%
U.S. Government and agency securities			10,114				8	%			8,056				6	%			2,058				26	%			9,828				7	%			286				3	%
State and municipal securities			30,147				23	%			29,597				23	%			550				2	%			34,688				25	%			(4,541	)			-13	%
FHLB Stock, at cost			2,865				2	%			2,896				2	%			(31	)			-1	%			2,985				2	%			(120	)			-4	%
Pacific Coast Bankers' Bank stock, at cost			1,000				1	%			1,000				1	%			-				0	%			-				0	%			1,000				100	%
Total investment securities			98,874				77	%			93,165				73	%			5,709				6	%			100,224				72	%			(1,350	)			-1	%
Total cash equivalents and investment securities		$	129,204				100	%		$	126,929				100	%		$	2,275				2	%		$	138,570				100	%		$	(9,366	)			-7	%
Total cash equivalents and investment securities as a % of total assets							17	%							17	%															19	%

 

Liquidity remains strong based on the current combined level of cash equivalents and investment securities. In an effort to support our net interest income and margin, we reduced the cash equivalent portion of our liquidity holdings, while increasing the portion held in investment securities, since December 31, 2014, primarily through the purchase of U.S. government agency and government guaranteed mortgage-backed securities. The purchases were primarily of 10 and 15-year fully amortized U.S. agency mortgage-backed securities, for which we expect to have limited extension risk. We also purchased municipal securities rated AA or better with maturities generally ranging from 5 to 15 years during this period. The expected modified duration (adjusted for calls, consensus pre-payment speeds and rate adjustment dates) of the investment portfolio was 4.1 years at March 31, 2015, 4.1 years at December 31, 2014 and 4.2 years at March 31, 2014.

 

LOANS

 

Loans by category

(Unaudited)

(Dollars in Thousands)

		March 31,				% of				December 31,				% of				$								March 31,				% of				$
		2015				Gross Loans				2014				Gross Loans				Change				% Change				2014				Gross Loans				Change				% Change
Commercial and agricultural		$	119,095				20	%		$	120,517				22	%		$	(1,422	)			-1	%		$	101,971				20	%		$	17,124				17	%
Real estate:
Construction and development			28,831				5	%			26,711				5	%			2,120				8	%			30,765				6	%			(1,934	)			-6	%
Residential 1-4 family			91,865				16	%			92,965				16	%			(1,100	)			-1	%			89,244				17	%			2,621				3	%
Multi-family			20,287				4	%			18,541				3	%			1,746				9	%			18,982				4	%			1,305				7	%
Commercial real estate — owner occupied			130,486				23	%			125,632				22	%			4,854				4	%			112,771				22	%			17,715				16	%
Commercial real estate — non owner occupied			116,095				20	%			117,137				21	%			(1,042	)			-1	%			119,803				23	%			(3,708	)			-3	%
Farmland			21,898				4	%			22,245				4	%			(347	)			-2	%			22,940				4	%			(1,042	)			-5	%
Consumer			45,411				8	%			40,565				7	%			4,846				12	%			23,156				4	%			22,255				96	%
Gross loans			573,968				100	%			564,313				100	%			9,655				2	%			519,632				100	%			54,336				10	%
Less:  allowance for loan losses			(8,254	)							(8,353	)							99								(8,288	)							34
Less:  deferred fees			(1,185	)							(1,214	)							29								(1,080	)							(105	)
Loans, net		$	564,529							$	554,746							$	9,783							$	510,264							$	54,265

 

  

Loan portfolio growth continues to be well diversified, with higher balances in most lending categories. The recent loan growth was generated predominately within our Western Washington and Oregon markets. The portfolio does include $33.2 million in purchased government-guaranteed commercial and commercial real estate loans. In addition, the portfolio contains $34.6 million in indirect consumer loans to finance luxury and classic cars as a part of a strategy to diversify the loan portfolio. These loans are to individuals with high credit scores and have exhibited very low loss experience to date. The Company manages new loan origination volume using concentration limits that establish maximum exposure levels by designated industry segment, real estate product types, geography, and single borrower limits.

 

DEPOSITS

 

Deposits
(Unaudited)
(Dollars in Thousands)		March 31, 2015				Percent of Total				December 31, 2014				Percent of Total				$ Change				March 31, 2014				Percent of Total				$ Change
Interest-bearing demand and money market		$	291,083				44	%		$	274,614				42	%		$	16,469			$	263,953				42	%		$	27,130
Savings			83,346				13	%			79,997				13	%			3,349				78,055				13	%			5,291
Time deposits			115,419				18	%			118,683				19	%			(3,264	)			125,532				20	%			(10,113	)
Total interest-bearing deposits			489,848				75	%			473,294				74	%			16,554				467,540				75	%			22,308
Non-interest bearing demand			167,264				25	%			165,760				26	%			1,504				152,916				25	%			14,348
Total deposits		$	657,112				100	%		$	639,054				100	%		$	18,058			$	620,456				100	%		$	36,656

 

Total deposits grew during first quarter 2015, a trend that continued from recent quarters. The current increase is due to recent success in acquiring business deposit relationships in conjunction with the growth in lending achieved over the past year. Time deposits declined as a percentage of total deposits in the current quarter as compared to fourth quarter 2014 and first quarter 2014.

 

Total brokered deposits were $21.8 million at March 31, 2015, which included $1.4 million via reciprocal deposit arrangements. In addition, the Company’s funding structure includes $11.4 million in borrowings from the Federal Home Loan Bank.

 

CAPITAL

 

Pacific, and its subsidiary Bank of the Pacific, exceeded the thresholds to be considered “Well-Capitalized” under published regulatory standards for total risk-based capital, Tier 1 risk-based capital, Tier 1 common equity and Tier 1 leverage capital at March 31, 2015. Capital ratios have decreased slightly as compared to fourth quarter 2014 and the first quarter of 2014, primarily due to the successful execution of the Company’s growth strategy and related shift in the balance sheet mix to higher risk-weighted assets, such as loans.

 

The Federal Deposit Insurance Corporation (“FDIC”) has established minimum requirements for capital adequacy for state non-member banks under the Basel III capital framework. The Bank is required to comply with the new framework . On April 9, 2015, The Board of Governors of the Federal Reserve System (“Federal Reserve”) issued a final rule to amend the Small Bank Holding Company Policy Statement. With this amendment, small bank holding companies, including Pacific, will not be subject to Basel III capital rules. For illustrative purposes, Basel III framework capital ratios are displayed below for both the Company and the Bank. For more information on these topics and Basel III, see the discussions under the subheadings “Capital Adequacy” in the section “Business” included in Item 1 of the Company’s 2014 Form 10-K.

 

The total risk based capital ratios of the Company include $13.4 million of junior subordinated debentures, all of which qualified as Tier 1 capital at March 31, 2015, under guidance issued by the Federal Reserve.

 

 

 

The following table summarizes the capital measures of the Company and the Bank, respectively, at the dates listed below.

 

		March 31, 2015				December 31, 2014				Change				March 31, 2014				Change		Regulatory Minimum to be "Well Capitalized"*
																				greater than or equal to
Pacific Financial Corporation
Actual amount
Total risk-based capital ratio			13.28	%			13.61	%			(0.33	)			13.88	%		(0.60	)		10.5	%
Tier 1 risk-based capital ratio			12.02	%			12.36	%			(0.34	)			12.62	%		(0.60	)		8.5	%
Common equity tier 1 ratio			9.91	%			n/a				n/a				n/a			n/a			7.0	%
Leverage ratio			10.01	%			9.80	%			0.21				10.02	%		(0.01	)		5.0	%
Tangible common equity ratio			8.09	%			8.05	%			0.04				7.81	%		0.28			n/a
Bank of the Pacific
Total risk-based capital ratio			13.21	%			13.52	%			(0.31	)			13.93	%		(0.72	)		10.5	%
Tier 1 risk-based capital ratio			11.96	%			12.27	%			(0.31	)			12.67	%		(0.71	)		8.5	%
Common equity tier 1 ratio			11.96	%			n/a				n/a				n/a			n/a			7.0	%
Leverage ratio			9.96	%			9.73	%			0.23				9.99	%		(0.03	)		5.0	%

 

*: Includes Basel III Capital Conservation Buffer

 

PACIFIC FINANCIAL CORPORATION

(Dollars in Thousands, Except per Share Data)

(UNAUDITED)

 

		For the Three Months Ended
		March 31,				December 31,				March 31,
		2015				2014				2014
Operations Data
Net interest income		$	6,923			$	6,800			$	6,555
Provision for credit losses			30				100				-
Non-interest income			1,973				2,021				1,608
Non-interest expense			7,484				7,127				6,830
Provision for income taxes			286				473				305
Net income		$	1,096			$	1,121			$	1,028
Net income per share:
Basic(1)		$	0.11			$	0.11			$	0.10
Diluted(1)			0.10				0.11				0.10
Performance Ratios
Efficiency ratio(2)			84.13	%			80.80	%			83.67	%
Return on average assets, annualized			0.59	%			0.59	%			0.59	%
Return on average equity, annualized			6.05	%			5.98	%			6.12	%
Balance Sheet Data
Total assets		$	762,096			$	744,807			$	717,440
Loans, net			564,529				554,746				510,264
Total deposits			657,112				639,054				620,456
Total borrowings			24,819				24,856				23,403
Shareholders' equity			74,137				72,483				68,595
Book value per share(3)			7.14				6.99				6.74
Tangible book value per share(4)			5.83				5.68				5.40
Equity to assets ratio			9.73	%			9.73	%			9.56	%
Asset Quality Ratios
Nonperforming loans to total loans			1.20	%			1.62	%			1.41	%
Allowance for loan losses to total loans			1.44	%			1.48	%			1.59	%
Allowance for loan losses to
nonperforming loans			119.62	%			91.54	%			114.43	%
Nonperforming assets to total assets			1.05	%			1.36	%			1.35	%

  

⁽¹⁾ Net interest income divided by average shares outstanding

⁽²⁾ Non-interest expense divided by the sum of net interest income and non-interest income

⁽³⁾ Shareholder equity divided by shares outstanding

⁽⁴⁾ Shareholder equity less intangibles divided by shares outstanding

 

  

Net Interest Margin

 

Net interest margin (“NIM”) for first quarter 2015 increased as compared to fourth quarter and first quarter 2014, predominantly due to a shift in the mix of earning assets toward higher-yielding loans. NIM was also favorably impacted by the lower cost of interest bearing liabilities. The growth in the proportion of noninterest bearing deposits over the past several quarters has supported the improvement in NIM as well. In first quarter 2014, loan yields and net interest margin were each enhanced by 7 basis points due to the collection of $108,000 in non-accrual interest. Improvement in yields on investment securities also contributed to the increase in net interest margin between the periods, partially due to a decline in amortization expense associated with a decrease in prepayment speeds of mortgage-backed securities during the current period. In addition, the Company reduced the proportion of lower yielding cash-equivalent investments and increased the proportion of relatively higher-yielding federal government guaranteed and municipal securities during the first quarter of 2015.

 

The following tables set forth information with regard to average balances of interest earning assets and interest bearing liabilities and the resultant yields or cost, net interest income, and the net interest margin on a tax equivalent basis. Loans held for sale and non-accrual loans are included in total loans.

 

(Dollars in Thousands) (Unaudited)

Average Interest Earning Balances: 

		For the Three Months Ended
		March 31, 2015												December 31, 2014												March 31, 2014
		Average Balance				Interest Income or Expense				Average Yields or Rates				Average Balance				Interest Income or Expense				Average Yields or Rates				Average Balance				Interest Income or Expense				Average Yields or Rates
(Dollars in Thousands)
ASSETS:
Interest bearing certificate of deposit		$	2,727			$	10				1.49	%		$	2,727			$	11				1.60	%		$	2,727			$	11				1.64	%
Interest bearing deposits in banks			17,857				10				0.23	%			26,735				15				0.22	%			17,954				11				0.25	%
Investments - taxable			66,924				305				1.85	%			66,466				320				1.91	%			67,695				339				2.03	%
Investments – nontaxable			28,525				279				3.97	%			28,427				280				3.91	%			32,770				347				4.29	%
Gross loans (1)			567,788				6,911				4.94	%			554,886				6,787				4.85	%			511,200				6,492				5.15	%
Loans held for sale			6,735				57				3.43	%			7,306				66				3.58	%			5,436				49				3.66	%
Total interest earning assets			690,556				7,572				4.45	%			686,547				7,479				4.32	%			637,782				7,249				4.61	%
Cash and due from banks			13,585												13,483												11,989
Bank premises and equipment (net)			16,314												16,414												16,806
Other real estate owned			1,059												1,063												2,565
Deferred fees			(1,169	)											(1,172	)											(1,137	)
Allowance for loan losses			(8,387	)											(8,306	)											(8,388	)
Other assets			40,808												40,142												41,129
Total assets		$	752,766											$	748,171											$	700,746
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing deposits		$	363,696			$	151				0.17	%		$	351,653			$	166				0.19	%		$	336,201			$	141				0.17	%
Time deposits			116,985				242				0.84	%			118,624				252				0.84	%			126,841				276				0.88	%
FHLB borrowings			11,446				56				1.98	%			11,466				57				1.97	%			10,000				53				2.15	%
Junior subordinated debentures			13,403				60				1.82	%			13,403				61				1.81	%			13,403				60				1.82	%
Total interest bearing liabilities			505,530				509				0.41	%			495,146				536				0.43	%			486,445				530				0.44	%
Non-interest-bearing deposits			167,391												172,002												140,980
Other liabilities			6,382												6,655												5,196
Equity			73,463												74,368												68,125
Total liabilities and shareholders' equity		$	752,766											$	748,171											$	700,746
Net interest income (3)						$	7,063											$	6,943											$	6,719
Net interest spread											4.04	%											3.89	%											4.17	%
Average yield on earning assets (2) (3)											4.45	%											4.32	%											4.61	%
Interest expense to earning assets											0.30	%											0.31	%											0.34	%
Net interest income to earning assets (2) (3)											4.15	%											4.01	%											4.27	%
Average yield on investments (4)											2.11	%											2.00	%											2.37	%
Cost of average interest bearing deposits											0.33	%											0.35	%											0.37	%
Cost of average borrowings											1.89	%											1.88	%											1.96	%
Cost of average total deposits and borrowings											0.31	%											0.32	%											0.34	%
Cost of average interest bearing liabilities											0.41	%											0.43	%											0.44	%
Reconciliation of Non-GAAP measure:
Tax Equivalent Net Interest Income
Net interest income						$	6,923											$	6,800											$	6,555
Tax equivalent adjustment for municipal loan interest							45												48												46
Tax equivalent adjustment for municipal bond interest							95												95												118
Tax equivalent net interest income						$	7,063											$	6,943											$	6,719

 

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited.

Management believes that presentation of this non-GAAP measure provides useful information frequently used by shareholders in the evaluation of a company.

Non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.

 

(1) Non-accrual loans of approximately $6.9 million at 03/31/15, $8.7 million at 12/31/2014, and $7.3 million for 03/31/2014 are included in the average loan balances.

(2) Loan interest income includes loan fee income of $219,000, $196,000, and $149,000 for the three months ended 03/31/2015, 12/31/2014, and 03/31/2014, respectively.

(3) Tax-exempt income has been adjusted to a tax equivalent basis at a 34% effective rate. The amount of such adjustment was an addition to recorded pre-tax income of $140,000, $143,000, and $164,000 for the three months ended March 31, 2015, December 31, 2014, and March 31, 2014, respectively.

(4) Includes certificate of deposits, deposits in banks, and investments.

 

  

		For the Three Months Ended												For the Three Months Ended
		March 31, 2015 vs. December 31, 2014												March 31, 2015 vs. March 31, 2014
		Increase (Decrease) Due To												Increase (Decrease) Due To
(Dollars in Thousands) (Unaudited)										Net												Net
		Volume				Rate				Change				Volume				Rate				Change
ASSETS:
Interest bearing certificate of deposit		$	-			$	(1	)		$	(1	)		$	-			$	(1	)		$	(1	)
Interest bearing deposits in banks			(5	)			-				(5	)			-				(1	)			(1	)
Investments - taxable			2				(17	)			(15	)			(4	)			(30	)			(34	)
Investments - nontaxable			1				(2	)			(1	)			(45	)			(23	)			(68	)
Gross loans			154				(30	)			124				719				(300	)			419
Loans held for sale			(5	)			(4	)			(9	)			12				(4	)			8
Total interest earning assets		$	147			$	(54	)		$	93			$	682			$	(359	)		$	323
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing deposits		$	6			$	(21	)		$	(15	)		$	12			$	(2	)		$	10
Time deposits			(3	)			(7	)			(10	)			(21	)			(13	)			(34	)
FHLB borrowings			-				(1	)			(1	)			8				(5	)			3
Long-term borrowings			-				(1	)			(1	)			-				-				-
Total interest bearing liabilities			3				(30	)			(27	)			(1	)			(20	)			(21	)
Net increase (decrease) in net interest income		$	144			$	(24	)		$	120			$	683			$	(339	)		$	344

 

SUMMARY AVERAGE BALANCE SHEETS
(Unaudited)
(Dollars in Thousands)
Averages for the Three Months Ended		March 31,				December 31,												March 31,
		2015				2014				$ Change				% Change				2014				$ Change				% Change
Assets:
Cash and due from banks		$	13,585			$	13,483			$	102				1	%		$	11,989			$	1,596				13	%
Interest-bearing deposits in banks			17,857				26,735				(8,878	)			-33	%			17,954				(97	)			-1	%
Interest bearing certificate of deposit			2,727				2,727				-				0	%			2,727				0				0	%
Investment securities			95,449				94,893				556				1	%			100,465				(5,016	)			-5	%
Loans, net of deferred loan fees			573,354				561,020				12,334				2	%			515,499				57,855				11	%
Allowance for loan losses			(8,387	)			(8,306	)			(81	)			1	%			(8,388	)			1				0	%
Net loans			564,967				552,714				12,253				2	%			507,111				57,856				11	%
Other assets			58,181				57,619				562				1	%			60,500				(2,319	)			-4	%
Total assets		$	752,766			$	748,171			$	4,595				1	%		$	700,746			$	52,020				7	%
Liabilities:
Total deposits		$	648,072			$	642,279			$	5,793				1	%		$	604,022			$	44,050				7	%
Borrowings			24,849				24,869				(20	)			0	%			23,403				1,446				6	%
Other liabilities			6,382				6,655				(273	)			-4	%			5,196				1,186				23	%
Total liabilities			679,303				673,803				5,500				1	%			632,621				46,682				7	%
Equity:
Common equity			73,463				74,368				(905	)			-1	%			68,125				5,338				8	%
Total equity			73,463				74,368				(905	)			-1	%			68,125				5,338				8	%
Total liabilities and shareholders' equity		$	752,766			$	748,171			$	4,595				1	%		$	700,746			$	52,020				7	%

 

  

ASSET QUALITY

 

At March 31, 2015, classified loans remained unchanged, as compared to December 31, 2014, but increased as compared to March 31, 2014. This increase is primarily due to the downgrade of a commercial and commercial real estate relationship totaling $4.8 million in second quarter 2014. Nonperforming loans have continued to decline and are centered primarily in commercial real estate. Total 30-89 days delinquencies remain below 0.50%, mirroring the improvement in overall credit quality.

 

At March 31, 2015, total nonperforming assets were down compared to December 31, 2014 and March 31, 2014. Nonperforming assets also declined in terms of percentage of total assets. Reductions in nonperforming assets continued primarily from the decline in non-accrual loans. Nonperforming assets as of March 31, 2014, include a $1.8 million commercial real estate loan supported 100% by a government guarantee.

 

Adversely classified loans and securities (Unaudited) (Dollars in Thousands)

		March 31,  2015				December 31, 2014				$ Change				% Change				March 31, 2014				$ Change				% Change
Rated substandard or worse, but not impaired		$	9,265			$	7,368			$	1,897				26	%		$	6,842			$	2,423				35	%
Impaired			9,489				11,311				(1,822	)			-16	%			9,952				(463	)			-5	%
Total adversely classified loans1		$	18,754			$	18,679			$	75				0	%		$	16,794			$	1,960				12	%
Total investment securities2		$	194			$	199			$	(5	)			-3	%		$	1,751			$	(1,557	)			-89	%
Gross loans (excluding deferred loan fees)		$	573,968			$	564,313			$	9,655				2	%		$	519,632			$	54,336				10	%
Adversely classified loans to gross loans			3.27	%			3.31	%											3.23	%
Allowance for loan losses		$	8,254			$	8,353			$	(99	)			-1	%		$	8,288			$	(34	)			0	%
Allowance for loan losses as a percentage of adversely classified loans			44.01	%			44.72	%											49.35	%
Allowance for loan losses to total impaired loans			86.98	%			73.85	%											83.28	%
Adversely classified loans and securities to total assets			2.49	%			2.53	%											2.58	%

 

¹Adversely classified loans are defined as loans having a well-defined weakness or weaknesses related to the borrower's financial capacity or to pledged collateral that may jeopardize the repayment of the debt. They are characterized by the possibility that the Bank may sustain some loss if the deficiencies giving rise to the substandard classification are not corrected. Note that any loans internally rated worse than substandard are included in the impaired loan totals.

²Adversely classified investment securities consist of one private label collateralized mortgage obligation (CMO) as of 03/31/2015 and 12/31/2014 and three private label CMOs as of 03/31/2014. 

30-89 Days Past Due by type

(Dollars in Thousands)

		March 31, 2015				% of Category				December 31, 2014				% of Category				$ Change				% Change				March 31, 2014				% of Category				$ Change				% Change
Commercial and agricultural		$	253				35.9	%		$	-				0.0	%		$	253				100	%		$	32				4.1	%		$	221				691	%
Real estate:
Construction and development			-				0.0	%			18				2.1	%			(18	)			-100	%			-				0.0	%			-				0	%
Residential 1-4 family			442				62.7	%			605				71.9	%			(163	)			-27	%			180				23.1	%			262				146	%
Multi-family			-				0.0	%			-				0.0	%			-				0	%			-				0.0	%			-				0	%
Commercial real estate — owner occupied			-				0.0	%			-				0.0	%			-				0	%			309				39.6	%			(309	)			-100	%
Commercial real estate — non owner occupied			-				0.0	%			-				0.0	%			-				0	%			251				32.2	%			(251	)			-100	%
Farmland			-				0.0	%			46				5.5	%			(46	)			-100	%			-				0.0	%			-				0	%
Total real estate		$	442							$	669							$	(227	)			-34	%		$	740							$	(298	)
Consumer			10				1.4	%			172				20.5	%			(162	)			-94	%			8				1.0	%			2				25	%
Total loans 30-89 days past due, not in nonaccrual status		$	705				100.0	%		$	841				100.0	%		$	(136	)			-16	%		$	780				100.0	%		$	(75	)			-10	%
Delinquent loans to total loans, not in nonaccrual status			0.12	%							0.23	%															0.15	%

 

  

Non-performing assets

(Unaudited)
(Dollars in Thousands)		March 31, 2015				December 31, 2014				$ Change				% Change				March 31, 2014				$ Change				% Change
Loans on nonaccrual status		$	6,900			$	8,716			$	(1,816	)			-21	%		$	7,296			$	(396	)			-5	%
Loans past due greater than 90 days but not on nonaccrual status			-				409				(409	)			-100	%			-				-				0	%
Total non-performing loans			6,900				9,125				(2,225	)			-24	%			7,296				(396	)			-5	%
Other real estate owned and foreclosed assets			1,124				999				125				13	%			2,386				(1,262	)			-53	%
Total nonperforming assets		$	8,024			$	10,124			$	(2,100	)			-21	%		$	9,682			$	(1,658	)			-17	%
Percentage of nonperforming assets to total assets			1.05	%			1.36	%											1.35	%

 

OREO property disposition activities continued during first quarter 2015, while the level of additional real estate properties taken into the OREO portfolio continued to be nominal. During first quarter 2015, the Company sold one OREO property with a book value of $90,000. OREO valuation adjustments continue to be minimal. The largest balances in the OREO portfolio at the end of the quarter were attributable to commercial properties, followed by residential properties, all of which are located within our market area.

 

Other real estate owned and foreclosed assets

(Unaudited)

(Dollars in Thousands)

For the Three Months Ended		March 31, 2015				% of Category				December 31, 2014				% of Category				$ Change				% Change				March 31, 2014				% of Category				$ Change				% Change
Other real estate owned, beginning of period		$	999				90	%		$	1,210				121	%		$	(211	)			-17	%		$	2,771				117	%		$	(1,772	)			-64	%
Transfers from outstanding loans			219				19	%			-				0	%			219				100	%			111				5	%			108				97	%
Proceeds from sales			(57	)			-5	%			(183	)			-18	%			126				-69	%			(448	)			-19	%			391				-87	%
Net (loss) on sales			(6	)			-1	%			(28	)			-3	%			22				-79	%			(36	)			-2	%			30				-83	%
Impairment charges			(31	)			-3	%			-				0	%			(31	)			-100	%			(12	)			-1	%			(19	)			158	%
Total other real estate owned		$	1,124				100	%		$	999				100	%		$	125				13	%		$	2,386				100	%		$	(1,262	)			-53	%

 

Other real estate owned and foreclosed assets by type

(Unaudited)

(Dollars in Thousands) 

		March 31, 2015				# of Properties				December 31, 2014				# of Properties				$ Change				% Change				March 31, 2014				# of Properties				$ Change				% Change
Construction, Land Dev & Other Land		$	32				1			$	35				1			$	(3	)			-9	%		$	60				3			$	(28	)			-47	%
1-4 Family Residential Properties			219				2				-				-				219				0	%			789				7				(570	)			-72	%
Nonfarm Nonresidential Properties			873				2				964				3				(91	)			-9	%			1,537				8				(664	)			-43	%
Total OREO by type		$	1,124				5			$	999				4			$	125				13	%		$	2,386				18			$	(1,262	)			-53	%

 

ALLOWANCE FOR LOAN LOSSES

 

The allowance for loan losses continues to decline in concert with the general trend of reduced levels of classified loans, loan delinquencies and other relevant credit metrics. With the reduction in net charge-offs compared to the past several years, changes in the loan portfolio composition and overall improvement in credit quality, loss factors used in estimates to establish reserve levels have declined commensurately. Provision expense was incurred to enhance the allowance for loan losses in first quarter 2015 and fourth quarter 2014 commensurate with the loan portfolio growth experienced during those periods. In addition, $120,000 was expensed as other noninterest expense to establish a separate reserve for unfunded commitments, much of which had already been incorporated into the Company’s allowance for loan losses valuation methodology. No provision expense was incurred in first quarter 2014.

 

  

For the quarter ended March 31, 2015, total net loan charge-offs were up slightly compared to the quarters ended December 31, 2014 and March 31, 2014, respectively. The charge-offs incurred in the current period were centered in various residential real estate and consumer loan relationships, none of which were of notable size. The ratio of net loan charge-offs to average gross loans (annualized) for the current quarter is modest, continuing the recent trends from previous quarters.

 

The overall risk profile of the loan portfolio continues to improve. However, the trend of future provision for loan losses will depend primarily on economic conditions, growth in the loan portfolio, level of adversely-classified assets, and changes in collateral values.

 

Allowance for Loan Losses
(Unaudited)
(Dollars in Thousands)
For the Three Months Ended		March 31, 2015				December 31, 2014				$ Change				% Change				March 31, 2014				$ Change				% Change
Gross loans outstanding at end of period		$	573,968			$	564,313			$	9,655				2	%		$	519,632			$	54,336				10	%
Average loans outstanding, gross		$	567,788			$	554,886			$	12,902				2	%		$	511,200			$	56,588				11	%
Allowance for loan losses, beginning of period		$	8,353			$	8,255			$	98				1	%		$	8,359			$	(6	)			0	%
Charge-offs
Commercial			-				-				-				0	%			(17	)			17				-100	%
Commercial Real Estate			(8	)			(10	)			2				-20	%			(7	)			(1	)			14	%
Residential Real Estate			(86	)			(24	)			(62	)			258	%			(40	)			(46	)			115	%
Consumer			(64	)			(20	)			(44	)			220	%			(18	)			(46	)			256	%
Total charge-offs			(158	)			(54	)			(104	)			193	%			(82	)			(76	)			93	%
Recoveries
Commercial			6				2				4				200	%			1				5				500	%
Commercial Real Estate			3				44				(41	)			-93	%			5				(2	)			-40	%
Residential Real Estate			9				5				4				80	%			4				5				125	%
Consumer			11				1				10				1,000	%			1				10				1,000	%
Total recoveries			29				52				(23	)			-44	%			11				18				164	%
Net charge-offs			(129	)			(2	)			(127	)			6,350	%			(71	)			(58	)			82	%
Provision charged to income			30				100				(70	)			-70	%			-				30				100	%
Allowance for loan losses, end of period		$	8,254			$	8,353			$	(99	)			-1	%		$	8,288			$	(34	)			0	%
Ratio of net loans charged-off to average gross loans outstanding, annualized			0.09	%			0.00	%			0.09	%			100	%			0.06	%			0.03	%			50	%
Ratio of allowance for loan losses to  gross loans outstanding			1.44	%			1.48	%			-0.04	%			-3	%			1.59	%			-0.15	%			-9	%

 

Liquidity and Sources of Funds

 

The Bank’s sources of funds include core deposits, loan repayments, advances from the FHLB or the Federal Reserve Bank discount window, brokered deposits, maturities of investment securities, sales of “Available-for-Sale” securities, loan and OREO sales, net income and the use of Federal Funds markets. Stated maturities of investment securities, loan repayments from maturities and core deposits are a relatively stable source of funds, while brokered deposit inflows, unscheduled loan prepayments, and loan and OREO sales are not. Deposit inflows, sales of securities, loan and OREO properties, and unscheduled loan prepayments may, amongst other factors, be influenced by general interest rate levels, interest rates available on other investments, competition, pricing considerations, and general economic conditions.

 

Deposits are our primary source of funds. Our loan to deposit ratio has increased as a result of loan demand due to the improvement of economic conditions in our region and customer dissatisfaction at other financial institutions, most likely attributable to recent merger activity. The increase in loan balances has resulted in increased demands on our liquidity. As such, our current approach to managing our liquidity is directed toward increasing non-interest bearing core deposits from businesses and consumers. The Company continued to reduce higher cost time deposits during the most recent quarter.

 

The following table summarizes the primary (on-balance sheet) liquidity, short-term funds availability, net non-core funding dependency, and loan to deposit ratios of the Bank. The primary liquidity ratio represents the sum of net interest-bearing cash/federal funds sold, short-term and readily marketable assets divided by total assets. The short-term funds availability ratio consists of the sum of net interest-bearing cash/federal funds sold, short-term and readily marketable assets and available capacity under borrowing facilities divided by assets. The net non-core funding dependency ratio is non-core liabilities less short-term investments divided by long-term assets. Despite the increase in the loan to deposit ratio due to recent loan growth, the Bank’s primary liquidity, short-term funds availability, and net non-core funding dependency ratios remained strong at quarter end.

 

  

		March 31				December 31,				March 31
		2015				2014				2014
Primary liquidity			8.0	%			8.7	%			14.8	%
Short term funds availability			22.7	%			23.8	%			28.3	%
Net non-core funding dependency			5.3	%			4.8	%			4.1	%
Gross loans to deposits			87.3	%			88.3	%			82.20	%

 

An analysis of liquidity should encompass a review of the changes that appear in the consolidated statements of cash flow for the three months ended March 31, 2015 and 2014.

 

At March 31, 2015, the Bank had $11.4 million in outstanding borrowings against its $149.0 million in established borrowing capacity with the FHLB. The Bank had the same amount outstanding in borrowings at December 31, 2014, and $10.0 million in outstanding borrowings at March 31, 2014. The borrowing capacity at the FHLB was $149.7 million and $140.9 million at December 31, 2014 and March 31, 2014, respectively. The Bank’s borrowing facility with the FHLB is subject to collateral and stock ownership requirements. The Bank also had an available discount window primary credit line with the Federal Reserve Bank of San Francisco of approximately $59.2 million, subject to collateral requirements, and $16.0 million from correspondent banks with no balance outstanding on either of these facilities.

 

Off-Balance Sheet Arrangements

 

At March 31, 2015, the Bank had commitments to extend credit and standby letters related to extensions of credit of $119.4 million compared to $111.0 million at December 31, 2014 and $102.9 million at March 31, 2014. Such commitments represented 20.8%, 19.7% and 19.9% of total net loans as of March 31, 2015, December 31, 2014 and March 31, 2014, respectively. Please refer to Note 7 – “Commitments and Contingencies” in the unaudited condensed consolidated financial statements included under Item 1 for further information.

 

Critical Accounting Policies

 

Management has identified the calculation of our allowance for credit losses, goodwill, investment valuation and Other-Than-Temporary-Impairment (OTTI), valuation of OREO, and estimates relating to income taxes as critical accounting policies. Each of these policies are discussed in our 2014 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies.”

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises principally from interest rate risk in its lending, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks, such as credit quality and liquidity risk, in the normal course of business, Management considers interest rate risk to be a significant market risk, which could have a material effect on the Company’s financial condition and results of operations. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities. The Company did not experience a significant change in market risk at March 31, 2015, as compared to December 31, 2014.

The Company attempts to monitor interest rate risk from the perspective of changes in the economic value of equity, also referred to as net portfolio value (NPV), and changes in net interest income. Changes to the NPV and net interest income are simulated using instant and permanent rates up and down shocks of various increments. It is the Company’s policy to manage interest rate risk to maximize long-term profitability under the range of likely interest-rate scenarios. For additional information, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset and Liability Management” in the Company’s 2014 10-K.

 

ITEM 4. CONTROLS AND PROCEDURES

 

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

As of the end of the period covered by this report, Pacific Financial Corporation’s Management, with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, Management, including our President & Chief Executive Officer and Chief Financial Officer, has concluded that our disclosure controls and procedures were effective, including in timely alerting them to information relating to the Company that is required to be included in our periodic filings with the SEC.

  

  

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

There have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during our most recent quarter ended March 31, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, in the normal course of business, Pacific or the Bank may become party to various legal actions. Management is unaware of any existing legal actions against the Company or its subsidiaries that Management believes will have a materially adverse impact on our business, financial condition or results of operations.

 

ITEM 1A. RISK FACTORS

 

There were no material changes in the risk factors presented in the Company’s 2014 10-K.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a) None

 

(b) [Not applicable.]

 

(c) None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

(a) [Not applicable.]

 

(b) [Not applicable.]

 

ITEM 4. MINE SAFETY DISCLOSURES

 

(a) [Not applicable.]

 

ITEM 5. OTHER INFORMATION

 

None.

 

  

ITEM 6. EXHIBITS

 

EXHIBIT NO.		EXHIBIT
10.1		Amended and Restated Employment Agreement dated as of May 1, 2015, between Bank of the Pacific and Denise Portmann. Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated April 29, 2015.
31.1		Certification of CEO under Rule 13a – 14(a) of the Exchange Act.
31.2		Certification of CFO under Rule 13a – 14(a) of the Exchange Act.
32.1		Certification of CEO under 18 U.S.C. Section 1350.
32.2		Certification of CFO under 18 U.S.C. Section 1350.
101.		INS XBRL Instance Document
101.		SCH XBRL Taxonomy Extension Schema Document
101.		CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.		DEF XBRL Taxonomy Extension Definition Linkbase Document
101.		LAB XBRL Taxonomy Extension Label Linkbase Document
101.		PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

 

SIGNATURES: Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

DATED: May 14, 2015

 

Pacific Financial Corporation

 

/s/ Denise Portmann
Denise Portmann, President and Chief Executive Officer

 

/s/ Douglas N. Biddle
Douglas N. Biddle, Executive Vice President and Chief Financial Officer