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Table of Contents

 

 

UNITED STATES

SECURITIES & EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark one)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2016.

OR

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from                      to                     .

COMMISSION FILE NUMBER: 0-30106

 

 

PACIFIC CONTINENTAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

OREGON   93-1269184
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No)

111 West 7th Avenue

Eugene, Oregon

  97401
(Address of principal executive offices)   (Zip Code)

(541) 686-8685

(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 website, 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 the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Act. (Check one)

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller Reporting company   ¨

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 of common stock outstanding as of November 1, 2016 was 22,603,651.

 

 

 


Table of Contents

PACIFIC CONTINENTAL CORPORATION

FORM 10-Q

QUARTERLY REPORT

TABLE OF CONTENTS

 

 

PART I   FINANCIAL INFORMATION      3   
ITEM 1   Financial Statements      3   
  Consolidated Balance Sheets      3   
  Consolidated Statements of Income      4   
  Consolidated Statements of Comprehensive Income      5   
  Consolidated Statements of Changes in Shareholders’ Equity      6   
  Consolidated Statements of Cash Flows      7   
  Notes to Consolidated Financial Statements      8   
ITEM 2   Management’s Discussion and Analysis of Financial Condition and Results of Operations      47   
ITEM 3   Quantitative and Qualitative Disclosures about Market Risk      71   
ITEM 4   Controls and Procedures      71   
PART II   OTHER INFORMATION      72   
ITEM 1   Legal Proceedings      72   
ITEM 1A   Risk Factors      73   
ITEM 2   Unregistered Sales of Equity Securities and Use of Proceeds      76   
ITEM 3   Defaults upon Senior Securities      76   
ITEM 4   Mine Safety Disclosures      76   
ITEM 5   Other Information      76   
ITEM 6   Exhibits      76   

 

2


Table of Contents

PART I FINANCIAL INFORMATION

ITEM 1 Financial Statements

Pacific Continental Corporation and Subsidiary

Consolidated Balance Sheets

(In thousands, except share amounts)

(Unaudited)

 

     September 30,
2016
    December 31,
2015
 

ASSETS

    

Cash and due from banks

   $ 35,819      $ 23,819   

Interest-bearing deposits with banks

     71,353        12,856   
  

 

 

   

 

 

 

Total cash and cash equivalents

     107,172        36,675   

Securities available-for-sale

     482,408        366,598   

Loans, net of deferred fees

     1,806,736        1,404,482   

Allowance for loan losses

     (20,531     (17,301
  

 

 

   

 

 

 

Net loans

     1,786,205        1,387,181   

Interest receivable

     5,957        5,721   

Federal Home Loan Bank stock

     4,643        5,208   

Property and equipment, net of accumulated depreciation

     19,656        18,014   

Goodwill and intangible assets

     70,684        43,159   

Deferred tax asset

     7,380        5,670   

Other real estate owned

     13,066        11,747   

Bank-owned life insurance

     34,927        22,884   

Other assets

     6,962        6,621   
  

 

 

   

 

 

 

Total assets

   $ 2,539,060      $ 1,909,478   
  

 

 

   

 

 

 
    

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Deposits

    

Noninterest-bearing demand

   $ 901,290      $ 568,688   

Savings and interest-bearing checking

     1,082,202        889,802   

Core time deposits

     65,860        75,452   
  

 

 

   

 

 

 

Total core deposits

     2,049,352        1,533,942   

Other deposits

     113,281        63,151   
  

 

 

   

 

 

 

Total deposits

     2,162,633        1,597,093   

Repurchase agreements

     1,107        71   

Federal Home Loan Bank borrowings

     45,500        77,500   

Subordinated debentures

     34,072        —     

Junior subordinated debentures

     11,272        8,248   

Accrued interest and other payables

     8,005        8,075   
  

 

 

   

 

 

 

Total liabilities

     2,262,589        1,690,987   
  

 

 

   

 

 

 

Shareholders’ equity

    

Common stock, shares authorized: 50,000,000; shares issued and outstanding: 22,603,421 at September 30, 2016, and 19,604,182 at December 31, 2015

     205,120        156,099   

Retained earnings

     66,112        59,693   

Accumulated other comprehensive income

     5,239        2,699   
  

 

 

   

 

 

 
     276,471        218,491   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 2,539,060      $ 1,909,478   
  

 

 

   

 

 

 

See accompanying notes.

 

3


Table of Contents

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Income

(In thousands, except share and per share amounts)

(Unaudited)

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2016     2015      2016     2015  

Interest and dividend income

         

Loans

   $ 20,145      $ 17,240       $ 55,810      $ 48,020   

Taxable securities

     1,995        1,713         5,551        4,825   

Tax-exempt securities

     482        490         1,435        1,491   

Interest-bearing deposits with banks

     40        7         104        23   
  

 

 

   

 

 

    

 

 

   

 

 

 
     22,662        19,450         62,900        54,359   
  

 

 

   

 

 

    

 

 

   

 

 

 

Interest expense

         

Deposits

     984        854         2,678        2,509   

Federal Home Loan Bank borrowings

     286        227         758        694   

Subordinated debentures

     553        —           553        —     

Junior subordinated debentures

     66        57         179        169   

Federal funds purchased

     2        4         6        10   
  

 

 

   

 

 

    

 

 

   

 

 

 
     1,891        1,142         4,174        3,382   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income

     20,771        18,308         58,726        50,977   

Provision for loan losses

     1,380        625         3,575        1,175   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income after provision for loan losses

     19,391        17,683         55,151        49,802   
  

 

 

   

 

 

    

 

 

   

 

 

 

Noninterest income

         

Service charges on deposit accounts

     717        703         2,099        1,939   

Bankcard income

     314        276         899        687   

Bank-owned life insurance income

     172        156         463        435   

Net gain on sale of investment securities

     —          143         309        336   

Impairment losses on investment securities (OTTI)

     (2     —           (19     (13

Other noninterest income

     718        436         1,726        1,234   
  

 

 

   

 

 

    

 

 

   

 

 

 
     1,919        1,714         5,477        4,618   
  

 

 

   

 

 

    

 

 

   

 

 

 

Noninterest expense

         

Salaries and employee benefits

     7,520        6,822         23,084        20,223   

Property and equipment

     1,202        1,148         3,404        3,221   

Data processing

     924        838         2,682        2,343   

Legal and professional services

     569        496         2,321        1,386   

Business development

     460        369         1,492        1,134   

FDIC insurance assessment

     273        283         848        769   

Other real estate (income) expense, net

     71        122         (32     303   

Merger related expense

     1,767        —           3,745        1,836   

Other noninterest expense

     1,039        1,104         3,222        2,971   
  

 

 

   

 

 

    

 

 

   

 

 

 
     13,825        11,182         40,766        34,186   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income before provision for income taxes

     7,485        8,215         19,862        20,234   

Provision for income taxes

     2,634        2,890         6,946        7,012   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 4,851      $ 5,325       $ 12,916      $ 13,222   
  

 

 

   

 

 

    

 

 

   

 

 

 

Earnings per share

         

Basic

   $ 0.24      $ 0.27       $ 0.65      $ 0.69   
  

 

 

   

 

 

    

 

 

   

 

 

 

Diluted

   $ 0.23      $ 0.27       $ 0.64      $ 0.68   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted average shares outstanding

         

Basic

     20,511,392        19,591,666         19,940,709        19,133,682   

Common stock equivalents attributable to stock-based awards

     165,572        225,104         154,813        224,308   
  

 

 

   

 

 

    

 

 

   

 

 

 

Diluted

     20,676,964        19,816,770         20,095,522        19,357,990   
  

 

 

   

 

 

    

 

 

   

 

 

 

See accompanying notes.

 

4


Table of Contents

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)

 

     Three months ended     Nine months ended  
     September 30,     September 30,  
     2016     2015     2016     2015  

Net income

   $ 4,851      $ 5,325      $ 12,916      $ 13,222   

Other comprehensive income:

        

Available-for-sale securities:

        

Unrealized (loss) gain arising during the period

     (1,929     2,133        5,397        1,943   

Reclassification adjustment for gains realized in net income

     —          (143     (309     (336

Other than temporary impairment

     2        —          19        13   

Income tax effects

     751        (776     (1,991     (632

Derivative agreements—cash flow hedge

        

Unrealized gain (loss) gain arising during the period

     160        (154     (944     (212

Income tax effects

     (62     60        368        83   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive (loss) income , net of tax

     (1,078     1,120        2,540        859   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income

   $ 3,773      $ 6,445      $ 15,456      $ 14,081   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

5


Table of Contents

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

(In thousands, except share, and per share amounts)

(Unaudited)

 

     Number
of Shares
     Common
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
    Total  

Balance, December 31, 2014

     17,717,676       $ 131,375      $ 48,984      $ 3,802      $ 184,161   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

          18,751          18,751   

Other comprehensive loss, net of tax

            (1,103     (1,103
         

 

 

   

 

 

 

Comprehensive income

              17,648   
           

 

 

 

Stock issuance and related tax benefit

     108,404         95            95   

Stock issued through acquisition

     1,778,102         23,578            23,578   

Share-based compensation expense

        1,700            1,700   

Vested employee RSUs and SARs surrendered to cover tax consequences

        (649         (649

Cash dividends ($0.42 per share)

          (8,042       (8,042
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2015

     19,604,182       $ 156,099      $ 59,693      $ 2,699      $ 218,491   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

          12,916          12,916   

Other comprehensive income, net of tax

            2,540        2,540   
         

 

 

   

 

 

 

Comprehensive income

              15,456   
           

 

 

 

Stock issuance and related tax benefit

     145,877         661            661   

Stock issued through acquisition

     2,853,362         47,794            47,794   

Share-based compensation expense

        1,427            1,427   

Vested employee RSUs and SARs surrendered to cover tax consequences

        (861         (861

Cash dividends ($0.33 per share)

          (6,497       (6,497
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2016

     22,603,421       $ 205,120      $ 66,112      $ 5,239      $ 276,471   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

6


Table of Contents

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

     Nine months ended  
     September 30,  
     2016     2015  

Cash flows from operating activities:

    

Net income

   $ 12,916      $ 13,222   

Adjustments to reconcile net income to net cash from operating activities:

    

Depreciation and amortization, net of accretion

     4,919        5,476   

Deferred income taxes

     3        —     

Bank-owned life insurance income

     (469     (435

Share-based compensation

     1,427        1,178   

Provision for loan losses

     3,575        1,175   

Gain on sale of investment securities

     (309     (336

Valuation adjustment on foreclosed assets

     162        125   

Gain on sale of foreclosed assets

     (302     12   

Other than temporary impairment on investment securities

     19        13   

Change in:

    

Interest receivable

     698        (368

Deferred loan fees

     381        249   

Accrued interest payable and other liabilities

     (1,991     (1,321

Income tax receivable

     —          69   

Other assets

     (1,073     1,376   
  

 

 

   

 

 

 

Net cash provided by operating activities

     19,956        20,435   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Proceeds from maturities and sales of available-for-sale investment securities

     135,319        75,718   

Purchase of available-for-sale investment securities

     (160,943     (87,025

Net loan principal originations

     (133,405     (107,951

Proceeds from sale of foreclosed assets

     1,371        2,350   

Net purchase of property and equipment

     (2,196     (739

Redemption of Federal Home Loan Bank stock

     1,097        3,878   

Cash consideration received (paid), net of cash acquired in merger

     43,855        (3,249
  

 

 

   

 

 

 

Net cash used by investing activities

     (114,902     (117,018
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Change in deposits

     169,032        87,894   

Change in repurchase agreements

     1,036        209   

Change in federal funds purchased and Federal Home Loan Bank short-term borrowings

     (44,500     25,500   

FHLB term advances originated

     12,500        —     

Proceeds from stock options exercised

     620        13   

Excess tax benefit from stock options exercised

     41        —     

Redemption of Capital Pacific Bell State Bank Debt

     —          (3,344

Proceeds from subordinated debenture issuance

     34,072        —     

Dividends paid

     (6,497     (5,886

Vested employee RSUs and SARs surrendered to cover tax consequences

     (861     (599
  

 

 

   

 

 

 

Net cash provided by financing activities

     165,443        103,787   
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     70,497        7,204   

Cash and cash equivalents, beginning of period

     36,675        25,787   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 107,172      $ 32,991   
  

 

 

   

 

 

 

Supplemental information:

    

Noncash investing and financing activities:

    

Transfer of loans to other real estate owned

   $ 958      $ 967   

Change in fair value of securities, net of deferred income taxes

   $ 3,116      $ 988   

Change in fair value of cash flow hedge, net of deferred income taxes

   $ (576   $ (129

Acquisitions:

    

Assets acquired

   $ 450,040      $ 257,924   

Liabilities assumed

   $ 402,246      $ 232,698   

Cash paid during the period for:

    

Income taxes

   $ 7,667      $ 4,878   

Interest

   $ 3,653      $ 3,429   

See accompanying notes.

 

7


Table of Contents

Pacific Continental Corporation and Subsidiary

Notes to Consolidated Financial Statements

(Unaudited)

A complete set of Notes to Consolidated Financial Statements is a part of the Company’s 2015 Form 10-K filed March 14, 2016. The notes below are included due to material changes in the consolidated financial statements or to provide the reader with additional information not otherwise available. In preparing these consolidated financial statements, the Company has evaluated subsequent events and transactions for potential recognition or disclosure in the consolidated financial statements. All dollar amounts in the following notes are expressed in thousands, except share and per share amounts or where otherwise indicated.

Certain amounts contained in the prior period consolidated financial statements have been reclassified where appropriate to conform to the financial statement presentation used in the current period. These reclassifications had no effect on previously reported net income, earnings per share or retained earnings.

NOTE 1 - BASIS OF PRESENTATION

The accompanying interim consolidated financial statements include the accounts of Pacific Continental Corporation (the “Company”), a bank holding company, and its wholly owned subsidiary, Pacific Continental Bank (the “Bank”), and the Bank’s wholly owned subsidiaries, PCB Services Corporation and PCB Loan Services Corporation (both of which are presently inactive). All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared by the Company without audit and in conformity with generally accepted accounting principles in the United States of America for interim financial information. The consolidated financial statements include all adjustments and normal accruals, which the Company considers necessary for a fair presentation of the results of operations for such interim periods. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, as of the date of the balance sheets and income and expenses for the periods. Areas including allowance for loan losses, goodwill and intangibles and other real estate owned are particularly susceptible to change, and actual results could differ from those estimates.

The balance sheet data as of December 31, 2015, was derived from audited consolidated financial statements, but does not include all disclosures contained in the Company’s 2015 Form 10-K. The interim consolidated financial statements should be read in conjunction with the December 31, 2015, consolidated financial statements, including the notes thereto, included in the Company’s 2015 Form 10-K.

 

8


Table of Contents

NOTE 2 – BUSINESS COMBINATIONS

On September 6, 2016, the Company completed its acquisition of all of the common stock of Foundation Bancorp, Inc. (Foundation Bancorp) and its wholly-owned subsidiary, Foundation Bank, of Bellevue, Washington (the “Merger”). The acquisition of Foundation Bank reflects the Company’s overall banking expansion strategy, and expanded the combined Bank’s presence in the greater Puget Sound market.

The transaction has been accounted for under the acquisition method of accounting. The assets and liabilities were recorded at their estimated fair values as of the acquisition dates, however some valuations related to some other real estate owned properties are pending and could cause goodwill to change. The application of the acquisition method resulted in the recognition of preliminary goodwill of $21,407 which is all attributable to the value of Foundation Bank’s lending and deposit gathering banking activities. None of the goodwill is deductible for income tax purposes as the Merger was accounted for as a tax-free exchange.

A summary of the net assets acquired and the estimated fair value adjustments of Foundation Bancorp are presented below:

 

     September 6, 2016  

Cost basis net assets

   $ 90,993   

Less:

  

Cash payment to shareholders

     (19,337

Stock issued

     (47,794

Fair value adjustments:

  

Loans, net

     (11,257

Core deposit intangible

     5,762   

Junior subordinated debentures

     3,173   

Deferred tax asset adjustment

     (2,948

Securities

     1,541   

Other

     1,274   
  

 

 

 

Goodwill

   $ 21,407   
  

 

 

 

Pursuant to the terms of the merger agreement, former Foundation Bancorp shareholders received either $12.50 per share in cash or 0.7911 shares of Pacific Continental common stock for each share of Foundation Bancorp common stock, or a combination of 30.0% in the form of cash and 70.0% in the form of Pacific Continental common stock. Pursuant to the merger agreement, the maximum aggregate cash component of the merger consideration was $19,337 and the aggregate stock component of the merger consideration was 2,853,361 shares of Pacific Continental common stock, the value of which was calculated based on a closing stock price of $16.75 per share. The cash election was oversubscribed; therefore shareholders electing all cash received $8.72 in cash and 0.23915 shares of Pacific Continental common stock for each share of Foundation Bancorp common stock. Former Foundation Bancorp shareholders making a valid mixed election received $3.75 in cash and 0.55377 shares of Pacific Continental common stock for each share of Foundation Bancorp common stock.

The operations of Foundation Bank are included in the operating results beginning September 6, 2016. Foundation Bank’s results of operations prior to the acquisition are not included in the operating results. Revenue information for Foundation Bank related revenue and expense cannot be practically separated from Pacific Continental, therefore proforma revenue disclosures have not been included. Merger-related expense of $1,767 were recorded during the quarter ended September 30, 2016, and were $3,745 for the nine months ended September 30, 2016 and are included within the merger-related expense line item on the Consolidated Statements of Income.

 

9


Table of Contents

The statement of assets acquired and liabilities assumed at their fair values are presented below as of the transaction closing date:

FOUNDATION BANCORP, INC.

Opening balance sheet

(in thousands)

unaudited

 

     September 6,
2016
 

ASSETS

  

Cash and due from banks, net of consideration paid

   $ 43,855   

Securities available-for-sale

     88,331   

Gross loans

     281,790   

Fair value adjustments

  

Credit quality-related

     (8,884

Interest rate-related

     (2,373
  

 

 

 

Net Loans

     270,533   

Interest receivable

     934   

Federal Home Loan Bank stock

     532   

Property and equipment

     408   

Goodwill

     21,407   

Core deposit intangible

     5,762   

Deferred tax asset

     3,894   

Other real estate owned

     1,592   

Bank-owned life insurance

     11,574   

Other asset

     1,218   
  

 

 

 

Total Assets

   $ 450,040   
  

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

  

Deposits

   $ 396,509   

Other liabilities

     2,724   

Junior subordinated debentures

     3,013   
  

 

 

 

Total liabilities

     402,246   

Common stock issued to Foundation Bancorp shareholders

     47,794   
  

 

 

 

Total liabilities and shareholders’ equity

   $ 450,040   
  

 

 

 

Acquired loans at the acquisition date and as of September 30, 2016, are presented below:

 

     September 6,
2016
     September 30,
2016
 

Contractually required principal payments

   $ 281,790       $ 277,683   

Purchase adjustment for credit and interest rate

     (11,257      (10,748
  

 

 

    

 

 

 

Balance of acquired loans

   $ 270,533       $ 266,935   
  

 

 

    

 

 

 

Purchased credit impaired loans accounted for under ASC 310-30 acquired through the acquisition have a contractually required payments receivable on the acquisition date of $21,575.

 

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Table of Contents

The acquisition of Foundation Bancorp and it wholly-owned subsidiary Foundation Bank is not considered significant to the Company’s consolidated financial statements and, therefore, pro forma financial information is not presented.

 

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Table of Contents

NOTE 3 – SECURITIES AVAILABLE-FOR-SALE

The amortized cost and estimated fair values of securities available-for-sale at September 30, 2016, were as follows:

 

            Gross      Gross     Estimated      Percentage  
     Amortized      Unrealized      Unrealized     Fair      of  
     Cost      Gains      Losses     Value      Portfolio  
Unrealized Loss Positions              

Private-label mortgage-backed securities

     249         —           (24     225         0

Mortgage-backed securities

     83,009         —           (328     82,681         17

SBA pools

     19,261         —           (95     19,166         4

Obligations of states and political subdivisions

     13,236         —           (60     13,176         3

Corporate securities

     899         —           (13     886         0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 116,654       $ —         $ (520   $ 116,134         24
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
Unrealized Gain Positions              

Obligations of U.S. government agencies

   $ 25,290       $ 1,262       $ —        $ 26,552         6

Obligations of states and political subdivisions

     97,705         4,629         —          102,334         21

Private-label mortgage-backed securities

     1,728         157         —          1,885         0

Mortgage-backed securities

     206,376         3,678         —          210,054         44

SBA pools

     25,205         245         —          25,449         5
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 356,304       $ 9,971       $ —        $ 366,274         76
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 472,958       $ 9,971       $ (520   $ 482,408         100
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

At September 30, 2016, the Bank held 484 investment securities, of which 61 were in unrealized loss positions. Unrealized losses existed on certain securities classified as obligations of US government agencies, private-label mortgage-backed securities, mortgage-backed securities, SBA pools obligations of states and political subdivisions, and corporate securities. The unrealized losses on all securities are deemed to be temporary, as these securities retain strong credit ratings, continue to perform adequately, and are backed by various government sponsored enterprises. These decreases in fair value are associated with the changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities has resulted from changes in interest rates relative to where these investments fall within the yield curve and their individual characteristics. Because the Company does not currently intend to sell these securities nor does the Company consider it more likely than not that it will be required to sell these securities before the recovery of amortized cost basis, which may be upon maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2016.

 

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Table of Contents

The following table presents a summary of securities in a continuous unrealized loss position at September 30, 2016:

 

     Securities in
Continuous
Unrealized
Loss
Position for
Less Than
12 Months
     Gross
Unrealized Loss
on Securities

in Loss
Position for
Less Than

12 Months
     Securities in
Continuous
Unrealized
Loss
Position for
12 Months
or Longer
     Gross
Unrealized Loss
on Securities

in Loss
Position for
12 Months
or Longer
 

Private-label mortgage-backed securities

   $ —         $ —         $ 225       $ (24

Mortgage-backed securities

     79,207         (282      3,474         (46

SBA pools

     15,240         (72      3,926         (23

Obligations of states and political subdivisions

     13,176         (60      —           —     

Corporate securities

     —           —           886         (13
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 107,623       $ (414    $ 8,511       $ (106
  

 

 

    

 

 

    

 

 

    

 

 

 

On a monthly basis, management reviews all private-label mortgage-backed securities for the presence of other than temporary impairment (“OTTI”) and recorded $2 and $0 during the three months ended September 30, 2016 and 2015, respectively. Management’s evaluation included the use of independently-generated third-party credit surveillance reports that analyze the loans underlying each security. These reports include estimates of default rates and severities, life collateral loss rates and static voluntary prepayment assumptions to generate estimated cash flows at the individual security level. Additionally, management considered factors such as downgraded credit ratings, severity and duration of the impairments, the stability of the issuers and any discounts paid when the securities were purchased. Management has considered all available information related to the collectability of the impaired investment securities and believes that the estimated credit loss is appropriate.

Following is a tabular roll-forward of the aggregate amount of credit-related OTTI at the beginning and end of the periods presented along with the amounts recognized in earnings during the three and nine months ended September 30, 2016, and 2015:

 

     Three months ended      Nine months ended  
     September 30,      September 30,  
     2016      2015      2016      2015  

Balance, beginning of period:

   $ 266       $ 241       $ 249       $ 227   

Additions:

           

Initial OTTI credit loss

     2         —           19         14   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period:

   $ 268       $ 241       $ 268       $ 241   
  

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2016, ten of the Company’s private-label mortgage-backed securities, with an amortized cost of $1,440, were classified as substandard as their underlying credit was considered impaired. At December 31, 2015, six securities with an amortized cost of $1,506 were classified as substandard.

At September 30, 2016, and December 31, 2015, the projected average life of the securities portfolio was 4.72 years and 4.21 years, respectively.

 

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Table of Contents

The amortized cost and estimated fair values of securities available-for-sale at December 31, 2015, were as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
     Percentage
of
Portfolio
 
Unrealized Loss Positions              

Obligations of U.S. government agencies

   $ 14,491       $ —         $ (119   $ 14,372         3.92

Obligations of states and political subdivisions

     13,438         —           (149     13,289         3.62

Private-label mortgage-backed securities

     663         —           (33     630         0.17

Mortgage-backed securities

     95,040         —           (856     94,184         25.69

SBA pools

     17,225         —           (101     17,124         4.67

Corporate securities

     899         —           (5     893         0.25
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 141,756       $ —         $ (1,263   $ 140,492         38.32
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
Unrealized Gain Positions              

Obligations of U.S. government agencies

   $ 29,669       $ 582       $ —        $ 30,251         8.25

Obligations of states and political subdivisions

     80,119         3,743         —          83,862         22.88

Private-label mortgage-backed securities

     2,028         131         —          2,159         0.59

Mortgage-backed securities

     90,126         1,060         —          91,186         24.87

SBA pools

     18,560         88         —          18,648         5.09
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 220,502       $ 5,604       $ —        $ 226,106         61.68
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 362,258       $ 5,604       $ (1,263   $ 366,598         100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

At December 31, 2015, the Bank held 432 investment securities, of which 92 were in unrealized loss positions. The following table presents a summary of securities in a continuous unrealized loss position at December 31, 2015:

 

     Securities in
Continuous
Unrealized
Loss
Position for
Less Than
12 Months
     Gross
Unrealized Loss
on Securities

in Loss
Position for
Less Than
12 Months
     Securities in
Continuous
Unrealized
Loss
Position for
12 Months
or Longer
     Gross
Unrealized Loss
on Securities

in Loss
Position for
12 Months
or Longer
 

Obligations of U.S. government agencies

   $ 14,372       $ (119    $ —         $ —     

Obligations of states and political subdivisions

     12,761         (145      528         (4

Private-label mortgage-backed securities

     240         (4      390         (29

Mortgage-backed securities

     87,896         (711      6,288         (145

SBA pools

     13,539         (78      3,585         (23

Corporate securities

     893         (5      —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 129,701       $ (1,062    $ 10,791       $ (201
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

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Table of Contents

The amortized cost and estimated fair value of securities at September 30, 2016, by maturity, are shown below. Obligations of U.S. government agencies, states and political subdivisions and corporate securities are shown by contractual maturity. Mortgage-backed securities and SBA variable pools are shown by projected average life.

 

     September 30, 2016  
     Amortized
Cost
     Estimated
Fair

Value
 

Due in one year or less

   $ 8,466       $ 8,523   

Due after one year through 5 years

     240,116         243,481   

Due after 5 years through 10 years

     180,377         185,187   

Due after 10 years

     43,999         45,217   
  

 

 

    

 

 

 
   $ 472,958       $ 482,408   
  

 

 

    

 

 

 

During the quarter ended September 30, 2016, 30 investment securities were sold resulting in proceeds of $54,426. The sales generated no gain or loss as they related to sales of securities acquired from Foundation Bank, which were sold at their acquisition date fair value. During the nine months ended September 30, 2016, 60 investment securities were sold resulting in proceeds of $98,309. The sales generated a gross gain of $552 and a gross loss of $243, totaling a net gain of $309. The specific identification method was used to determine the cost of the securities sold.

During the quarter ended September 30, 2015, 19 investment securities were sold resulting in proceeds of $21,069. The sales generated a gross gain of $143 and a gross loss of $0, totaling a net gain of $143. During the nine months ended September 30, 2015, 41 investment securities were sold resulting in proceeds of $35,216. The sales generated a gross gain of $585 and a gross loss of $249, totaling a net gain of $336. The specific identification method was used to determine the cost of the securities sold.

The following table presents investment securities which were pledged to secure public deposits and repurchase agreements as permitted or required by law:

 

     September 30, 2016      December 31, 2015  
     Amortized
Cost
     Estimated
Fair
Value
     Amortized
Cost
     Estimated
Fair
Value
 

Pledged to secure public deposits

   $ 24,435       $ 26,677       $ 27,938       $ 29,052   

Pledged to secure repurchase agreements

     1,637         1,714         3,985         4,111   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 26,072       $ 28,391       $ 31,923       $ 33,163   
  

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2016, and December 31, 2015, there was an outstanding balance for repurchase agreements of $1,107, and $71, respectively.

 

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Table of Contents

NOTE 4 - LOANS, ALLOWANCE FOR LOAN LOSSES, AND CREDIT QUALITY INDICATORS

Loans are stated at the amount of unpaid principal net of loan premiums or discounts for purchased loans, net of deferred loan origination fees, discounts associated with retained portions of loans sold, and an allowance for loan losses. Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding. Loan origination fees, net of origination costs and discounts, are amortized over the lives of the loans as adjustments to yield.

Major classifications of period-end loans are as follows:

 

     September 30,     % of Gross     December 31,     % of Gross  
     2016     Loans     2015     Loans  

Real estate loans

        

Multi-family residential

   $ 79,126        4.37   $ 66,445        4.73

Residential 1-4 family

     61,498        3.40     53,776        3.82

Owner-occupied commercial

     425,879        23.55     364,742        25.94

Nonowner-occupied commercial

     431,119        23.84     300,774        21.39
  

 

 

   

 

 

   

 

 

   

 

 

 

Total permanent real estate loans

     997,622        55.16     785,737        55.88

Construction loans

        

Multi-family residential

     24,567        1.36     7,027        0.50

Residential 1-4 family

     42,130        2.33     30,856        2.19

Commercial real estate

     78,369        4.33     42,680        3.04

Commercial bare land and acquisition & development

     19,050        1.05     20,537        1.46

Residential bare land and acquisition & development

     8,852        0.49     7,268        0.52
  

 

 

   

 

 

   

 

 

   

 

 

 

Total construction real estate loans

     172,968        9.56     108,368        7.71
  

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     1,170,590        64.72     894,105        63.59

Commercial loans

     630,091        34.84     501,976        35.70

Consumer loans

     3,201        0.18     3,351        0.24

Other loans

     4,764        0.26     6,580        0.47
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross loans

     1,808,646        100.00     1,406,012        100.00

Deferred loan origination fees

     (1,910       (1,530  
  

 

 

     

 

 

   
     1,806,736          1,404,482     

Allowance for loan losses

     (20,531       (17,301  
  

 

 

     

 

 

   

Total loans, net of allowance for
loan losses and net deferred
fees

   $ 1,786,205        $ 1,387,181     
  

 

 

     

 

 

   

At September 30, 2016, outstanding loans to dental professionals totaled $370,135 and represented 20.46% of total outstanding loan principal balances compared to dental professional loans of $340,162 or 24.19% of total outstanding loan principal balance at December 31, 2015. Additional information about the Company’s dental portfolio can be found in Note 5. There are no other industry concentrations in excess of 10% of the total loan portfolio. However, as of September 30, 2016, 64.72% of the Company’s loan portfolio was collateralized by real estate and is, therefore, susceptible to changes in local market conditions. While appropriate action is taken to manage identified concentration risks, management believes that the loan portfolio is well diversified by geographic location and among industry groups.

 

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Table of Contents

Purchased Credit Impaired Loans

The following table represents the contractually required principal balance of purchased credit impaired loans and the carrying balance at September 30, 2016 and December 31, 2015:

 

     September 30,      December 31,  
     2016      2015  

Contractually required principal payments for purchase credit impaired loans

   $ 27,668       $ 11,528   

Accretable yield

     (1,696      (1,070

Nonaccretable yield

     (919      (378
  

 

 

    

 

 

 

Balance of purchased credit impaired loans

   $ 25,053       $ 10,080   
  

 

 

    

 

 

 

The following tables summarize the changes in the accretable yield for purchased credit impaired loans for the periods ended September 30, 2016 and 2015:

 

     Three months ended September 30,  
     2016     2015  
     Century     Capital
Pacific
    Foundation     Total     Century     Capital
Pacific
    Total  

Balance, beginning of period

   $ —        $ 860      $ —        $ 860      $ 96      $ 1,364      $ 1,460   

Additions

     —          —          908        908        —          —          —     

Accretion to interest income

     —          (49     (22     (71     (28     (114     (142
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ —        $ 811      $ 886      $ 1,697      $ 68      $ 1,250      $ 1,318   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     Nine months ended September 30,  
     2016     2015  
     Century     Capital
Pacific
    Foundation     Total     Century     Capital
Pacific
    Total  

Balance, beginning of period

   $ 39      $ 1,031      $ —        $ 1,070      $ 151      $ —        $ 151   

Additions

     —          —          908        908        —          1,569        1,569   

Accretion to interest income

     (39     (220     (22     (281     (83     (319     (402
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ —        $ 811      $ 886      $ 1,697      $ 68      $ 1,250      $ 1,318   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Allowance for Loan Losses

The allowance for loan losses is established as an amount that management considers adequate to absorb possible losses on existing loans within the portfolio. The allowance consists of general, specific and unallocated components. The general component is based upon all loans collectively evaluated for impairment. The specific component is based upon all loans individually evaluated for impairment. The unallocated component represents credit losses inherent in the loan portfolio that may not have been contemplated in the general risk factors or the specific allowance analysis. Loans are charged against the allowance when management believes the collection of principal and interest is unlikely.

The Company performs regular credit reviews of the loan portfolio to determine the credit quality and adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. The Company’s internal risk rating methodology assigns risk ratings ranging from one to ten, where a higher rating represents higher risk. The ten-point risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan losses.

Estimated credit losses reflect consideration of all significant factors that affect the collectability of the loan portfolio. The historical loss rate for each group of loans with similar risk characteristics is determined based on the Company’s own loss experience in that group. Historical loss experience and recent trends in losses provide a reasonable starting point for analysis, however, they do not by themselves form a sufficient basis to determine the appropriate level for the allowance for loan losses. Qualitative or environmental factors that are likely to cause estimated credit losses to differ from historical losses are also considered, including but not limited to:

 

    Changes in international, regional and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments,

 

    Changes in the nature and volume of the portfolio and in the terms of loans,

 

    Changes in the volume and severity of past due loans, the volume of nonaccrual loans and the volume and severity of adversely classified or graded loans,

 

    Changes in the quality of the institution’s loan review system,

 

    Changes in the value of underlying collateral for collateral-dependent loans,

 

    The existence and effect of any concentrations of credit, and changes in the level of such concentrations,

 

    The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio,

 

    Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses, and

 

    Changes in the current and future U.S. political environment, including debt ceiling negotiations, government shutdown and healthcare reform that may affect national, regional and local economic conditions, taxation, or disruption of national or global financial markets.

The adequacy of the allowance for loan losses and the reserve for unfunded commitments is determined using a consistent, systematic methodology and is monitored regularly based on management’s evaluation of numerous factors. For each portfolio segment, these factors include:

 

    The quality of the current loan portfolio,

 

    The trend in the migration of the loan portfolio’s risk ratings,

 

    The velocity of migration of losses and potential losses,

 

    Current economic conditions,

 

    Loan concentrations,

 

    Loan growth rates,

 

    Past-due and nonperforming trends,

 

    Evaluation of specific loss estimates for all significant problem loans,

 

    Recovery experience, and

 

    Peer comparison loss rates.

 

18


Table of Contents

A summary of the activity in the allowance for loan losses by major loan classification follows:

 

     For the three months ended September 30, 2016  
     Commercial
and Other
    Real Estate      Construction      Consumer     Unallocated     Total  

Beginning balance

   $ 7,391      $ 9,137       $ 1,341       $ 46      $ 1,212      $ 19,127   

Charge-offs

     (43     —           —           (1     —          (44

Recoveries

     57        9         1         1        —          68   

Provision (reclassification)

     896        339         312         (4     (163     1,380   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Ending balance

   $ 8,301      $ 9,485       $ 1,654       $ 42      $ 1,049      $ 20,531   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 
     For the nine months ended September 30, 2016  
     Commercial
and Other
    Real Estate      Construction      Consumer     Unallocated     Total  

Beginning balance

   $ 6,349      $ 8,297       $ 1,258       $ 46      $ 1,351      $ 17,301   

Charge-offs

     (708     —           —           (4     —          (712

Recoveries

     159        44         162         2        —          367   

Provision (reclassification)

     2,501        1,144         234         (2     (302     3,575   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Ending balance

   $ 8,301      $ 9,485       $ 1,654       $ 42      $ 1,049      $ 20,531   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

At September 30, 2016, the allowance for loan losses on dental loans was $4,798, compared to $4,022 at December 31, 2015. See Note 5 for additional information on the dental loan portfolio.

 

19


Table of Contents

The following table presents the allowance and recorded investment in loans by major loan classification at September 30, 2016 and December 31, 2015:

 

     Balances as of September 30, 2016  
     Commercial
and Other
     Real Estate      Construction      Consumer      Unallocated      Total  

Ending allowance: collectively evaluated for impairment

   $ 7,567       $ 9,481       $ 1,654       $ 42       $ 1,049       $ 19,793   

Ending allowance: individually evaluated for impairment

     734         4         —           —           —           738   

Ending allowance: loans acquired with deteriorated credit quality

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance

   $ 8,301       $ 9,485       $ 1,654       $ 42       $ 1,049       $ 20,531   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending loan balance: collectively evaluated for impairment

   $ 620,997       $ 978,030       $ 170,816       $ 3,201       $ —         $ 1,773,044   

Ending loan balance: individually evaluated for impairment

     4,463         3,934         2,152            —           10,549   

Ending loan balance: loans acquired with deteriorated credit quality

     9,395         15,658         —           —           —           25,053   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loan balance

   $ 634,855       $ 997,622       $ 172,968       $ 3,201       $ —         $ 1,808,646   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Balances as of December 31, 2015  
     Commercial
and Other
     Real Estate      Construction      Consumer      Unallocated      Total  

Ending allowance: collectively evaluated for impairment

   $ 6,303       $ 8,267       $ 1,159       $ 46       $ 1,351       $ 17,126   

Ending allowance: individually evaluated for impairment

     46         30         99         —           —           175   

Ending allowance: loans acquired with deteriorated credit quality

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance

   $ 6,349       $ 8,297       $ 1,258       $ 46       $ 1,351       $ 17,301   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending loan balance: collectively evaluated for impairment

   $ 504,261       $ 771,543       $ 107,977       $ 3,351       $ —         $ 1,387,132   

Ending loan balance: individually evaluated for impairment

     2,627         5,782         391         —           —           8,800   

Ending loan balance: loans acquired with deteriorated credit quality

     1,668         8,412         —           —           —           10,080   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loan balance

   $ 508,556       $ 785,737       $ 108,368       $ 3,351       $ —         $ 1,406,012   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The September 30, 2016, ending allowance includes $738 in specific allowance for $10,549 of impaired loans ($9,551 net of government guarantees). At December 31, 2015, the Company had $8,800 of impaired loans ($7,527 net of government guarantees) with a specific allowance of $175 assigned.

Management believes that the allowance for loan losses was adequate as of September 30, 2016. However, future loan losses may exceed the levels provided for in the allowance for loan losses and could possibly result in additional charges to the provision for loan losses.

 

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Table of Contents

Credit Quality Indicators

The Company uses the following loan grades, which are also often used by regulators when assessing the credit quality of a loan portfolio.

Pass – Credit exposure in this category range between the highest credit quality to average credit quality. Primary repayment sources generate satisfactory debt service coverage under normal conditions. Cash flow from recurring sources is expected to continue to produce adequate debt service capacity. There are many levels of credit quality contained in the Pass definition, but none of the loans contained in this category rise to the level of Special Mention. This category includes loans with an internal risk rating of 1-6.

Special Mention – A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. The Bank strictly and carefully employs the FDIC definition in assessing assets that may apply to this category. It is apparent that, in many cases, asset weaknesses relevant to this definition either (1) better fit a definition of a “well-defined weakness,” or (2) in management’s experience, ultimately migrate to worse risk grade categories, such as Substandard and Doubtful. Consequently, management elects to downgrade most potential Special Mention credits to Substandard or Doubtful, and therefore adopts a conservative risk grade process in the use of the Special Mention risk grade. This category includes loans with an internal risk rating of 7.

Substandard – A Substandard asset is inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans in this category are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified Substandard. This category includes loans with an internal risk rating of 8.

Doubtful – An asset classified as Doubtful has all the weaknesses inherent in one classified Substandard, with the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values, highly questionable and improbable. This category includes loans with an internal risk rating of 9.

Management strives to consistently apply these definitions when allocating its loans by loan grade. The loan portfolio is continuously monitored for changes in credit quality and management takes appropriate action to update the loan risk ratings accordingly. Management has not changed the Company’s policy towards its use of credit quality indicators during the periods reported.

 

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Table of Contents

The following tables present the Company’s loan portfolio information by loan type and credit grade at September 30, 2016 and December 31, 2015:

Credit Quality Indicators

As of September 30, 2016

 

     Loan Grade        
     Pass     Special Mention     Substandard     Doubtful     Totals  

Real estate loans

          

Multi-family residential

   $ 79,126      $ —        $ —        $ —        $ 79,126   

Residential 1-4 family

     57,629        —          3,869        —          61,498   

Owner-occupied commercial

     413,835        —          12,044        —          425,879   

Nonowner-occupied commercial

     424,397        —          6,722        —          431,119   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     974,987        —          22,635        —          997,622   

Construction

          

Multi-family residential

     24,567        —          —          —          24,567   

Residential 1-4 family

     42,130        —          —          —          42,130   

Commercial real estate

     78,369        —          —          —          78,369   

Commercial bare land and acquisition & development

     19,050        —          —          —          19,050   

Residential bare land and acquisition & development

     6,630        —          2,222        —          8,852   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total construction loans

     170,746        —          2,222        —          172,968   

Commercial and other

     613,144          20,050        1,661        634,855   

Consumer

     3,201        —          —          —          3,201   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals

   $ 1,762,078      $ —        $ 44,907      $ 1,661      $ 1,808,646   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of portfolio

     97.43     0.00     2.48     0.09     100.00
Credit Quality Indicators   
As of December 31, 2015   
     Loan Grade        
     Pass     Special Mention     Substandard     Doubtful     Totals  

Real estate loans

          

Multi-family residential

   $ 66,208      $ —        $ 237      $ —        $ 66,445   

Residential 1-4 family

     49,077        —          4,699        —          53,776   

Owner-occupied commercial

     353,249        —          11,493        —          364,742   

Nonowner-occupied commercial

     296,528        —          4,246        —          300,774   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     765,062        —          20,675        —          785,737   

Construction

          

Multi-family residential

     7,027        —          —          —          7,027   

Residential 1-4 family

     30,803        —          53        —          30,856   

Commercial real estate

     42,580        —          100        —          42,680   

Commercial bare land and acquisition & development

     20,265        —          272        —          20,537   

Residential bare land and acquisition & development

     4,969        —          2,299        —          7,268   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total construction loans

     105,644        —          2,724        —          108,368   

Commercial and other

     494,267        —          14,289        —          508,556   

Consumer

     3,350        —          1        —          3,351   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals

   $ 1,368,323      $ —        $ 37,689      $ —        $ 1,406,012   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of portfolio

     97.32     0.00     2.68     0.00     100.00

At September 30, 2016 and December 31, 2015, the Company had $3,370, and $360, respectively, in unfunded commitments on its classified loans, which amounts are included in the calculation of our classified asset ratio.

 

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Table of Contents

Past Due and Nonaccrual Loans

The Company uses the terms “past due” and “delinquent” interchangeably. Amortizing loans are considered past due or delinquent based upon the number of contractually required payments not made. Delinquency status for all contractually matured loans, commercial and commercial real estate loans with non-monthly amortization, and all other extensions of credit is determined based upon the number of calendar months past due.

The following tables present an aging analysis of past due and nonaccrual loans at September 30, 2016 and December 31, 2015:

Age Analysis of Loans Receivable

As of September 30, 2016

 

     30-59 Days
Past Due
Still Accruing
    60-89 Days
Past Due
Still Accruing
    Greater
Than 90 days
Past Due
Still Accruing
    Nonaccrual     Total Past
Due and
Nonaccrual
    Total
Current
    Total Loans
Receivable
 

Real estate loans

              

Multi-family residential

   $ —        $ —        $ —        $ —        $ —        $ 79,126      $ 79,126   

Residential 1-4 family

     23        —          —          162        185        58,634        58,819   

Owner-occupied commercial

     —          —          —          —          —          416,118        416,118   

Nonowner-occupied commercial

     —          —          —          663        663        427,238        427,901   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     23        —          —          825        848        981,116        981,964   

Construction

              

Multi-family residential

     —          —          —          —          —          24,567        24,567   

Residential 1-4 family

     —          —          —          —          —          42,130        42,130   

Commercial real estate

     —          —          —          —          —          78,369        78,369   

Commercial bare land and acquisition & development

     —          —          —          —          —          19,050        19,050   

Residential bare land and acquisition & development

     —          —          —          —          —          8,852        8,852   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total construction loans

     —          —          —          —          —          172,968        172,968   

Commercial and other

     149        —          —          2,847        2,996        622,464        625,460   

Consumer

     —          —          —          —          —          3,201        3,201   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 172      $ —        $ —        $ 3,672      $ 3,844      $ 1,779,749      $ 1,783,593   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of portfolio

     0.01     0.00     0.00     0.21     0.22     99.78     100.00

Age Analysis of Loans Receivable

As of December 31, 2015

 

     30-59 Days
Past Due
Still Accruing
    60-89 Days
Past Due
Still Accruing
    Greater
Than 90 days
Past Due
Still Accruing
    Nonaccrual     Total Past
Due and
Nonaccrual
    Total
Current
    Total Loans
Receivable
 

Real estate loans

              

Multi-family residential

   $ —        $ —        $ —        $ —        $ —        $ 66,445      $ 66,445   

Residential 1-4 family

     —          —          —          374        374        51,578        51,952   

Owner-occupied commercial

     —          —          —          —          —          359,065        359,065   

Nonowner-occupied commercial

     —          —          —          750        750        299,486        300,236   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     —          —          —          1,124        1,124        776,574        777,698   

Construction

              

Multi-family residential

     —          —          —          —          —          7,027        7,027   

Residential 1-4 family

     480        —          —          53        533        30,323        30,856   

Commercial real estate

     —          —          —          —          —          42,580        42,580   

Commercial bare land and acquisition & development

     —          —          —          —          —          20,265        20,265   

Residential bare land and acquisition & development

     —          —          —          —          —          7,268        7,268   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total construction loans

     480        —          —          53        533        107,463        107,996   

Commercial and other

     —          —          —          1,495        1,495        505,392        506,887   

Consumer

     1        3        —          —          4        3,347        3,351   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 481      $ 3      $ —        $ 2,672      $ 3,156      $ 1,392,776      $ 1,395,932   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of portfolio

     0.03     0.00     0.00     0.19     0.23     99.77     100.00

 

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Table of Contents

Impaired Loans

Regular credit reviews of the portfolio are performed to identify loans that are considered potentially impaired. Potentially impaired loans are referred to the Asset-Liability Committee “ALCO” for review and are included in the specific calculation of allowance for loan losses. A loan is considered impaired when, based on current information and events, the Company is unlikely to collect all principal and interest due according to the terms of the loan agreement. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. Impaired loans are often reported net of government guarantees to the extent that the guarantees are expected to be collected. Impaired loans generally include all loans classified as nonaccrual and troubled debt restructurings.

Accrual of interest is discontinued on impaired loans when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal or interest is doubtful. Accrued, but uncollected, interest is generally reversed when loans are placed on nonaccrual status. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized. Interest income may be recognized on impaired loans that are not on nonaccrual status.

 

24


Table of Contents

The following tables display an analysis of the Company’s impaired loans at September 30, 2016, and December 31, 2015:

Impaired Loan Analysis

As of September 30, 2016

 

     Recorded
Investment
With No Specific
Allowance
Valuation
     Recorded
Investment
With Specific
Allowance
Valuation
     Total
Recorded
Investment
     Unpaid
Principal
Balance
     Average
Recorded
Investment
     Related
Specific
Allowance
Valuation
 

Real estate

                 

Multi-family residential

   $ —         $ —         $ —         $ —         $ —         $ —     

Residential 1-4 family

     461         303         764         785         606         3   

Owner-occupied commercial

     104         874         978         978         1,192         1   

Nonowner-occupied commercial

     2,192         —           2,192         2,254         2,249         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     2,757         1,177         3,934         4,017         4,047         4   

Construction

                 

Multi-family residential

     —           —           —           —           —           —     

Residential 1-4 family

     —           —           —           —           50         —     

Commercial real estate

     —           —           —           —           —           —     

Commercial bare land and acquisition & development

     —           —           —           —           —           —     

Residential bare land and acquisition & development

     2,152         —           2,152         2,151         1,764         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total construction loans

     2,152         —           2,152         2,151         1,814         —     

Commercial and other

     2,305         2,158         4,463         4,834         3,215         734   

Consumer

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 7,214       $ 3,335       $ 10,549       $ 11,002       $ 9,076       $ 738   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired Loan Analysis

As of December 31, 2015

 

     Recorded
Investment
With No Specific
Allowance
Valuation
     Recorded
Investment
With Specific
Allowance
Valuation
     Total
Recorded
Investment
     Unpaid
Principal
Balance
     Average
Recorded
Investment
     Related
Specific
Allowance
Valuation
 

Real estate

                 

Multi-family residential

   $ —         $ —         $ —         $ —         $ —         $ —     

Residential 1-4 family

     374         308         682         911         766         5   

Owner-occupied commercial

     2,788         —           2,788         2,788         1,177         —     

Nonowner-occupied commercial

     2,287         25         2,312         2,374         2,395         25   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     5,449         333         5,782         6,073         4,338         30   

Construction

                 

Multi-family residential

     —           —           —           —           —           —     

Residential 1-4 family

     53         —           53         72         32         —     

Commercial real estate

     —           —           —           —           —           —     

Commercial bare land and acquisition & development

     —           —           —           —           —           —     

Residential bare land and acquisition & development

     —           338         338         338         347         99   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total construction loans

     53         338         391         410         379         99   

Commercial and other

     2,091         536         2,627         3,018         2,404         46   

Consumer

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 7,593       $ 1,207       $ 8,800       $ 9,501       $ 7,121       $ 175   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The impaired balances reported above are not adjusted for government guarantees of $998, and $1,273 at September 30, 2016 and December 31, 2015, respectively. The recorded investment in impaired loans, net of government guarantees, totaled $9,551 and $7,527 at September 30, 2016, and December 31, 2015, respectively.

 

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Table of Contents

Troubled Debt Restructurings

In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties.

The following table displays the Company’s TDRs by class at September 30, 2016 and December 31, 2015:

 

     Troubled Debt Restructurings as of  
     September 30, 2016      December 31, 2015  
     Number of
Contracts
     Post-Modification
Outstanding Recorded
Investment
     Number of
Contracts
     Post-Modification
Outstanding Recorded
Investment
 

Real estate

           

Multifamily residential

     —         $ —           —         $ —     

Residential 1-4 family

     4         764         6         682   

Owner-occupied commercial

     3         1,421         3         2,788   

Non owner-occupied commercial

     6         2,192         7         2,312   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     13         4,377         16         5,782   

Construction

           

Multifamily residential

     —           —           —           —     

Residential 1-4 family

     —           —           —           —     

Commercial real estate

     —           —           —           —     

Commercial bare land and acquisition & development

     —           —           —           —     

Residential bare land and acquisition & development

     2         1,827         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total construction loans

     2         1,827         —           —     

Commercial and other

     14         2,883         11         2,170   

Consumer

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     29       $ 9,087         27       $ 7,952   
  

 

 

    

 

 

    

 

 

    

 

 

 

The recorded investment in TDRs on nonaccrual status totaled $2,228, and $1,807 at September 30, 2016 and December 31, 2015, respectively. The Company’s policy is that loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Company’s policy generally refers to a minimum of six months of payment performance as sufficient to warrant a return to accrual status.

For the nine months ended September 30, 2016, the Company restructured 9 loans into TDRs for which impairment was previously measured under the Company’s general loan loss allowance methodology.

The types of modifications offered can generally be described in the following categories:

 

  Rate Modification - A modification in which the interest rate is modified.
  Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.
  Interest-only Modification - A modification in which the loan is converted to interest-only payments for a period of time.
  Combination Modification - Any other type of modification, including the use of multiple types of modifications.

 

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Table of Contents

Below is a table of the newly restructured loans identified in the nine months ended September 30, 2016.

 

     Troubled Debt Restructurings Identified During  
     the nine months ended September 30, 2016  
     Rate
Modification
     Term
Modification
     Interest-only
Modification
     Combination
Modification
 

Real estate

           

Multi-family residential

   $ —         $ —         $ —         $ —     

Residential 1-4 family

     —           —           —           299   

Owner-occupied commercial

     —           —           444         —     

Nonowner-occupied commercial

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     —           —           444         299   

Construction

           

Multi-family residential

     —           —           —           —     

Residential 1-4 family

     —           —           —           —     

Commercial real estate

     —           —           —           —     

Commercial bare land and acquisition & development

     —           —           —           —     

Residential bare land and acquisition & development

     —           —           —           1,827   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total construction loans

     —           —           —           1,827   

Commercial and other

     —           —           363         673   

Consumer

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ 807       $ 2,799   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subsequent to a loan being classified as a TDR, a borrower may become unwilling or unable to abide by the terms of the modified agreement. In such cases of default, the Company takes appropriate action to recover principal and interest payments including the use of foreclosure proceedings. The following table represents loans receivable modified as TDRs that subsequently defaulted within the first twelve months of restructure during the period.

 

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Table of Contents
     Troubled Debt Restructurings  
     that Subsequently Defaulted During  
     the nine months ended September 30,  
     2016      2015  
     Number of
Contracts
     Recorded
Investment
     Number of
Contracts
     Recorded
Investment
 

Real estate

           

Multi-family residential

     —         $ —           —         $ —     

Residential 1-4 family

     —           —           —           —     

Owner-occupied commercial

     1         444         —           —     

Nonowner-occupied commercial

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     1         444         —           —     

Construction

           

Multi-family residential

     —           —           —           —     

Residential 1-4 family

     —           —           —           —     

Commercial real estate

     —           —           —           —     

Commercial bare land and acquisition & development

     —           —           —           —     

Residential bare land and acquisition & development

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total construction loans

     —           —           —           —     

Commercial and other

     —           —           —           —     

Consumer

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1       $ 444       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

No TDRs subsequently defaulted during the three months ended September 30, 2016 and 2015.

At September 30, 2016 and December 31, 2015, the Company had no commitments to lend additional funds on loans restructured as TDRs.

 

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Table of Contents

NOTE 5 – DENTAL LOAN PORTFOLIO

Dental lending is not operated as a business segment, and dental loans are made in the normal course of commercial lending activities throughout the Company. However, to assist in understanding the concentrations and risks associated with the Company’s loan portfolio, the following Note has been included to provide additional information relating to the Company’s dental loan portfolio. At September 30, 2016 and December 31, 2015, loans to dental professionals totaled $370,135, and $340,162, respectively, and represented 20.46%, and 24.19% in principal amount of total outstanding loans, respectively. As of September 30, 2016 and December 31, 2015, dental loans were supported by government guarantees totaling $6,852 and $9,027, respectively. These guarantees represented 1.85%, and 2.65% in principal amount of the outstanding dental loan balances as of such respective dates. The Company defines a “dental loan” as a loan to dental professionals for the purpose of practice expansion, acquisition or other purpose supported by the cash flows of a dental practice.

Loan Classification

Major classifications of dental loans at September 30, 2016 and December 31, 2015, were as follows:

 

     September 30,
2016
     December 31,
2015
 

Real estate secured loans:

     

Owner-occupied commercial

   $ 59,323       $ 56,145   

Other dental real estate loans

     893         2,198   
  

 

 

    

 

 

 

Total permanent real estate loans

     60,216         58,343   

Dental construction loans

     3,149         4,334   
  

 

 

    

 

 

 

Total real estate loans

     63,365         62,677   

Commercial loans

     306,770         277,485   
  

 

 

    

 

 

 

Gross loans

   $ 370,135       $ 340,162   
  

 

 

    

 

 

 

Market Area

The Bank’s principal “market area” is within the States of Oregon and Washington west of the Cascade Mountain Range. This area is serviced by branch locations in Eugene, Portland and Puget Sound. The Company also makes national dental loans throughout the United States, and currently has dental loans in 43 states. National loan relationships are maintained and serviced by Bank personnel primarily located in Portland.

The following table summarizes the Company’s dental lending by borrower location:

 

     September 30,
2016
     December 31,
2015
 

Local

   $ 150,898       $ 145,817   

National

     219,237         194,345   
  

 

 

    

 

 

 

Total

   $ 370,135       $ 340,162   
  

 

 

    

 

 

 

 

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Table of Contents

Allowance

The allowance for loan losses identified for the dental loan portfolio is established as an amount that management considers adequate to absorb possible losses on existing loans within the dental portfolio. The allowance related to the dental loan portfolio consists of general and specific components. The general component is based upon all dental loans collectively evaluated for impairment, including qualitative conditions associated with: loan type, out-of-market location, start-up financing, practice acquisition financing, and specialty practice financing. The specific component is based upon dental loans individually evaluated for impairment.

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2016      2015      2016      2015  

Balance, beginning of period

   $ 4,151       $ 4,080       $ 4,022       $ 4,141   

Reclassification

     601         189         704         158   

Charge-offs

     (9      (36      (9      (78

Recoveries

     55         9         81         21   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 4,798       $ 4,242       $ 4,798       $ 4,242   
  

 

 

    

 

 

    

 

 

    

 

 

 

Credit Quality

Please refer to Note 4 for additional information on the definitions of the credit quality indicators.

The following tables present the Company’s dental loan portfolio by market and credit grade at September 30, 2016 and December 31, 2015:

As of September 30, 2016

 

     Loan Grade         
     Pass      Special Mention      Substandard      Doubtful      Totals  

Local

   $ 148,834       $ —         $ 2,064       $ —         $ 150,898   

National

     216,464         —           1,112         1,661         219,237   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 365,298       $ —         $ 3,176       $ 1,661       $ 370,135   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
As of December 31, 2015   
     Loan Grade         
     Pass      Special Mention      Substandard      Doubtful      Totals  

Local

   $ 143,541       $ —         $ 2,276       $ —         $ 145,817   

National

     191,574         —           2,771         —           194,345   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 335,115       $ —         $ 5,047       $ —         $ 340,162   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Past Due and Nonaccrual Loans

Please refer to Note 4 for additional information on the definitions of “past due.”

The following tables present an aged analysis of the dental loan portfolio by market, including nonaccrual loans, as of September 30, 2016 and December 31, 2015:

As of September 30, 2016

 

     30-59 Days
Past Due
Still Accruing
     60-89 Days
Past Due
Still Accruing
     Greater
Than 90 Days
Past Due Still
Accruing
     Nonaccrual      Total Past
Due and
Nonaccrual
     Total
Current
     Total Loans
Receivable
 

Local

   $ —         $ —         $ —         $ 465       $ 465       $ 150,433       $ 150,898   

National

     —           —           —           1,661         1,661         217,576         219,237   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ —         $ 2,126       $ 2,126       $ 368,009       $ 370,135   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2015

 

  

     30-59 Days
Past Due Still
Accruing
     60-89 Days
Past Due Still
Accruing
     Greater
Than 90 Days
Past Due Still
Accruing
     Nonaccrual      Total Past
Due and
Nonaccrual
     Total
Current
     Total Loans
Receivable
 

Local

   $ —         $ —         $ —         $ 513       $ 513       $ 145,304       $ 145,817   

National

     —           —           —           —           —           194,345         194,345   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ —         $ 513       $ 513       $ 339,649       $ 340,162   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

NOTE 6 – FEDERAL FUNDS AND OVERNIGHT FUNDS PURCHASED

The Company had unsecured federal funds borrowing lines with various correspondent banks totaling $129,000 at both September 30, 2016 and December 31, 2015. The terms of the lines are subject to change with interest payable at the then stated rate. At September 30, 2016 and December 31, 2015, there were no borrowings outstanding on these lines.

The Company also had a secured overnight borrowing line available from the Federal Reserve Bank that totaled $81,915 and $76,912 at September 30, 2016 and December 31, 2015, respectively. The Federal Reserve Bank borrowing line is secured through the pledging of $144,242 and $140,801 at September 30, 2016 and December 31, 2015, respectively, of commercial loans under the Company’s Borrower-In-Custody program. At September 30, 2016 and December 31, 2015, there were no outstanding borrowings on this line. The terms of the lines are subject to change with interest payable at the then stated rate.

NOTE 7 – FEDERAL HOME LOAN BANK BORROWINGS

The Company has a borrowing limit with the Federal Home Loan Bank of Des Moines (“FHLB”) equal to 35% of total assets, subject to the value of discounted collateral pledged and stock holdings.

At September 30, 2016, the maximum borrowing line was $888,671; however, the FHLB borrowing line was limited by the discounted value of collateral pledged. At September 30, 2016, the Company had pledged $827,300 in real estate loans to the FHLB that had a discounted collateral value of $602,715. There was $45,500 borrowed on this line at September 30, 2016.

At December 31, 2015, the maximum borrowing line was $657,086; however, the FHLB borrowing line was limited by the discounted value of collateral pledged. At December 31, 2015, the Company had pledged $666,297 in real estate loans to the FHLB that had a discounted collateral value of $414,044. There was $77,500 borrowed on this line at December 31, 2015.

Below is a summary of outstanding FHLB borrowings by maturity.

 

     Current
Rates
    September 30,
2016
 

Cash management advance

     NA      $ 15,000   

2016

     0.57-1.86     22,500   

2017

     2.28     3,000   

2018

     1.55     3,000   

2019

     —          —     

2020

     —          —     

Thereafter

     3.85     2,000   
    

 

 

 
     $ 45,500   
    

 

 

 

 

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Table of Contents

NOTE 8 – BORROWED FUNDS

Subordinated Debentures

In June 2016, the Company issued $35,000 in aggregate principal amount of fixed-to-floating rate subordinated debentures (the “Notes”) in a public offering. The Notes are callable at par after five years, have a stated maturity of September 30, 2026 and bear interest at a fixed annual rate of 5.875% per year, from and including June 27, 2016, but excluding September 30, 2021. From and including September 30, 2021 to the maturity date or early redemption date, the interest rate will reset quarterly to an annual interest rate equal to the then-current three-month LIBOR plus 471.5 basis points.

The Notes are included in Tier 2 capital (with certain limitations applicable) under current regulatory guidelines and interpretations.

Junior Subordinated Debentures

In November 2005, the Company completed the private placement of $8,000 in aggregate liquidation amount of trust preferred securities (the “TPS”), through its subsidiary, Pacific Continental Capital Trust I. The interest rate on the TPS was 6.265% until January 2011, after which it was converted to a floating rate of three-month LIBOR plus 135 basis points. The TPS mature in 2035, but are callable by the Company at par any time after January 7, 2011. The Company issued $8,248 of junior subordinated debentures (the “Debentures”) to the trust in exchange for ownership of all of the common security of the trust and the proceeds of the preferred securities sold by the trust. In accordance with current accounting guidance, the trust is not consolidated in the Company’s financial statements, but rather the Foundation Debentures are shown as a liability. The interest rate on the Debentures was 6.265% until January 2011, after which it was converted to a floating rate of three-month LIBOR plus 135 basis points. The Debentures have the same prepayment provisions as the TPS.

On September 6, 2016, the Company completed the acquisition of Foundation Bancorp. At that time, the Company assumed ownership of Foundation Statutory Trust I, which had previously issued $6,000 in aggregate liquidation amount of trust preferred securities. The interest rate on the these trust preferred securities is a floating rate of three-month LIBOR plus 173 basis points. The Company also acquired $6,148 of junior subordinated debentures (the “Foundation Debentures”) to the trust in exchange for ownership of all of the common security of the trust and the proceeds of the preferred securities sold by the trust. In accordance with current accounting guidance, the trust is not consolidated in the Company’s financial statements, but rather the Foundation Debentures are shown as a liability, and acquired at an acquisition date fair value of $3,013.

The Debentures and the Foundation Debentures are included in the Company’s Tier I capital (with certain limitations applicable) under current regulatory guidelines and interpretations.

NOTE 9 – SHARE-BASED COMPENSATION

The Company’s 2006 Stock Option and Equity Compensation Plan (the “2006 SOEC Plan”) authorizes the award of up to 1,550,000 shares in stock-based awards. The awards granted under this plan are service-based and are subject to vesting. The Compensation Committee of the Board of Directors may impose any terms or conditions on the vesting of an award that it determines to be appropriate. Awards granted generally vest over four years and have a maximum life of ten years. Awards may be granted at exercise prices of not less than 100.00% of the fair market value of the Company’s common stock at the grant date.

Pursuant to the 2006 SOEC Plan, incentive stock options (“ISOs”), nonqualified stock options, restricted stock, restricted stock units (“RSUs”), or stock appreciation rights (“SARs”) may be awarded to attract and retain the best available personnel to the Corporation and its subsidiary. SARs may be settled in common stock or cash as determined at the date of issuance. Liability-based awards (including all cash-settled SARs) have no impact on the number of shares available to be issued within the plan. Additionally, non-qualified option awards and restricted stock awards may be granted to directors under the terms of this plan.

 

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Table of Contents

The following table identifies the compensation expense recorded and tax benefits received by the Company on its share-based compensation plans for the three and nine months ended September 30, 2016, and 2015:

 

    

Three months ended

September 30,

 
     2016      2015  
     Compensation
Expense
     Tax Benefit      Compensation
Expense/
(Income)
     Tax Benefit
(Expense)
 

Equity-based awards:

           

Employee RSUs

   $ 397       $ 151       $ 372       $ 141   

Liability-based awards:

           

Employee cash SARs

     —           —           (100      (38
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 397       $ 151       $ 272       $ 103   
  

 

 

    

 

 

    

 

 

    

 

 

 
    

Nine months ended

September 30,

 
     2016      2015  
     Compensation
Expense
     Tax Benefit      Compensation
Expense/
(Income)
     Tax Benefit
(Expense)
 

Equity-based awards:

           

Director restricted stock

   $ 240       $ 91       $ 248       $ 94   

Employee RSUs

     1,187         451         1,080         410   

Liability-based awards:

           

Employee cash SARs

     —           —           (150      (57
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,427       $ 542       $ 1,178       $ 447   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following table identifies stock options, employee stock SARs, and employee cash SARs exercised during the three and nine months ended September 30, 2016 and 2015:

 

     Three months ended  
     September 30, 2016  
     Number
Exercised
     Weighted
Average
Exercise
Price
     Intrinsic
Value
     Number
of
Shares
Issued
     Net Cash
Payment
to
Employees
 

Stock options

     30,074       $ 16.54       $ 9         9,832         NA   

Employee stock SARs

     41,237       $ 15.83       $ 5         1,768         NA   

Employee cash SARs

     27,521       $ 15.95         NA         NA       $ 45   
  

 

 

       

 

 

    

 

 

    

 

 

 
     98,832          $ 14         11,600       $ 45   
  

 

 

       

 

 

    

 

 

    

 

 

 
     Nine months ended  
     September 30, 2016  
     Number
Exercised
     Weighted
Average
Exercise
Price
     Intrinsic
Value
     Number
of
Shares
Issued
     Net Cash
Payment
to
Employees
 

Stock options

     65,034       $ 13.86       $ 117         44,792         NA   

Employee stock SARs

     79,806       $ 14.54       $ 26         6,634         NA   

Employee cash SARs

     47,644       $ 15.11         NA         NA       $ 73   
  

 

 

       

 

 

    

 

 

    

 

 

 
     192,484          $ 143         51,426       $ 73   
  

 

 

       

 

 

    

 

 

    

 

 

 
     Three months ended  
     September 30, 2015  
     Number
Exercised
     Weighted
Average
Exercise
Price
     Intrinsic
Value
     Number
of
Shares
Issued
     Net Cash
Payment
to
Employees
 

Stock options

     —         $ —         $ —           —           NA   

Employee stock SARs

     2,204       $ 11.61       $ 2         171         NA   

Employee cash SARs

     1,271       $ 12.07         NA         NA       $ 1   
  

 

 

       

 

 

    

 

 

    

 

 

 
     3,475            2         171         1   
  

 

 

       

 

 

    

 

 

    

 

 

 
     Nine months ended  
     September 30, 2015  
     Number
Exercised
     Weighted
Average
Exercise
Price
     Intrinsic
Value
     Number
of
Shares
Issued
     Net Cash
Payment
to
Employees
 

Stock options

     1,102       $ 12.25       $ 2         1,102         NA   

Employee stock SARs

     3,417       $ 11.57       $ 4         265         NA   

Employee cash SARs

     1,479       $ 12.07         NA         NA       $ 1   
  

 

 

       

 

 

    

 

 

    

 

 

 
     5,998            6         1,367         1   
  

 

 

       

 

 

    

 

 

    

 

 

 

 

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Table of Contents

At September 30, 2016, the Company had estimated unrecognized compensation expense of approximately $3,811 for unvested RSUs. This amount is based on a historical forfeiture rate of 13.00% for all RSUs granted to employees. The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested RSUs was approximately 2.75 years as of September 30, 2016.

NOTE 10 – DERIVATIVE INSTRUMENTS

The Bank purchases derivative instruments as a way to help mitigate interest rate risk. During the first quarter 2013, the Company entered into an interest rate swap agreement with an $8,000 notional amount to convert its variable-rate Debentures debt into a fixed rate for a term of seven years at a rate of 2.73%. The derivative is designated as a cash flow hedge. The cash flow hedge meets the definition of highly effective and the Company expects the hedge to be highly effective throughout the remaining term of the swap. The fair value of the derivative instrument at September 30, 2016, was an $82 unrealized loss, which is recorded in accrued interest and other payables on the consolidated balance sheet. The Company pledged $400 under collateral arrangements to satisfy collateral requirements associated with the interest rate swap contract.

The Bank maintains two interest rate swaps with commercial banking customers tied to loans on the consolidated balance sheet. Those interest rate swaps are simultaneously hedged by offsetting the interest rate swaps that the Bank executes with a third party, such that the Bank minimizes its net risk exposure. As of September 30, 2016 and December 31, 2015, the Bank had non-hedge designated interest rate swaps with an aggregate notional amount of approximately $8,600 and $8,774, respectively, related to this program. The Bank does not require separately pledged collateral to secure its interest rate swaps with customers. However, it does make a practice of cross-collateralizing the interest rate swaps with collateral on the underlying loan. The Bank has minimum collateral posting thresholds with certain of its derivative counterparties, and has posted collateral totaling $250 consisting of cash held on deposit for the benefit of the counterparty against its obligations under these agreements as of September 30, 2016 and December 31, 2015.

The Bank entered into a swap with a third party to serve as a hedge to an equal amount of fixed rate loans. As of September 30, 2016 and December 31, 2015, the Bank had one swap designated a hedging instrument with a notional amount of $1,500 and $1,525 respective, hedging a 10-year fixed rate note bearing interest at 5.71% and maturing August 2023. The notional amount does not represent direct credit exposure. Direct credit exposure is limited to the net difference between the calculated amount to be received and paid. As the Bank has designated the swap a fair value hedge, the underlying hedged loan is carried at fair value on the consolidated balance sheet and included in loans, net of deferred fees.

During third quarter 2016, the Bank entered into forward-starting interest rate swaps, to convert certain existing and future short-term borrowings to fixed rate payments. The primary purpose of these hedges is to mitigate the risk of rising interest rates, specifically LIBOR rates, which are a benchmark for the short term borrowings. The hedging program qualifies as a cash flow hedge under FASB ASC 815, which provides for matching of the recognition of gains and losses of the interest rate swaps and the hedged items. The hedged item is the LIBOR portion of the series of existing or future short-term fixed rate borrowings over the term of the interest rate swap. The change in the fair value of the interest rate swaps is recorded in other comprehensive income. The Bank had notional amounts of $26,500 subject to interest rate swaps to hedge anticipated future borrowings as of September 30, 2016. The unrealized loss, gross of the related tax benefit, on these interest rate swaps as of September 30, 2016 was $475. The Company pledged cash totaling $1,250 under collateral arrangements to satisfy collateral requirements associated with the interest rate swap contract.

The following tables present quantitative information pertaining to the commercial loan related interest rate swaps as of September 30, 2016 and December 31, 2015:

 

     September 30, 2016     December 31, 2015  
     Hedge-
Designated
    Not-Hedge-
Designated
    Hedge-
Designated
    Not-Hedge-
Designated
 

Notional amount

   $ 1,500      $ 8,600      $ 1,525      $ 8,774   

Weighted average pay rate

     5.71     4.85     5.71     4.85

Weighted average receive rate

     3.52     3.61     3.20     3.28

Weighted average maturity in years

     6.9        5.7        7.6        6.5   

 

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Table of Contents

The following table presents the fair values of derivative instruments and their locations in the consolidated balance sheets as of September 30, 2016 and December 31, 2015:

 

          Asset Derivatives      Liability Derivatives  

Derivative

  

Balance sheet location

   September 30,
2016
     December 31,
2015
     September 30,
2016
     December 31,
2015
 

Cash flow hedge—trust preferred

   Other assets or other payables    $ —         $ 82       $ 82       $ —     

Cash flow hedge—long term borrowing

   Other assets or other payables      —           —           780         —     

Interest rate swap designated as hedging instrument

   Other assets or other payables      114         66         147         93   

Interest rate swap not designated as hedging instrument

   Other assets or other payables      162         24         162         24   
     

 

 

    

 

 

    

 

 

    

 

 

 
      $ 276       $ 172       $ 1,171       $ 117   
     

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the income statement impact of the derivative instruments for the three and nine months ended September 30, 2016 and 2015:

 

          Three months ended     Nine months ended  
    

Income statement

location

   September 30,     September 30,  

Derivative

      2016     2015     2016     2015  

Interest rate swap designated as hedging instrument

   Other noninterest income    $ (2   $ (10   $ (6   $ (9
     

 

 

   

 

 

   

 

 

   

 

 

 
      $ (2   $ (10   $ (6   $ (9
     

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTE 11 – FAIR VALUE

The following disclosures about fair value of financial instruments are made in accordance with provisions of ASC 825 “Financial Instruments.” The use of different assumptions and estimation methods could have a significant effect on fair value amounts. Accordingly, the estimates of fair value herein are not necessarily indicative of the amounts that might be realized in a current market exchange.

The estimated fair values of the financial instruments at September 30, 2016 and December 31, 2015:

 

     September 30, 2016      December 31, 2015  
     Carrying
Amount
     Fair Value      Carrying
Amount
     Fair Value  

Financial assets:

           

Cash and cash equivalents

   $ 107,173       $ 107,173       $ 36,675       $ 36,675   

Securities available-for-sale

     482,408         482,408         366,598         366,598   

Loans, net of deferred fees

     1,806,736         1,796,152         1,404,482         1,389,562   

Interest receivable

     5,957         5,957         5,721         5,721   

Federal Home Loan Bank stock

     4,643         4,643         5,208         5,208   

Bank-owned life insurance

     34,927         34,927         22,884         22,884   

Interest rate swaps

     275         275         172         172   

Financial liabilities:

           

Deposits

   $ 2,162,633       $ 2,162,127       $ 1,597,093       $ 1,597,280   

Federal Home Loan Bank borrowings

     45,500         45,613         77,500         77,651   

Subordinated debenture

     34,072         34,072         —           —     

Junior subordinated debentures

     11,272         6,706         8,248         2,741   

Interest payable

     711         711         138         138   

Interest rate swaps

     1,171         1,171         117         117   

Cash and cash equivalents – The carrying amount approximates fair value.

Securities available-for-sale – Fair value is based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans – For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying values. Fair value of fixed rate loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable, and consider credit risk. The Company uses an independent third-party to establish the fair value of loans.

Federal Home Loan Bank stock – The carrying amount represents the fair value and value at which FHLB of Des Moines would redeem the stock.

Interest receivable and payable – The carrying amounts of accrued interest receivable and payable approximate their fair value.

Bank-owned life insurance – The carrying amount is based on cash surrender value which approximates fair value.

Interest rate swaps – Fair value is based on quoted market prices.

 

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Deposits – Fair value of demand, interest bearing demand and savings deposits is the amount payable on demand at the reporting date. Fair value of time deposits is estimated using the interest rates currently offered for deposits of similar remaining maturities. The Company uses an independent third-party to establish the fair value of time deposits.

Federal Home Loan Bank borrowings – Fair value of FHLB borrowings is estimated by discounting future cash flows at rates currently available for debt with similar terms and remaining maturities.

Subordinated debentures – Fair value of subordinated debentures is estimated by discounting future cash flows at rates currently available for debt with similar credit risk, terms and remaining maturities.

Junior subordinated debentures – Fair value of junior subordinated debentures is estimated by discounting future cash flows at rates currently available for debt with similar credit risk, terms and remaining maturities.

Off-balance sheet financial instruments – The carrying amount and fair value are based on fees charged for similar commitments and are not material.

The Company also adheres to the FASB guidance with regards to ASC 820, “Fair Value Measures.” This guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The statement requires fair value measurement disclosure of all assets and liabilities that are carried at fair value on either a recurring or nonrecurring basis. The Company determines fair value based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available. The valuation techniques used are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:

 

    Level 1 – Quoted prices for identical instruments in active markets.

 

    Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active or model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

    Level 3 – Unobservable inputs are used to measure fair value to the extent that observable inputs are not available. The Company’s own data used to develop unobservable inputs is adjusted for market consideration when reasonably available.

Financial instruments, measured at fair value, are broken down in the tables below by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.

 

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The following table presents information about the level in the fair value hierarchy for the Company’s assets and liabilities not measured and carried at fair value as of September 30, 2016 and December 31, 2015:

 

     Carrying
Amount
     Fair Value at September 30, 2016  
      Level 1      Level 2      Level 3  

Financial assets:

           

Cash and cash equivalents

   $ 107,173       $ 107,173       $ —         $ —     

Loans, net of deferred fees

     1,806,736         —           —           1,796,152   

Interest receivable

     5,957         5,957         —           —     

Federal Home Loan Bank stock

     4,643         4,643         —           —     

Interest rate swaps

     275         275         —           —     

Financial liabilities:

           

Deposits

   $ 2,162,633       $ 1,983,492       $ 178,635       $ —     

Federal Home Loan Bank borrowings

     45,500         —           45,613         —     

Subordinated debentures

     34,072         —           34,072         —     

Junior subordinated debentures

     11,272         —           6,706         —     

Interest payable

     711         711         —           —     

Interest rate swaps

     1,171         1,171         —           —     
     Carrying
Amount
     Fair Value at December 31, 2015  
      Level 1      Level 2      Level 3  

Financial assets:

           

Cash and cash equivalents

   $ 36,675       $ 36,675       $ —         $ —     

Loans

     1,404,482         —           —           1,389,562   

Interest receivable

     5,721         5,721         —           —     

Federal Home Loan Bank stock

     5,208         5,208         —           —     

Interest rate swaps

     172         172         —           —     

Financial liabilities:

           

Deposits

   $ 1,597,093       $ 1,458,490       $ 138,790       $ —     

Federal Home Loan Bank borrowings

     77,500         —           77,651         —     

Junior subordinated debentures

     8,248         —           2,741         —     

Accrued interest payable

     138         138         —           —     

Interest rate swaps

     117         117         —           —     

 

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The tables below show assets and liabilities measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015:

 

     Carrying
Value
     Fair Value at September 30, 2016  
      Level 1      Level 2      Level 3  

Financial Assets

           

Available-for-sale securities

           

Obligations of U.S. government agencies

   $ 26,552       $ —         $ 26,552       $ —     

Obligations of states and political subdivisions

     115,509         —           115,509         —     

Agency mortgage-backed securities

     292,735         —           292,735         —     

Private-label mortgage-backed securities

     2,110         —           656         1,454   

SBA pools

     44,616         —           44,616         —     

Corporate securities

     886         —           886         —     

Interest rate swaps

     275         275         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured on a recurring basis

   $ 482,683       $ 275       $ 480,954       $ 1,454   
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities

           
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest rate swap liabilities measured on a recurring basis

   $ 1,171       $ 1,171       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     Carrying
Value
     Fair Value at December 31, 2015  
      Level 1      Level 2      Level 3  

Available-for-sale securities

           

Obligations of U.S. government agencies

   $ 44,623       $ —         $ 44,623       $ —     

Obligations of states and political subdivisions

     97,151         —           97,151         —     

Agency mortgage-backed securities

     185,370         —           185,370         —     

Private-label mortgage-backed securities

     2,790         —           1,204         1,586   

SBA pools

     35,771         —           35,771         —     

Corporate securities

     893         —           893         —     

Interest rate swaps

     172         172         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured on a recurring basis

   $ 366,770       $ 172       $ 365,012       $ 1,586   
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities

           
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest rate swap liabilities measured on a recurring basis

   $ 117       $ 117       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

No transfers to or from Levels 1 and 2 occurred on assets and liabilities measured at fair value on a recurring basis during the nine months ended September 30, 2016, or during the year ended December 31, 2015.

 

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The following is a description of the inputs and valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis. Fair value for all classes of available-for-sale securities and derivative instruments are estimated by obtaining quoted market prices for identical assets, where available. If such prices are not available, fair value is based on independent asset pricing services and models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, prepayments, defaults, cumulative loss projections and cash flows. There have been no significant changes in the valuation techniques during the periods reported.

The following table provides a reconciliation of private-label mortgage-backed securities measured at fair value on a recurring basis using unobservable inputs (Level 3) for the three and nine months ended September 30, 2016 and 2015:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2016      2015      2016      2015  

Beginning balance

   $ 1,399       $ 1,782       $ 1,586       $ 1,568   

Transfers into level 3

     70         —           70         300   

Transfers out of Level 3

     —           —           —           —     

Total gains or losses

           

Included in earnings

     (2      —           (14      (13

Included in other comprehensive income

     64         (2      45         65   

Paydowns

     (77      (85      (233      (225

Purchases, issuances, sales and settlements

           

Purchases

     —           —           —           —     

Issuances

     —           —           —           —     

Sales

     —           —           —           —     

Settlements

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 1,454       $ 1,695       $ 1,454       $ 1,695   
  

 

 

    

 

 

    

 

 

    

 

 

 

Fair value for all classes of available-for-sale securities is estimated by obtaining quoted market prices for identical assets, where available. If such prices are not available, fair value is based on quoted prices for similar instruments or model-derived valuations whose inputs are observable or whose significant value drivers are observable. In instances where quoted prices for identical or similar instruments and observable inputs are not available, unobservable inputs, including the Company’s own data, are used.

The Company utilizes FTN Financial as an independent third-party asset pricing service to estimate fair value on all of its available-for-sale securities. The inputs used to value all securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research, market indicators, and industry and economic trends. Additional inputs specific to each asset type are as follows:

 

    Obligations of U.S. government agencies – TRACE reported trades.

 

    Obligations of states and political subdivisions – MSRB reported trades, material event notices, and Municipal Market Data (MMD) benchmark yields.

 

    Private-label mortgage-backed securities – new issue data, monthly payment information, and collateral performance (whole loan collateral).

 

    Mortgage-backed securities – TBA prices and monthly payment information.

 

    SBA variable pools – TBA prices and monthly payment information.

 

    Corporate securities – TRACE reported trades.

Inputs may be prioritized differently on any given day for any security and not all inputs listed are available for use in the evaluation process on any given day for each security evaluation.

 

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The valuation methodology used by asset type includes:

 

    Obligations of U.S. government agencies – security characteristics, defined sector break-down, benchmark yields, applied base spread, yield to maturity (bullet structures), corporate action adjustment, and evaluations based on T+3 settlement.

 

    Obligations of states and political subdivisions – security characteristics, benchmark yields, applied base spread, yield to worst or market convention, ratings updates, prepayment schedules (housing bonds), material event notice adjustments, and evaluations based on T+3 settlement.

 

    Private-label mortgage-backed securities – security characteristics, prepayment speeds, cash flows, TBA, Treasury and swap curves, IO/PO strips or floating indexes, applied base spread, spread adjustments, yield to worst or market convention, ratings updates (whole-loan collateral), and evaluations based on T+0 settlement.

 

    Mortgage-backed securities – security characteristics, TBA, Treasury, or floating index benchmarks, spread to TBA levels, prepayment speeds, applied spreads, and evaluations based on T+0 settlement.

 

    SBA pools – security characteristics, TBA, Treasury, or floating index benchmarks, spread to TBA levels, prepayment speeds, applied spreads, and evaluations based on T+0 settlement.

 

    Corporate securities – security characteristics, defined sector break-down, benchmark yields, applied based spread, yield to maturity (bullet structures), corporate action adjustment, and evaluations based on T+3 settlement.

The third-party pricing service follows multiple review processes to assess the available market, credit and deal-level information to support its valuation estimates. If sufficient objectively verifiable information is not available to support a security’s valuation, an alternate independent evaluation source will be used.

The Company’s securities portfolio was valued through its independent third-party pricing service using evaluated pricing models and quoted prices based on market data. For further assurance, the Company’s estimate of fair value was compared to an additional independent third-party estimate at June 30, 2016, and the Company obtained key inputs for a sample of securities across sectors and evaluated those inputs for reasonableness. This analysis was performed at the individual security level and no material variances were noted.

There have been no significant changes in the valuation techniques during the periods reported.

 

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The tables below show assets measured at fair value on a nonrecurring basis as of September 30, 2016 and December 31, 2015:

 

     Carrying
Value
     Fair Value  
September 30, 2016       Level 1      Level 2      Level 3  

Other real estate owned

     9,966         —           —           9,966   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 9,966       $ —         $ —         $ 9,966   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Carrying
Value
     Fair Value  
December 31, 2015       Level 1      Level 2      Level 3  

Loans measured for impairment (net of government guarantees and specific reserves)

   $ 53       $ —         $ —         $ 53   

Other real estate owned

     10,147         —           —           10,147   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 10,200       $ —         $ —         $ 10,200   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following is a description of the inputs and valuation methodologies used for assets recorded at fair value on a nonrecurring basis.

Loans measured for impairment (net of government guarantees and specific reserves) include the estimated fair value of collateral-dependent loans, less collectible government guarantees, as well as certain noncollateral-dependent loans measured for impairment with an allocated specific reserve. When a collateral-dependent loan is identified as impaired, the value of the loan is measured using the current fair value of the collateral less selling costs. The fair value of collateral is generally estimated by obtaining external appraisals which are usually updated every 6 to 12 months based on the nature of the impaired loans. Certain noncollateral-dependent loans measured for impairment with an allocated specific reserve are valued based upon the estimated net realizable value of the loan. If the estimated fair value of the impaired loan, less collectible government guarantees, is less than the recorded investment in the loan, impairment is recognized as a charge-off through the allowance for loan losses. The carrying value of the loan is adjusted to the estimated fair value. The carrying value of loans fully charged off is zero.

Other real estate owned represents real estate which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically orders appraisals or performs valuations to ensure that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Appraisals are generally updated every 6 to 12 months on other real estate owned. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on other real estate owned for fair value adjustments based on the fair value of the real estate.

There have been no significant changes in the valuation techniques during the periods reported.

 

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Table of Contents

NOTE 12 – REGULATORY MATTERS

The Company and the Bank are subject to the regulations of certain federal and state agencies and receive periodic examinations by those regulatory authorities. In addition, they are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total capital, Tier 1 capital, common equity Tier 1 to risk-weighted assets and, Tier 1 capital to leverage assets. Management believes that, as of September 30, 2016, the Company and the Bank met all capital adequacy requirements to which they were subject.

As of September 30, 2016, and according to Federal Reserve and FDIC guidelines, the Bank was considered to be well-capitalized. To be categorized as well-capitalized, the Bank must maintain minimum Total capital, Tier 1 capital, common equity Tier 1 to risk-weighted assets and, Tier 1 capital to leverage assets ratios as set forth in the following table.

 

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Table of Contents
     Actual     For Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of September 30, 2016:

               

Total capital (to risk weighted assets)

               

Bank:

   $ 256,454         11.90   $ 172,432         8.00   $ 215,540         10.00

Company:

   $ 270,622         12.55     NA           NA      

Tier 1 capital (to risk weighted assets)

               

Bank:

   $ 235,375         10.92   $ 129,324         6.00   $ 172,432         8.00

Company:

   $ 215,471         9.99     NA           NA      

Common Equity Tier 1 (to risk weighted assets)

               

Bank:

   $ 235,375         10.92   $ 96,993         4.50   $ 140,101         6.50

Company:

   $ 203,359         9.43     NA           NA      

Tier 1 capital (to leverage assets)

               

Bank:

   $ 235,375         11.26   $ 83,578         4.00   $ 107,770         5.00

Company:

   $ 215,471         10.33     NA           NA      

As of December 31, 2015:

               

Total capital (to risk weighted assets)

               

Bank:

   $ 200,236         12.52   $ 127,990         8.00   $ 159,988         10.00

Company:

   $ 201,261         12.58     NA           NA      

Tier 1 capital (to risk weighted assets)

               

Bank:

   $ 182,575         11.41   $ 95,993         6.00   $ 127,990         8.00

Company:

   $ 183,600         11.47     NA           NA      

Common Equity Tier 1 (to risk weighted assets)

               

Bank:

   $ 182,575         11.41   $ 71,995         4.50   $ 103,992         6.50

Company:

   $ 175,600         10.97     NA           NA      

Tier 1 capital (to leverage assets)

               

Bank:

   $ 182,575         9.88   $ 73,939         4.00   $ 92,422         5.00

Company:

   $ 183,600         9.93     NA           NA      

 

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Table of Contents

ITEM 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition than can be obtained from reading the Consolidated Financial Statements alone. The discussion should be read in conjunction with the consolidated financial statements and the notes included in this report. Please refer also to our Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in the Company’s 2015 Form 10-K. All dollar amounts, except share and per share data, are expressed in thousands of dollars.

In addition to historical information, this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements regarding projected results, the expected interest rate environment and its impact on our business, loan yields and expected prepayments, the adequacy of the allowance for loan losses, net interest margin, expectations regarding nonperforming assets, loan growth, earning asset mix, expected cash flows from the securities portfolio and merger related expense, expectations regarding the Company’s securities portfolio, the structure and volatility of the securities portfolio and the purchase and sale of securities, their value and yields, growth in core deposits and cost, capital levels, liquidity and dividends, expectations regarding certain large depositor relationships and the expected loss of certain large temporary deposits, the outcome of legal proceedings, loan rates and expectations regarding the impact and compression of the net interest margin, the impact of recent accounting pronouncements, management’s plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations in the forward-looking statements, including those set forth in this report, and our other reports filed with the SEC:

 

    Local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets.

 

    The local housing or real estate market could decline.

 

    The risks presented by an economic recession, which could adversely affect credit quality, collateral values, including real estate collateral, investment values, liquidity and loan originations, and loan portfolio delinquency rates.

 

    Our concentration in loans to dental professionals exposes us to the risks affecting dental practices in general.

 

    Interest rate changes could significantly reduce net interest income and negatively affect funding sources.

 

    Projected business increases following any future or pending strategic expansion or opening of new branches could be lower than expected.

 

    Competition among financial institutions could increase significantly.

 

    The goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings.

 

    The reputation of the financial services industry could deteriorate, which could adversely affect our ability to access markets for funding and to acquire and retain customers.

 

    The efficiencies we may expect to receive from any investments in personnel, acquisitions, and infrastructure may not be realized.

 

    The level of nonperforming assets and charge-offs or changes in the estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements may increase.

 

    Changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, executive compensation, and insurance) could have a material adverse effect on our business, financial condition and results of operations.

 

    Acts of war or terrorism, or natural disasters, may adversely impact our business.

 

    The timely development and acceptance of new banking products and services and perceived overall value of these products and services by users may adversely impact our ability to increase market share and control expenses.

 

    Changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters, may impact the results of our operations.

 

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    The costs and effects of legal, regulatory and compliance developments, including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews, may adversely impact our ability to increase market share and control expenses, or may result in substantial uninsured liabilities, which could adversely affect our business, prospects, results of operations and financial condition.

 

    Our success at managing the risks involved in the foregoing items will have a significant impact on our results of operations and future prospects.

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Part I, Item 1A “Risk Factors” in the Company’s 2015 Form 10-K and Part II, Item 1A, “Risk Factors” in this report and elsewhere in this report or in our other reports with the SEC, and include risks and uncertainties described or referred to in Part I, Item 1 “Business” under the captions “Competition” and “Supervision and Regulation” in the Company’s 2015 Form 10-K and Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. Please take into account that forward-looking statements speak only as of the date of this report. The Company does not undertake any obligation to publicly correct or update any forward-looking statement whether as a result of new information, future events or otherwise.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

We follow accounting standards set by the Financial Accounting Standards Board, commonly referred to as the “FASB.” The FASB sets generally accepted accounting principles (“GAAP”) that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in this report are to the “FASB Accounting Standards Codification,” sometimes referred to as the “Codification” or “ASC.”

The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2015 Form 10-K. Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements in the Company’s 2015 Form 10-K should be considered critical under the SEC definition:

Nonaccrual Loans

Accrual of interest is discontinued on contractually delinquent loans when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal or interest is doubtful. At a minimum, loans that are past due as to maturity or payment of principal or interest by 90 days or more are placed on nonaccrual status, unless such loans are well-secured and in the process of collection. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized.

Allowance for Loan Losses and Reserve for Unfunded Commitments

The allowance for loan losses on outstanding loans is classified as a contra-asset account offsetting outstanding loans, and the allowance for unfunded commitments is classified as an “other” liability on the balance sheet. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balances of the allowance for loan losses for outstanding loans and unfunded commitments are maintained at an amount management believes will be adequate to absorb known and inherent losses in the loan portfolio and commitments to loan funds. The appropriate balance of the allowance for loan losses is determined by applying loss factors to the credit exposure from outstanding loans and unfunded loan commitments. Estimated loss factors are based on subjective measurements including management’s assessment of the internal risk classifications, changes in the nature of the loan portfolios, industry concentrations, and the impact of current local, regional, and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

 

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Troubled Debt Restructurings

In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties. Additional information regarding the Company’s TDRs can be found in Note 4 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

Goodwill and Intangible Assets

At September 30, 2016, the Company had $70,684 in goodwill and other intangible assets. In accordance with financial accounting standards, assets with indefinite lives are periodically tested for impairment. Management performs an impairment analysis of its goodwill and intangible assets with indefinite lives at least annually and has determined that there was no impairment as of December 31, 2015, the date the most recent analysis was performed.

Share-based Compensation

In accordance with FASB ASC 718, “Stock Compensation,” we recognize expense in the income statement for the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period). The requisite service period may be subject to performance conditions. The fair value of each grant is estimated as of the grant date using the Black-Scholes option-pricing model. Management assumptions utilized at the time of grant impact the fair value of the option calculated under the Black-Scholes methodology, and ultimately, the expense that will be recognized over the expected service period. Additional information is included in Note 9 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

Fair Value Measurements

GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820, “Fair Value Measurements,” establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. In general, fair values determined by Level 1 inputs utilize quoted prices for identical assets or liabilities traded in active markets that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Additional information regarding the Company’s fair value measurements can be found in Note 11 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), with an original effective date for annual reporting periods beginning after December 15, 2016. The core principle of this Topic is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606), which deferred the effective date of ASU 2014-09 to annual periods beginning after December 15, 2017. The adoption of ASU No. 2014-09 is not expected to have a material impact on the Company’s consolidated financial statements.

 

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In August 2014, the FASB issued ASU No. 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. ASU 2014-14 requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of ASU No. 2014-14 is not expected to have a material impact on the Company’s consolidated financial statements.

In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. ASU 2015-16 requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this Update require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The new standard is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The adoption of ASU No. 2015-16 is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. This ASU requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. In addition, the amendment requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. This ASU also eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The amendment also requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. ASU No. 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted for certain provisions. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The FASB is issuing this Update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-05, Derivatives and Hedging (Topic 815); Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The amendments in this Update clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of

 

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itself, require designation of that hedging relationship provided that all other hedge accounting criteria (including those in paragraphs 815-20-35-14 through 35-18) continue to be met. ASU 2016-05 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In March 2016-06, the FASB issued ASU No. 2016-06, Derivatives and Hedging (Topic 815); Contingent Put and Call Options in Debt Instruments. The amendments in this Update clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. The amendments in this Update clarify what steps are required when assessing whether the economic characteristics and risks of call (put) options are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative. Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. The amendments are an improvement to GAAP because they eliminate diversity in practice in assessing embedded contingent call (put) options in debt instruments. ASU 2016-06 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No 2016-07, Investments – Equity Method and Joint Ventures (Topic 323); Simplifying the Transition to the Equity method of accounting. The amendments in this Update eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The amendments in this Update require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. ASU 2016-07 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606); Principal versus agent considerations (reporting revenue gross versus net). The core principle of the guidance in Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this Update do not change the core principle of the guidance. The amendments clarify the implementation guidance on principal versus agent considerations. When another party is involved in providing goods or services to a customer, an entity is required to determine whether the nature of its promise is to provide the specified good or service itself (that is, the entity is a principal) or to arrange for that good or service to be provided by the other party (that is, the entity is an agent). When (or as) an entity that is a principal satisfies a performance obligation, the entity recognizes revenue in the gross amount of consideration to which it expects to be entitled in exchange for the specified good or service transferred to the customer. When (or as) an entity that is an agent satisfies a performance obligation, the entity recognizes revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging for the specified good or service to be provided by the other party. ASU 2016-08 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718); Improvements to employee share-based payment accounting. The areas for simplification in this Update involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the specific changes associated with the update include all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) being recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. An entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

 

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In March 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The core principle of the guidance in this update is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this Update do not change the core principle of the guidance in Topic 606. Rather, the amendments in this Update clarify the following two aspects of Topic 606: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. ASU 2016-10 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this Update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payment. The main purpose of this update is to address the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. This Update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements, but anticipates an immaterial impact.

 

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Financial Highlights

 

     For the three months ended     For the nine months ended  
     September 30,     September 30,  
     2016     2015     $ Change     2016     2015     $ Change  

Net interest income

   $ 20,771      $ 18,308      $ 2,463      $ 58,726      $ 50,977      $ 7,749   

Noninteret income

     1,919        1,714        205        5,477        4,618        859   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating revenue (1)

     22,690        20,022        2,668        64,203        55,595        8,608   

Provision for loan losses

     1,380        625        755        3,575        1,175        2,400   

Noninterest expense

     13,825        11,182        2,643        40,766        34,186        6,580   

Provision for income taxes

     2,634        2,890        (256     6,946        7,012        (66
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 4,851      $ 5,325      $ (474   $ 12,916      $ 13,222      $ (306
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share

            

Basic

   $ 0.24      $ 0.27      $ (0.03   $ 0.65      $ 0.69      $ (0.04

Diluted

   $ 0.23      $ 0.27      $ (0.04   $ 0.64      $ 0.68      $ (0.04

Assets, period-end

   $ 2,539,060      $ 1,878,283      $ 660,777         

Gross loans, period-end

   $ 1,808,646      $ 1,357,045      $ 451,601         

Core deposits, period end (2)

   $ 2,049,352      $ 1,465,547      $ 583,805         

Deposits, period-end

   $ 2,162,633      $ 1,524,954      $ 637,679         

Return on average assets (3)

     0.89     1.14       0.85     1.01  

Return on average equity (3)

     8.05     9.91       7.55     8.60  

Return on average tangible equity (3) (4)

     10.14     12.42       9.43     10.62  

 

(1)  Operating revenue is defined as net interest income plus noninterest income.
(2)  Defined by the Company as demand, interest checking, money market, savings, and local nonpublic time deposits, including local nonpublic time deposits in excess of $100.
(3)  Amounts annualized.
(4)  Tangible equity excludes goodwill and core deposit intangibles related to acquisitions, see non-GAAP disclosure below.

On September 6, 2016, the Company completed the acquisition of Foundation Bank. Subsequent to the end of the reporting period, during October 2016, the Company successfully converted the Foundation Bank core systems to the Company’s core operating system. A summary of the assets and liabilities acquired through this transaction is provided in Note 2 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

The Company earned $4,851, or $0.23 per diluted share, in third quarter 2016, compared to $5,325, or $0.27 per diluted share, in third quarter 2015. Included in third quarter income was $1,767 of merger related expense associated with the acquisition, which lowered third quarter 2016 net income by $1,149, or approximately $0.06 per share.

The Company recognized provision for loan losses of $1,380 in the third quarter 2016, representing an increase of $755 over third quarter 2015. The Company also saw net interest income grow $2,463 to $20,771 in the third quarter 2016, up from $18,308 in the third quarter 2015. Income growth was primarily attributable to growth in the loan portfolio associated with the acquired loans and organic loan growth experienced during the quarter.

During the third quarter 2016, the Company continued to experience growth in outstanding loans. Outstanding loans at September 30, 2016, were $1,808,646, up $402,634 over December 31, 2015, outstanding loans. Included in the growth was $270,533 in net loans acquired through the Foundation Bank acquisition. Excluding the acquired loans, the Company grew organic loans $132,101 since the prior year end, representing an annualized growth rate of 12.55% and expansion in all core lending segments, including construction loans, real estate loans and commercial loans.

 

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Outstanding core deposits at September 30, 2016, were $2,049,352, which represented growth of $515,410, since December 31, 2015. Included in the growth was $396,509 of deposits acquired through the Foundation Bank acquisition. Excluding acquired deposits, the Company experienced organic deposit growth of $118,901 since the prior year end, representing an annualized growth rate of 10.35%. Included in period end core deposits was a large temporary deposit of approximately $60,000, which was deposited toward the end of the quarter in conjunction with the sale of a client. The funds are temporary in nature and are expected to leave prior to the end of 2016.

Reconciliation of Non-GAAP financial information

Management utilizes certain non-GAAP financial measures to monitor the Company’s performance. While we believe the presentation of non-GAAP financial measures provides additional insight into our operating performance, readers of this report are urged to review the GAAP results as presented in the Financial Statements in Item 1 of Part I of this report.

The Company presents a computation of tangible equity along with tangible book value and return on average tangible equity. The Company defines tangible equity as total shareholders’ equity before goodwill and core deposit intangible assets. Tangible book value is calculated as tangible equity divided by total shares outstanding. Return on average tangible equity is calculated as net income divided by average tangible equity. We believe that tangible equity and certain tangible equity ratios are meaningful measures of capital adequacy which may be used when making period-to-period and company-to-company comparisons. Tangible equity and tangible equity ratios are considered to be non-GAAP financial measures and should be viewed in conjunction with total shareholders’ equity, book value and return on average equity. The following table presents a reconciliation of total shareholders’ equity to tangible equity.

 

     September 30,     June 30,     September 30,  
     2016     2016     2015  

Total shareholders’ equity

   $ 276,471      $ 226,426      $ 216,676   

Subtract:

      

Goodwill

     (61,436     (40,027     (39,075

Core deposit intangible assets

     (9,248     (3,657     (4,027
  

 

 

   

 

 

   

 

 

 

Tangible shareholders’ equity (non-GAAP)

   $ 205,787      $ 182,742      $ 173,574   
  

 

 

   

 

 

   

 

 

 

Book value per share

   $ 12.23      $ 11.48      $ 11.06   

Tangible book value per share (non-GAAP)

   $ 9.10      $ 9.26      $ 8.86   

Year-to-date return on average equity

     7.55     7.28     8.60

Year-to-date return on average tangible equity
(non-GAAP)

     9.43     9.05     10.62

The Company presents a computation of core net interest margin and adjusted net interest income, which exclude prepayment penalties on loans, prepayment penalties on brokered deposits, and accretion of fair value marks, for third quarter 2016, second quarter 2016, and third quarter 2015. Core net interest margin and adjusted net interest income are considered non-GAAP financial measures and should be viewed in conjunction with the consolidated statement of income and average balance analysis of net interest income. The following table presents a reconciliation of net interest margin to core net interest margin.

 

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Reconciliation of Adjusted Net Interest Income to Net Interest Income

 

     Three months ended  
     September 30,     June 30,     September 30,  
     2016     2016     2015  

Tax equivalent net interest income (1)

   $ 21,354      $ 19,665      $ 18,745   

Subtract

      

Century Bank accretion

     68        16        84   

Capital Pacific Bank accretion

     300        140        532   

Foundation Bank accretion

     509        —          —     

Prepayment penalties on loans

     276        166        33   

Prepayment penalties on brokered deposits

     —          —          (54
  

 

 

   

 

 

   

 

 

 

Total adjustments

     1,153        322        595   
  

 

 

   

 

 

   

 

 

 

Adjusted net interest income (non-GAAP)

   $ 20,201      $ 19,343      $ 18,150   
  

 

 

   

 

 

   

 

 

 

Average earnings assets

   $ 2,014,889      $ 1,852,130      $ 1,726,201   

Net interest margin

     4.22     4.27     4.31

Core net interest margin (non-GAAP)

     3.99     4.20     4.17

 

(1) Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of $582, $518, and $264 for the three months ended September 30, 2016, June 30, 2016, and September 30, 2015, respectively.

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of a company, they have limitations as analytical tools, and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the primary source of the Company’s revenue. Net interest income is the difference between interest income derived from earning assets, principally loans, and interest expense associated with interest-bearing liabilities, principally deposits. The volume and mix of earning assets and funding sources, market rates of interest, demand for loans, and the availability of deposits affect net interest income.

Net interest margin as a percentage of average earning assets for third quarter 2016 was 4.22%, representing reductions of 5 basis points and 9 basis points from second quarter 2016 and third quarter 2015, respectively. The linked-quarter margin contracted primarily due to the higher cost of interest bearing wholesale funding, reflecting the increased interest expense on the subordinated debentures issued at the end of June 2016. During third quarter 2016, accretion of loan fair value discounts and other items was $1,153 and added 23 basis points to the net interest margin, compared to loan fair value accretion and other nonrecurring items of $322 in second quarter 2016 that added 7 basis points to the net interest margin. The increase in accretion income is primarily attributable to the acquisition of Foundation Bank, which was completed on September 6, 2016.

The Company also saw a reduction in yields on the taxable portion of the loan portfolio, as new loans were being booked at rates below the current portfolio yield, which are expected to continue to place downward pressure on the net interest margin.

 

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The decrease in the year-over-year net interest margin of 9 basis point was primarily due to a reduction in nonrecurring interest items, primarily accretion income booked on the acquired loan portfolios and the increase in interest expense on the Notes. Prior to issuance of the Notes in the second quarter, the core net interest margin, which removes the effect of fair value accretion and nonrecurring items, remained relatively stable due to a continued shift in earning asset mix as higher yielding loans represented a larger proportion of total earning assets versus the lower yielding securities portfolio. With the increase in the additional interest expense on the Notes, the core margin is expected to experience some margin compression in future quarters. Core net interest margin is considered to be a non-GAAP financial measure. See “Reconciliation of non-GAAP financial information” above.

 

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The following table presents condensed balance sheet information, together with interest income and yields on average interest earning assets, and interest expense and rates on interest-bearing liabilities, for the quarter ended September 30, 2016, compared to the quarter ended September 30, 2015:

Table I

Average Balance Analysis of Net Interest Income

(dollars in thousands)

 

     Three months ended
September 30, 2016
    Three months ended
September 30, 2015
 
     Average
Balance
     Interest
Income or
(Expense)
    Average
Yields or
Rates
    Average
Balance
     Interest
Income or
(Expense)
    Average
Yields or
Rates
 

Interest earning assets

              

Federal funds sold and interest-bearing deposits

   $ 28,811       $ 40        0.55   $ 12,793       $ 7        0.22

Federal Home Loan Bank stock

     6,975         46        2.62     5,348         11        0.82

Securities available-for-sale:

              

Taxable

     346,658         1,949        2.24     316,412         1,702        2.13

Tax-exempt(1)

     74,427         742        3.96     72,026         754        4.15

Loans, net of deferred fees and allowance(2)

              

Taxable

     1,502,108         19,545        5.18     1,286,716         16,920        5.22

Tax-exempt(3)

     55,910         923        6.57     32,906         494        5.96
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-earning assets

     2,014,889         23,245        4.59     1,726,201         19,888        4.57

Non earning assets

              

Cash and due from banks

     28,300             22,395        

Property and equipment

     19,380             17,810        

Goodwill and intangible assets

     49,517             43,168        

Interest receivable and other assets

     51,901             49,844        
  

 

 

        

 

 

      

Total nonearning assets

     149,098             133,217        
  

 

 

        

 

 

      

Total assets

   $ 2,163,987           $ 1,859,418        
  

 

 

        

 

 

      

Interest-bearing liabilities

              

Money market and NOW accounts

   $ 825,800       $ (553     -0.27   $ 794,266       $ (508     -0.25

Savings deposits

     75,344         (23     -0.12     61,309         (18     -0.12

Time deposits - core (4)

     59,830         (59     -0.39     88,641         (80     -0.36
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-bearing core deposits

     960,974         (635     -0.26     944,216         (606     -0.25

Time deposits - noncore

     107,753         (349     -1.29     62,481         (249     -1.58

Interest-bearing repurchase agreements

     780         —          0.00     —           —          0.00

Federal funds purchased

     909         (2     -0.88     2,392         (4     -0.66

FHLB borrowings

     117,277         (286     -0.97     82,571         (227     -1.09

Subordinated debenture

     34,079         (553     -6.46     —           —          0.00

Junior subordinated debenture

     9,034         (66     -2.91     8,248         (57     -2.74
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-bearing wholesale funding

     269,832         (1,256     -1.85     155,692         (537     -1.37
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-bearing liabilities

     1,230,806         (1,891     -0.61     1,099,908         (1,143     -0.41

Noninterest-bearing liabilities

              

Demand deposits

     687,803             538,768        

Interest payable and other

     5,594             7,512        
  

 

 

        

 

 

      

Total noninterest liabilities

     693,397             546,280        
  

 

 

        

 

 

      

Total liabilities

     1,924,203             1,646,188        

Shareholders’ equity

     239,784             213,230        
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 2,163,987           $ 1,859,418        
  

 

 

        

 

 

      

Net interest income

      $ 21,354           $ 18,745     
     

 

 

        

 

 

   

Net interest margin(1)

        4.22          4.31  
     

 

 

        

 

 

   

 

(1)  Tax-exempt securities income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $260 and $264 for the three months ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 5 and 6 basis points for the three months ended September 30, 2016, and September 30, 2015, respectively.
(2)  Interest income includes recognized loan origination fees of $340 and $231 for the three months ended September 30, 2016, and September 30, 2015, respectively.
(3)  Tax-exempt loan income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $323 and $173 for the three months ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 6 and 4 basis points for the three months ended September 30, 2016, and September 30, 2015, respectively.
(4)  Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $100.

 

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Table I shows that earning asset yields in third quarter 2016 were 4.59%, down 2 basis points from the 4.57% recorded in third quarter 2015. The Bank experienced a decrease in yield on the taxable loan portfolio of 4 basis points when compared to the prior period. New loans continued to be booked at rates lower than the average portfolio rate, which continued to slowly reduce the overall portfolio yield; however, an increase in accretion income attributable to the acquired loan portfolios partially offseting that decline. The increase in the yield on the taxable portion of the securities portfolio reflected more recent purchases, which were longer in nature, resulting in an increase in yield.

The cost of interest-bearing liabilities increased by 20 basis points from 0.41% in third quarter 2015 compared to 0.61% in third quarter 2016. The increase in the cost of interest-bearing liabilities was primarily due to the issuance of the Debentures in the second quarter, which have a stated coupon rate of 5.875%. The rates paid on interest-bearing core deposits increased by 1 basis point, due to a change in the depositor composition of the core deposits.

 

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Table of Contents

The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the three months ended September 30, 2016, compared to the three months ended September 30, 2015.

Table II

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

 

     Three months ended
September 30, 2016
compared to September 30, 2015
Increase (decrease) due to
 
     Volume      Rate      Net  

Interest earned on:

        

Federal funds sold and interest-bearing deposits

   $ 9       $ 24       $ 33   

Federal Home Loan Bank stock

     3         32         35   

Securities available-for-sale:

        

Taxable

     157         90         247   

Tax-exempt(1)

     23         (35      (12

Loans, net of deferred fees and allowance

        

Taxable

     2,779         (154      2,625   

Tax-exempt(2)

     342         86         428   
  

 

 

    

 

 

    

 

 

 

Total interest-earning assets

     3,313         43         3,356   
  

 

 

    

 

 

    

 

 

 

Interest paid on:

        

Money market and NOW accounts

     19         26         45   

Savings deposits

     4         1         5   

Time deposits - core (3)

     (26      5         (21
  

 

 

    

 

 

    

 

 

 

Total interest-bearing core deposits

     (3      32         29   

Time deposits - noncore

     179         (79      100   

Federal funds purchased

     (2      —           (2

FHLB and FRB borrowings

     95         (36      59   

Subordinated debenture

     (2      555         553   

Junior subordinated debenture

     5         4         9   
  

 

 

    

 

 

    

 

 

 

Total interest-bearing wholesale funding

     834         (115      719   
  

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

     831         (83      748   
  

 

 

    

 

 

    

 

 

 

Net interest income(1)

   $ 2,482       $ 126       $ 2,608   
  

 

 

    

 

 

    

 

 

 

 

(1)  Tax-exempt securities income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $260 and $264 for the three months ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 5 and 6 basis points for the three months ended September 30, 2016, and September 30, 2015, respectively.
(2)  Tax-exempt loan income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $323 and $173 for the three months ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 6 and 4 basis points for the three months ended September 30, 2016, and September 30, 2015, respectively.
(3)  Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $100.

The third quarter 2016 rate/volume analysis shows that net interest income increased by $2,608 over third quarter 2015. Interest income increased $3,356, while interest expense increased $748. The increase in interest income was primarily due to higher volumes, which generated an additional $3,313 in interest income, which was partially offset by a decline in interest income of $43 due to lower rates.

 

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Table of Contents

Table III

Average Balance Analysis of Net Interest Income

(dollars in thousands)

 

     Nine months ended
September 30, 2016
    Nine months ended
September 30, 2015
 
     Average
Balance
     Interest
Income or
(Expense)
    Average
Yields or
Rates
    Average
Balance
     Interest
Income or
(Expense)
    Average
Yields or
Rates
 

Interest earning assets

            

Federal funds sold and interest-bearing deposits

   $ 26,539       $ 104        0.52   $ 12,916       $ 23        0.24

Federal Home Loan Bank stock

     6,016         94        2.09     8,060         18        0.30

Securities available-for-sale:

            

Taxable

     322,679         5,456        2.26     304,945         4,807        2.11

Tax-exempt(1)

     72,703         2,208        4.06     73,057         2,294        4.20

Loans, net of deferred fees and allowance(2)

            

Taxable

     1,418,191         54,244        5.11     1,191,869         47,250        5.30

Tax-exempt(3)

     50,831         2,411        6.34     27,249         1,185        5.81
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest earning assets

     1,896,959         64,516        4.54     1,618,096         55,577        4.59

Non earning assets

              

Cash and due from banks

     25,809             22,094      

Property and equipment

     18,970             17,823      

Goodwill and intangible assets

     45,641             39,217      

Interest receivable and other assets

     49,548             48,387      
  

 

 

        

 

 

      

Total non earning assets

     139,968             127,521      
  

 

 

        

 

 

      

Total assets

   $ 2,036,927           $ 1,745,617      
  

 

 

        

 

 

      

Interest-bearing liabilities

            

Money market and NOW accounts

   $ 820,173       $ (1,615     -0.26   $ 731,198       $ (1,440     -0.26

Savings deposits

     70,843         (65     -0.12     58,816         (55     -0.13

Time deposits - core (4)

     66,022         (182     -0.37     79,535         (235     -0.40
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-bearing core deposits

     957,038         (1,862     -0.26     869,549         (1,730     -0.27

Time deposits - non-core

     80,092         (816     -1.36     72,903         (779     -1.43

Interest-bearing repurchase agreements

     493         —          0.00     —           —          0.00

Federal funds purchased

     872         (6     -0.92     1,839         (10     -0.73

FHLB borrowings

     95,356         (758     -1.06     84,924         (694     -1.09

Subordinated debenture

     11,940         (553     -6.19     —           —          0.00

Junior subordinated debenture

     8,512         (179     -2.81     8,248         (169     -2.74
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-bearing wholesale funding

     197,265         (2,312     -1.57     167,914         (1,652     -1.32
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-bearing liabilities

     1,154,303         (4,174     -0.48     1,037,463         (3,382     -0.44

Noninterest-bearing liabilities

              

Demand deposits

     647,967             495,965      

Interest payable and other

     6,065             6,585      
  

 

 

        

 

 

      

Total noninterest liabilities

     654,032             502,550      
  

 

 

        

 

 

      

Total liabilities

     1,808,335             1,540,013      

Shareholders’ equity

     228,592             205,604      
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 2,036,927           $ 1,745,617      
  

 

 

        

 

 

      

Net interest income

      $ 60,342             $ 52,195   
     

 

 

          

 

 

 

Net interest margin(1)

        4.25            4.31
     

 

 

          

 

 

 

 

(1)  Tax-exempt securities income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $773 and $803 for the YTD period ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 5 and 7 basis points for the YTD period ended September 30, 2016, and September 30, 2015, respectively.
(2)  Interest income includes recognized loan origination fees of $776 and $478 for the YTD period ended September 30, 2016, and September 30, 2015, respectively.
(3)  Tax-exempt loan income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $844 and $415 for the YTD period ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 6 and 3 basis points for the YTD period ended September 30, 2016, and September 30, 2015, respectively.
(4)  Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $100 .

 

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Table of Contents

Table IV

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

 

     Nine months ended
September 30, 2016
Compared to nine months ended September 30, 2015
Increase (decrease) due to
 
     Volume      Rate      Days      Net  

Interest earned on:

           

Federal funds sold and interest-bearing deposits

   $ 24       $ 57       $ —         $ 81   

Federal Home Loan Bank stock

     (5      80         1         76   

Securities available-for-sale:

           

Taxable

     280         364         5         649   

Tax-exempt(1)

     (11      (77      2         (86

Loans, net of deferred fees and allowance

           

Taxable

     8,980         (2,028      42         6,994   

Tax-exempt(2)

     1,026         198         2         1,226   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest earning assets

     10,294         (1,406      52         8,940   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest paid on:

           

Money market and NOW accounts

     175         (2      2         175   

Savings deposits

     11         (1      —           10   

Time deposits - core (3)

     (40      (13      —           (53
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-bearing core deposits

     146         (16      2         132   

Time deposits - noncore

     77         (41      2         38   

Federal funds purchased

     (5      1         —           (4

FHLB borrowings

     85         (22      1         64   

Subordinated debenture

     —           552         1         553   

Junior subordinated debenture

     5         4         1         10   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-bearing wholesale funding

     162         494         5         661   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

     308         478         7         793   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income(1)

   $ 9,986       $ (1,884    $ 45       $ 8,147   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Tax-exempt securities income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $773 and $803 for the YTD period ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 5 and 7 basis points for the YTD period ended September 30, 2016, and September 30, 2015, respectively.
(2)  Tax-exempt loan income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $844 and $415 for the YTD period ended September 30, 2016, and September 30, 2015, respectively. Net interest margin was positively impacted by 6 and 3 basis points for the YTD period ended September 30, 2016, and September 30, 2015, respectively.
(3)  Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $100.

 

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Table of Contents

Loan Loss Provision and Allowance

Below is a summary of the Company’s allowance for loan losses for the three and nine months ended September 30, 2016, and 2015:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2016      2015      2016      2015  

Balance, beginning of period

   $ 19,127       $ 16,013       $ 17,301       $ 15,637   

Provision charged to income

     1,380         625         3,575         1,175   

Loans charged against allowance

     (44      (104      (712      (631

Recoveries credited to allowance

     68         78         367         431   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 20,531       $ 16,612       $ 20,531       $ 16,612   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company recorded $1,380 in provision for loan losses during the third quarter 2016, which was attributable to growth in the loan portfolio and the downgrade of a dental loan relationship totaling $1,661. The Company’s classified assets at September 30, 2016, were 23.80% of regulatory capital, compared to 23.03% and 25.14% of regulatory capital at December 31, 2015 and September 30, 2015, respectively. Classified assets totaled $56,166, at September 30, 2016, up $13,337 from June 30, 2016. The increase was primarily attributable to the acquisition of Foundation Bank, which as of September 30, 2016, added $19,233 to the classified assets totals.

For the nine months ended September 30, 2016, the Company recorded net charge offs of $369, or annualized 0.05% of average outstanding loans, compared to net charge offs of $200, or 0.03% of average loans, for the same period in 2015. The allowance for loan losses for outstanding loans at September 30, 2016, was $20,531, or 1.14% of outstanding loans, compared to 1.23% and 1.23% of outstanding loans at December 31, 2015, and September 30, 2015, respectively. The decrease in the allowance as a percentage of total loans was primarily attributable to loans acquired through acquisition, which were booked net of their credit related fair value adjustment and were only included in the allowance for loan losses to the extent their credit impairment exceeded the remaining credit related fair value discount. As these loans mature or are refinanced into the non-acquired loan portfolio, they are included in the allowance for loan losses, therefore increasing the allowance as a percentage of total loans. At September 30, 2016, the Company had a total of $9,999 of credit related fair value adjustment assigned to acquired loans. The balance of these acquired loans totaled $439,178, before the credit and interest rate fair value adjustments. When acquired loans with an assigned credit fair value mark are excluded from outstanding loans, the allowance for loan losses of $20,531 as a percentage of organic loans outstanding was 1.48% as of September 30, 2016. The allowance as a percentage of nonperforming loans, net of government guarantees, was 210.23% at September 30, 2016, compared to 636.30% and 744.60% at December 31, 2015, and September 30, 2015, respectively.

At September 30, 2016, $9,551 of loans (net of government guarantees) were classified as impaired. A specific allowance of $738 (included in the ending allowance at September 30, 2016) was assigned to these loans. That compares to impaired loans of $7,527 (net of government guarantees) and a specific allowance assigned of $175 at December 31, 2015.

Total nonperforming assets, net of government guarantees, were $22,832, or 0.90% of total assets, at September 30, 2016, up $8,366 from December 31, 2015, primarily due to the acquisition of Foundation Bank. At September 30, 2016, nonperforming assets consisted of $9,766 in nonaccrual loans (net of government guarantees), no loans were 90 days past due and still accruing interest, and there was $13,066 of other real estate owned.

 

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Table of Contents

The following table shows a summary of nonaccrual loans, loans past due 90 days or more, and other real estate owned for the periods covered in this report:

Nonperforming Assets and Asset Quality Ratios

 

     September 30,
2016
    December 31,
2015
    September 30,
2015
 

NONPERFORMING ASSETS

      

Nonaccrual loans

      

Real estate loans

      

Multi-family residential

   $ —        $ —        $ —     

Residential 1-4 family

     1,465        733        569   

Owner-occupied commercial

     1,634        2,369        2,371   

Nonowner-occupied commercial

     3,475        790        829   
  

 

 

   

 

 

   

 

 

 

Total permanent real estate loans

     6,574        3,892        3,769   

Construction loans

      

Multi-family residential

     —          —          —     

Residential 1-4 family

     —          53        53   

Commercial real estate

     —          —          —     

Commercial bare land and acquisition & development

     —          —          —     

Residential bare land and acquisition & development

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Total construction real estate loans

     —          53        53   
  

 

 

   

 

 

   

 

 

 

Total real estate loans

     6,574        3,945        3,822   

Commercial loans

     5,619        1,564        983   
  

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     12,193        5,509        4,805   

90-days past due and accruing interest

     —          —          —     

Total nonperforming loans

     12,193        5,509        4,805   

Nonperforming loans guaranteed by government

     (2,427     (2,790     (2,574
  

 

 

   

 

 

   

 

 

 

Net nonperforming loans

     9,766        2,719        2,231   

Other real estate owned

     13,066        11,747        11,854   
  

 

 

   

 

 

   

 

 

 

Total nonperforming assets, net of guaranteed loans

   $ 22,832      $ 14,466      $ 14,085   
  

 

 

   

 

 

   

 

 

 

ASSET QUALITY RATIOS

      

Allowance for loan losses as a percentage of total loans outstanding

     1.14     1.23     1.23

Allowance for loan losses as a percentage of total nonperforming loans, net of government guarantees

     210.23     636.30     744.60

Net loan charge offs (recovery) as a percentage of average loans, annualized

     0.03     -0.02     0.00

Net nonperforming loans as a percentage of total loans

     0.54     0.19     0.16

Nonperforming assets as a percentage of total assets

     0.90     0.76     0.75

Consolidated classified asset ratio(1)

     23.80     23.03     25.14

 

(1)  Consolidated classified asset ratio is defined as the sum of all loan-related contingent liabilities and loans internally graded substandard or worse (net of government guarantees), adversely classified securities, and other real estate owned, divided by total consolidated Tier 1 capital plus the allowance for loan losses.

Other real estate owned at September 30, 2016, consisted of ten properties. One of the properties, a commercial land development project valued at $9,839, comprised 75.30% of the total other real estate owned category. The Company has been actively marketing this property; however, the location and nature of the commercial land development property make it susceptible to possible future valuation write-downs as it is appraised on an annual basis.

 

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Noninterest Income

 

     Noninterest Income Summary  
     Three months ended     Nine months ended  
     September 30,     September 30,      Change     September 30,     September 30,     Change  
     2016     2015      $     2016     2015     $  

Service charges on deposit accounts

   $ 717      $ 703       $ 14      $ 2,099      $ 1,939      $ 160   

Bankcard income

     314        276         38        899        687        212   

Bank-owned life insurance income

     172        156         16        463        435        28   

Net gain on sale of investment securities

     —          143         (143     309        336        (27

Impairment losses on investment securities (OTTI)

     (2     —           (2     (19     (13     (6

Other noninterest income

     718        436         282        1,726        1,234        492   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
   $ 1,919      $ 1,714       $ 205      $ 5,477      $ 4,618      $ 859   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

For the three months ended September 30, 2016, noninterest income was $1,919, up $205 from the same period last year. The increase in the quarter to date noninterest income through September 30, 2016, when compared to the same period last year, was primarily due to a one-time payment of $160 from the SBA for reimbursement of legal and collection fees incurred by Capital Pacific Bank, prior to that acquisition.

Noninterest Expense

 

     Noninterest Expense Summary  
     Three months ended     Nine months ended  
     September 30,      September 30,      Change     September 30,     September 30,      Change  
     2016      2015      $     2016     2015      $  

Salaries and employee benefits

   $ 7,520       $ 6,822       $ 698      $ 23,084      $ 20,223       $ 2,861   

Property and equipment

     1,202         1,148         54        3,404        3,221         183   

Data processing

     924         838         86        2,682        2,343         339   

Legal and professional services

     569         496         73        2,321        1,386         935   

Business development

     460         369         91        1,492        1,134         358   

FDIC insurance assessment

     273         283         (10     848        769         79   

Other real estate (income) expense

     71         122         (51     (32     303         (335

Merger related expense

     1,767         —           1,767        3,745        1,836         1,909   

Other noninterest expense

     1,039         1,104         (65     3,222        2,971         251   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 
   $ 13,825       $ 11,182       $ 2,643      $ 40,766      $ 34,186       $ 6,580   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

For the three months ended September 30, 2016, noninterest expense was $13,825, representing an increase of $2,643 or 23.64% over the prior year. Included in the current period total is merger expense related to the acquisition of Foundation Bank, totaling $1,767. Excluding merger related expenses, non-interest expense increased $876, or 7.83%. After merger related expense, the next largest increase was related to salaries and employee benefits expense, which increased $698 or 10.23%. The increase was due to the full year of salary expense from the Capital Pacific acquisition, which closed in March 2015, salary expense related to the retained Foundation Bank employees, which was included in Pacific Continental’s salary expense beginning September 7, 2016, and overall performance increases.

In fourth quarter 2016, the Company anticipates additional merger related expenses due to the core systems conversion and associated retention bonuses and severance payments not occurring until October 2016.

 

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BALANCE SHEET

Loans

A summary of outstanding loans by market at September 30, 2016, June 30, 2016, December 31, 2015, and September 30, 2015, follows:

 

     Period Ended  
     September 30,      June 30,      December 31,      September 30,  
     2016      2016      2015      2015  

Eugene market gross loans, period-end

   $ 404,858       $ 396,260       $ 379,048       $ 368,666   

Portland market gross loans, period-end

     728,749         697,664         667,995         647,527   

Puget Sound market gross loans, period-end

     423,581         141,788         142,104         137,830   

National healthcare gross loans, period-end

     251,458         250,391         216,865         203,022   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total gross loans, period-end

   $ 1,808,646       $ 1,486,103       $ 1,406,012       $ 1,357,045   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Bank recorded loan growth of $322,543 during the third quarter 2016, which included loans acquired in the Foundation Bank acquisition of $270,533, which are reflected in the Puget Sound Market totals. Portland lending accelerated in third quarter 2016, increasing $31,085 from June 30, 2016. The Company’s overall loan growth during the third quarter 2016 occurred across several loan types, including owner-occupied commercial real estate, non-owner occupied commercial real estate, and commercial and industrial loans.

Outstanding loans to dental professionals, which are comprised of both local and national loans, at September 30, 2016, totaled $370,135 or 20.46% of the loan portfolio, compared to $340,162 or 24.19% of the loan portfolio at December 31, 2015. The Company’s national dental loans increased by $24,892 from December 31, 2015 and were represented in 43 states by the end of the third quarter 2016. In addition to national growth, the Company saw growth in the local dental market, with the portfolio growing $5,081 from year-end 2015, which was primarily due to a slowdown of prepayments and an increase in production in the Company’s Portland market local lending. At September 30, 2016, $6,852 or 1.85% of the outstanding dental loans were supported by government guarantees. Loans to dental professionals include loans for such purposes as starting up a practice, acquisition of a practice, equipment financing, financing owner-occupied facilities, and working capital. National dental loans are limited only to acquisition of a seasoned practice by experienced dental professionals, practice refinances and owner-occupied real estate loans. Additional data on the Company’s dental loan portfolio and the credit quality of this portfolio can be found in Note 5 of the Notes to Consolidated Financial Statements in this report.

All loans to related parties were made in the ordinary course of business and on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable loans with persons not related to the Company.

Detailed credit quality data on the entire loan portfolio can be found in Note 4 of the Notes to Consolidated Financial Statements in this report.

Securities

At September 30, 2016, the balance of securities available-for-sale was $482,408, up $115,810 over December 31, 2015. The growth in the portfolio was partially attributable to securities acquired in the Foundation Bank acquisition of $88,331. At September 30, 2016, the portfolio had an unrealized pre-tax gain of $9,450, compared to an unrealized pre-tax gain of $4,341, at December 31, 2015. The average life and duration of the portfolio at September 30, 2016, was 4.7 years and 4.3 years, respectively. At September 30, 2016, $28,391 of the securities portfolio was pledged as collateral for public deposits in Oregon and Washington and for repurchase agreements.

During the third quarter 2016, the Company sold approximately $55,000 in securities acquired from Foundation Bank, and replaced the securities with new purchases. This transaction had minimal impact on the average life of the portfolio, however, the sold securities had a weighted average yield of approximately 1.64% and were replaced with securities yielding 1.98%. The Company expects to benefit from the increased yield in future quarters.

 

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The Company continued to structure the portfolio to provide consistent cash flow and reduce the market value volatility of the portfolio in a rising rate environment in light of the Company’s current liability sensitive position. The portfolio is structured to generate sufficient cash flow to allow reinvestment at higher rates should interest rates move up or to fund loan growth in future periods. In a stable rate environment, approximately $56,395 in cash flow from the securities portfolio is anticipated over the next twelve months. Going forward, purchases will be dependent upon core deposit growth, loan growth, and the Company’s interest rate risk position, with the Company targeting securities between 19% and 20% of total assets.

At September 30, 2016, $2,110, or 0.44% of the total securities portfolio, was composed of private-label mortgage-backed securities. Management previously booked OTTI on this portion of the portfolio totaling $266, with $2 of additional OTTI booked in third quarter 2016. On a monthly basis, Management reviews all available information, including current and projected default rates and current and projected loss severities, related to the collectability of its potentially impaired investment securities to determine if an additional OTTI is required. Recognition of additional OTTI on the private-label mortgage-backed portion of the portfolio is possible in future quarters depending upon economic conditions, default rates on home mortgages, loss severities on foreclosed homes, unemployment levels, and home values.

In management’s opinion, the remaining securities in the portfolio in an unrealized loss position were considered only temporarily impaired at the quarter ended September 30, 2016. At September 30, 2016, the Company had no intent, nor was it more likely than not that it would be required, to sell its impaired securities before their recovery. The impairment was due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal was expected at September 30, 2016.

Goodwill and Intangible Assets

At September 30, 2016, the Company had the following goodwill and core deposit intangibles (“CDI”) associated with prior bank acquisitions:

 

     September 30, 2016  
     Foundation
Bank
     Capital Pacific
Bank
     Century
Bank
     Northwest
Business Bank
     Total  

Goodwill

   $ 21,407       $ 17,145       $ 851       $ 22,031       $ 61,434   

CDI

     5,716         3,132         402         —           9,250   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 27,123       $ 20,277       $ 1,253       $ 22,031       $ 70,684   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company periodically tests goodwill for impairment. Management performs an impairment analysis of the intangible assets with indefinite lives at least annually, but more frequently if an impairment triggering event is deemed to have occurred. The last impairment test was performed at December 31, 2015, at which time no impairment was determined to exist.

The CDI for Foundation Bank was determined to have an expected life of 10 years, and is being amortized over that period using a straight-line method and will be fully amortized in August 2026. The CDI for Capital Pacific Bank was determined to have an expected life of ten years, and is being amortized over that period using the straight-line method and will be fully amortized in February 2025. The CDI for Century Bank was determined to have an expected life of seven years, and is being amortized over that period using the straight-line method and will be fully amortized in January 2020.

 

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Deposits

Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and nonpublic local time deposits, including nonpublic local time deposits in excess of $100, were $2,049,352 and represented 94.76% of total deposits at September 30, 2016. During the third quarter the Company experienced growth in core deposits of $541,333. The increase, was partially attributable to the Foundation Bank acquisition of $396,509 and the remaining increase was due to organic deposit growth of $144,924.

A key component of core deposits is noninterest-bearing demand deposits, which totaled $901,290 and represented 43.98% of core deposits at September 30, 2016. The weighted average cost of core deposits, when factoring in non-interest bearing core deposits, for the third quarter 2016 was 0.15%.

A summary of outstanding core deposits and average core deposits by market and wholesale funding classified as non-core deposits at September 30, 2016, June 30, 2016, and September 30, 2015, follows:

 

     Period Ended  
     September 30,      June 30,      September 30,  
     2016      2016      2015  

Eugene market core deposits, period-end(1)

   $ 785,053       $ 712,061       $ 747,298   

Portland market core deposits, period-end(1)

     671,747         590,880         549,113   

Puget Sound market core deposits, period-end(1)

     592,552         205,078         169,136   
  

 

 

    

 

 

    

 

 

 

Total core deposits, period-end(1)

     2,049,352         1,508,019         1,465,547   

Non-core deposits, period-end

     113,281         92,113         59,407   
  

 

 

    

 

 

    

 

 

 

Total deposits, period-end

   $ 2,162,633       $ 1,600,132       $ 1,524,954   
  

 

 

    

 

 

    

 

 

 
     Three Months Ended  
     September 30,
2016
     June 30,
2016
     September 30,
2015
 

Eugene market core deposits, average(1)

   $ 721,271       $ 738,435       $ 776,755   

Portland market core deposits, average(1)

     631,440         624,490         537,911   

Puget Sound market core deposits, average(1)

     296,066         196,281         168,318   
  

 

 

    

 

 

    

 

 

 

Total core deposits, average(1)

     1,648,777         1,559,206         1,482,984   

Non-core deposits, average

        68,536         62,481   
  

 

 

    

 

 

    

 

 

 

Total deposits, average

   $ 1,648,777       $ 1,627,742       $ 1,545,465   
  

 

 

    

 

 

    

 

 

 

 

(1)  Core deposits include all demand, savings, money market, interest checking accounts, plus all nonpublic local time deposits including local time deposits in excess of $100.

 

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Other Deposits

The Company uses public and brokered deposits to provide short-term and long-term funding sources. The Company defines short-term as having a contractual maturity of less than one year. The Company uses brokered deposits to help mitigate interest rate risk in a rising rate environment.

Below is a schedule detailing public and brokered deposits by type, including weighted average rate and weighted average maturity.

Non-Core Deposit Summary

 

     September 30, 2016      September 30, 2015  
     Balance      Weighted
average rate
    Weighted
average
maturity
     Balance      Weighted
average rate
    Weighted
average
maturity
 
     (dollars in thousands)      (dollars in thousands)  

<3 Months

   $ 30,375         0.79     57 Days       $ 26,474         0.26     37 Days   

3-6 Months

     —           —          —           —           —          —     

6-12 Months

     1,744         0.87     335 Days         309         0.35     204 Days   

>12 Months

     81,162         1.27     3.42 Years         32,624         1.93     5.58 Years   
  

 

 

         

 

 

      
   $ 113,281            $ 59,407        
  

 

 

         

 

 

      

Borrowings

The Company has both secured and unsecured borrowing lines with the FHLB, FRB and various correspondent banks. The Federal Reserve and correspondent borrowings are generally short-term, with a maturity of less than 30 days. The FHLB borrowings can be either short-term or long-term in nature. See Note 7 of the Notes to Consolidated Financial Statements in Part I, Item 1 of this report for a full maturity and interest rate schedule for the FHLB borrowings.

At September 30, 2016, the Company held $4,653 of stock in the FHLB of Des Moines, which included $532 in FHLB stock acquired through the Foundation Bank acquisition. The FHLB stock is broken into two classes: membership and activity. The membership class is based on asset size and the holder is required to be a member of the FHLB. The amount of membership stock held at September 30, 2016 was $2,823 and is updated in the first quarter of each year. The activity stock outstanding at September 30, 2016 totaled $1,820; however, it is subject to fluctuation on a daily basis based on outstanding borrowings. At September 30, 2016, membership stock paid dividends at 0.50% annually and activity stock paid dividends at 3.50% annually. Both classes of FHLB stock are listed in the asset section of the Company’s balance sheet.

Subordinated Debentures

In June 2016, the Company issued $35,000 in aggregate principal amount of fixed-to-floating rate subordinated debentures (the “Notes”). The Notes have a fixed annual rate for a five-year period at 5.875%. After five years, the interest rate will reset quarterly to an annual interest rate equal to the then-current three-month LIBOR plus 471.5 basis points. The Notes are included in Tier 2 capital under current regulatory guidelines and interpretations.

Junior Subordinated Debentures

On September 6, 2016, the Company completed the acquisition of Foundation Bancorp. At that time, the Company assumed $6,148 of junior subordinated debentures (the “Foundation Debentures”), with a fair value on acquisition date of $3,013. The interest rate on the Foundation Debentures is a floating rate of three-month LIBOR plus 173 basis points. The $6,000 of the Foundation Debentures qualifies as Tier 1 capital under regulatory capital guidelines.

 

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The Company had $8,248 in Debentures outstanding at September 30, 2016, which were issued in conjunction with the 2005 acquisition of Northwest Business Bank. The Debentures had an interest rate of 6.265% that was fixed until January 2011, after which the rate changed to three-month LIBOR plus 135 basis points. On April 22, 2013, the Bank entered into a cash flow hedge on $8,000 of the TPS, swapping the variable interest rate for a fixed rate of 2.73% for approximately seven years. At September 30, 2016, the fair value of the interest rate swap on the Company’s Debentures was ($82). The $8,000 of junior subordinated debentures qualifies as Tier 1 capital under regulatory capital guidelines.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances, such as the Company’s junior subordinated debentures, as Tier 1 capital. Under final rules adopted by the Federal Reserve and the other U.S. Federal banking agencies, our trust preferred securities will remain as Tier 1 capital since total assets of the Company are less than $15 billion. Additional information regarding these final capital rules is included in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” of this report and in Part II, Item 1A “Risk Factors” of our 2015 Form 10-K under the heading “We operate in a highly regulated environment and the effects of recent and pending federal legislation or of changes in, or supervisory enforcement of, banking or other laws and regulations could adversely affect us.”

Additional information regarding the terms of the cash flow hedge is included in Note 10 of the Notes to Consolidated Financial Statements in Part I, Item 1 of this report.

Capital Resources

Capital is the shareholders’ investment in the Company. Capital grows through the retention of earnings and the issuance of new stock or other equity securities whether through stock offerings or through the exercise of equity awards. Capital formation allows the Company to grow assets and provides flexibility in times of adversity. Shareholders’ equity at September 30, 2016, was $276,471, up $57,980 from December 31, 2015. The increase in shareholders’ equity was primarily due to stock issued through the Foundation Bank acquisition of $47,794, in addition to an increase in the unrealized gain on the investment portion combined with retention of a portion of income earned during 2016.

In June 2016, the Company issued $35,000 in aggregate principal amount of fixed-to-floating rate subordinated debentures (the “Notes”). The Notes are included in Tier 2 capital under current regulatory guidelines and interpretations. In third quarter 2016, the Company made a capital investment in the Bank totaling $20,000, which qualifies as Tier 1 capital under current regulatory guidelines and interpretations.

The Federal Reserve and the FDIC have in place guidelines for risk-based capital requirements applicable to U.S. bank holding companies and banks. In July 2013, the Federal Reserve Board and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the Basel Committee’s current international regulatory capital accord (Basel III). These rules were effective January 1, 2015 and replaced the federal banking agencies’ general risk-based capital rules, advanced approaches rule, market-risk rule, and leverage rules, in accordance with certain transition provisions. The rules establish more restrictive capital definitions, create additional categories and higher risk-weightings for certain asset classes and off-balance sheet exposures, higher leverage ratios and a capital conservation buffer that will be added to the minimum capital requirements and must be met for banking organizations to avoid being subject to certain limitations on dividends and discretionary bonus payments to executive officers. The rules also implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. When fully phased in, the final rules will provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.50%; (b) a Tier 1 capital ratio of 6.00% (an increase from 4.00%); (c) a total capital ratio of 8.00%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4.00%. The new rules permit depository institution holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, to include trust preferred securities in Tier 1 capital. Under the new rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements (equal to 2.50% of total risk-weighted assets). The phase-in of the capital conservation buffer began January 1, 2016, and will be completed by January 1, 2019. The new rules also provide for various adjustments and deductions to the definitions of regulatory capital that will phase in from January 1, 2014, to December 31, 2017. The new rules made it optional for banks and bank holding companies to include accumulated other comprehensive income in their calculations of Tier 1 capital. The Company’s accumulated other comprehensive income consists primarily of the unrealized gain or loss on the securities portfolio as a result of marking securities available-for-sale to market. The Company opted to exclude accumulated other comprehensive income from its calculation of Tier 1 capital. Overall, the new rules did not materially impact the Company’s reported capital ratios. The Company will continue to evaluate the impact of the rules as they are phased in over the next few years.

 

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The Company’s common equity Tier 1 capital ratio, Tier 1 risk based capital ratio, total risk based capital ratio, and Tier 1 leverage capital ratio were 9.43%, 9.99%, 12.55% and 10.33%, respectively, at September 30, 2016, with all capital ratios for the Company above the minimum regulatory designations. For additional information regarding the Company’s regulatory capital levels, see Note 12 in Notes to Consolidated Financial Statements in Part I, Item I of this report.

The Company has regularly paid cash dividends on a quarterly basis, typically in February, May, August and November of each year. The Board of Directors considers the dividend amount quarterly and takes a broad perspective in its dividend deliberations including a review of recent operating performance, capital levels, concentrations of loans as a percentage of capital, and growth projections. The Board also considers dividend payout ratios, dividend yield, and other financial metrics in setting the quarterly dividend. There can be no assurance that dividends will be paid in the future.

On July 20, 2016, the Board of Directors approved a regular third quarter cash dividend of $0.11 that was paid on August 18, 2016. Subsequent to the end of the third quarter 2016, on October 18, 2016, the Board of Directors declared a regular quarterly cash dividend of $0.11 per share payable to shareholders on November 23, 2016.

OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

In the normal course of business, the Company commits to extensions of credit and issues letters of credit. The Company uses the same credit policies in making commitments to lend funds and conditional obligations as it does for other credit products. In the event of nonperformance by the customer, the Company’s exposure to credit loss is represented by the contractual amount of the instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established by the contract. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At September 30, 2016, the Company had $408,639 in commitments to extend credit, up from $256,156 at December 31, 2015.

Letters of credit written are conditional commitments issued by the Company to guarantee performance of a customer to a third party. The credit risk involved is essentially the same as that involved in extending loan facilities to customers. At September 30, 2016, the Company had $1,393 in letters of credit and financial guarantees outstanding.

LIQUIDITY AND CASH FLOWS

Liquidity is the term used to define the Company’s ability to meet its financial commitments. The Company maintains sufficient liquidity to ensure funds are available for both lending needs and the withdrawal of deposit funds. The Company derives liquidity through core deposit growth, maturity of investment securities, and loan payments. Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $100. Additional liquidity and funding sources are provided through the sale of loans, sales of securities, access to national CD markets, and both secured and unsecured borrowings. The Company uses a number of measurements to monitor its liquidity position on a daily, weekly, and monthly basis, which includes its ability to meet both short-term and long-term obligations, and requires the Company to maintain a certain amount of liquidity on the asset side of its balance sheet. The Company also prepares projections of its liquidity position. In addition, the Company has a Liquidity Funding Policy (“LFP”) that is reviewed and approved annually by the Company’s Asset and Liability Committee and the Board of Directors. Included in the LFP is a contingency funding plan based on both a short-term and long-term cash flow analysis, which are reviewed periodically by ALCO.

Core deposits at September 30, 2016, were $2,049,352 and represented 94.76% of total deposits. Core deposits at September 30, 2016, were up $515,410 from December 31, 2015. During the same time period, the Company experienced an increase in outstanding loans of $402,634. The liability growth was partially offset by a decrease in FHLB borrowing. It is anticipated that cash flows from the securities portfolio and additional non-core funding sources will provide an additional portion of the funding during the remainder of 2016, as loans are expected to continue to increase. The securities portfolio represented 19.00% of total assets at September 30, 2016. At September 30, 2016, $28,391 of the securities portfolio was pledged to support public deposits and repurchase agreements, leaving $454,017 of the securities portfolio unencumbered and available-for-sale. In addition, at September 30, 2016, the Company had $26,619 of government guaranteed loans that could be sold in the secondary market to support the Company’s liquidity position.

 

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Due to its strategic focus to market to specific segments, the Company has been successful in developing deposit relationships with several large clients, which are generally defined as deposit relationships of $2,000 or more, which are closely monitored by management. The loss of any such deposit relationship or other large deposit relationships could cause an adverse effect on short-term liquidity. The Company uses a 10-point risk-rating system to evaluate each of its large depositors in order to assist management in its daily monitoring of the volatility of this portion of its core deposit base. The risk-rating system attempts to determine the stability of the deposits of each large depositor, evaluating, among other things, the length of time the depositor has been with the Company and the likelihood of loss of individual large depositor relationships. Risk ratings on large depositors are reviewed at least quarterly and adjusted if necessary. Company management maintain close relationships and hold regular meetings with its large depositors to assist in management of these relationships.

During the quarter, the Company experienced an increase in core deposits, attributed to the Foundation Bank acquisition, and growth in the organic core deposit base. At September 30, 2016, in addition to the temporary deposit of $60,000 mentioned previously, the Bank had approximately $66,000 in additional risk rated 10 deposits, the highest risk rating. Currently, the Company anticipates that these funds will leave the Bank by December 31, 2016. The Company continues to review and implement its funding strategy to offset deposit reductions. The Company currently maintains sufficient short-term liquidity to cover any potential volatility in the large depositor base. However, there can be no assurance that any of our other large depositor relationships will be maintained or that the loss of one or more of these clients will not adversely affect the Company’s liquidity.

At September 30, 2016, the Company had secured borrowing lines with the FHLB of Des Moines and the FRB, along with unsecured borrowing lines with various correspondent banks, totaling $813,630. The Company’s secured lines with the FHLB and FRB were limited by the amount of collateral pledged. At September 30, 2016, the Company had pledged $602,715 in discounted collateral value in commercial real estate loans, first and third lien single-family residential loans, multi-family loans, and securities to the FHLB. Additionally, certain commercial and commercial real estate loans with a discounted value of $81,915 were pledged to the FRB under the Company’s Borrower-In-Custody program. The Company’s unsecured correspondent bank lines totaled $129,000. At September 30, 2016, the Company had $45,500 in borrowings outstanding from the FHLB, no borrowings outstanding with the FRB, and no borrowings on its overnight correspondent bank lines, leaving a total of $768,130 available on its secured and unsecured borrowing lines as of such date.

Net cash provided by operating activities was $19,957 during the nine months ended September 30, 2016. During the same period, cash of $114,903 was used in investing activities, consisting principally of a net loan principal increase of $133,405 and net purchases of securities of $25,624. Cash provided by financing activities during the first nine months of 2016 was $165,443 and primarily consisted of an increase in borrowings and cash related to the Notes issuance. Additional information on the Company cash flows can be reviewed in the Consolidated Statement of Cash Flows in Part I, Item 1 of this report.

ITEM 3 Quantitative and Qualitative Disclosures about Market Risk

There has been no material change in the Company’s exposure to market risk. Readers are referred to the Company’s 2015 Form 10-K and the Annual Report to Shareholders for the year ended December 31, 2015, for additional information.

ITEM 4 Controls and Procedures

Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer and Principal Financial and Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

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Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the quarter ended September 30, 2016, that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1 Legal Proceedings

On August 23, 2013, a putative class action lawsuit (“Class Action”) was filed in the Circuit Court of the State of Oregon for the County of Multnomah on behalf of individuals who placed money with Berjac of Oregon and Berjac of Portland (collectively, “Berjac”). The Berjac entities merged and the surviving company, Berjac of Oregon, is currently in Chapter 7 bankruptcy. The Class Action complaint, which has been amended several times, currently asserts three claims against Pacific Continental Bank, Fred “Jack” W. Holcomb, Holcomb Family Limited Partnership, Jones & Roth, P.C., and Umpqua Bank, as defendants. The lawsuit asserts that the Bank is jointly and severally liable for materially aiding or participating in Berjac’s sales of securities in violation of the Oregon Securities Law. Claimants seek the return of the money placed with Berjac of Oregon and Berjac of Portland, plus interest, and costs and attorneys’ fees. The current version of the complaint seeks $100 million in damages from all defendants.

On August 28, 2014, the court-appointed bankruptcy trustee for Berjac of Oregon filed an adversary complaint (Trustee’s Lawsuit) in the U.S. Bankruptcy Court for the District of Oregon alleging that the Company, the Bank, Umpqua Bank, Century Bank and Summit Bank provided lines of credit that enabled continuation of the alleged Ponzi scheme operated by Berjac of Oregon and the two partners of the pre-existing Berjac general partnerships, Michael Holcomb and Gary Holcomb. The Company acquired Century Bank on February 1, 2013. The Trustee’s Lawsuit was transferred from the U.S. Bankruptcy Court to the U.S. District Court for the District of Oregon (Eugene Division), where it is currently pending.

In addition to seeking an award of punitive damages, the trustee is asserting fraudulent transfer law and unjust enrichment in an effort to recover payments made by Berjac to Century Bank and the Bank. Among other claims for relief, the trustee is seeking the disgorgement of monies advanced to the Holcomb Family Limited Partnership by Century Bank and returned to the estate by court order following the post-petition cash collateral hearing, and of monies received by the Bank from the proceeds of the sale of stock held by the Holcomb Family Limited Partnership and securing one of the lines of credit previously held by Century Bank. The trustee also asserts a claim for alleged aiding and abetting of breaches of duties owed to Berjac. The complaint in the Trustee’s Lawsuit indicates the range of damages sought by the trustee which include, among other claims for relief, an award of punitive damages not to exceed $10 million, recovery of payments associated with allegedly fraudulent transfers totaling up to approximately $55.3 million, including up to $20.7 million from Century Bank and up to $7.7 million from the Bank. This case is not currently set for trial.

On November 16, 2015, the U.S. District Court judge stayed all deadlines in the Trustee’s Lawsuit and all parties were ordered to participate in a judicial settlement conference. The judicial settlement conference sessions were held on February 18, 2016 and April 20, 2016. At the April 20, 2016, settlement conference, the Bank reached a tentative settlement of the Class Action and the Trustee’s Lawsuit. The settlement of the Class Action will require approval of the Circuit Court judge. The settlement is not expected to have a material adverse effect on the Company’s financial condition.

We may from time to time be involved in claims, proceedings and litigation arising from our business and property ownership. Based on currently available information, the Company does not expect that the results of such proceedings, including the above-described proceeding, in the aggregate, to have a material adverse effect on our financial condition.

 

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ITEM 1A Risk Factors

For a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our 2015 Form 10-K, which is incorporated by reference herein, in addition to the following information:

 

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Industry Factors

Fluctuating interest rates could adversely affect our profitability.

As is the case with many banks, our profitability is dependent to a large extent upon our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect, and has in past years, impacted, our net interest margin, and, in turn, our profitability. This impact could result in a decrease in our interest income relative to interest expense. Increases in interest rates may also adversely impact the value of our securities investment portfolio. At September 30, 2016, our balance sheet was liability sensitive, and an increase in interest rates could cause our net interest margin and our net interest income to decline. Since the financial crisis of 2008, the banking industry has operated in an extremely low interest rate environment relative to historical averages, and the Federal Reserve has pursued highly accommodative monetary policies (including a very low Federal funds rate and substantial purchases of long-term U.S. Treasury and agency securities) in an effort to facilitate growth in the U.S. economy and a reduction in levels of unemployment. This environment has placed downward pressure on the net interest margins of U.S. banks, including the Bank. In December 2015, the Federal Reserve raised the target range for the federal funds rate from 1/4 to 1/2 percent. The Federal Reserve further indicated future policy actions to normalize interest rates will depend upon progress towards its objectives of maximum employment and two percent inflation, although the stance of monetary policy remains accommodative, and, even after employment and inflation are near its objectives, economic conditions may warrant for some time keeping the target federal funds rate below longer-term normal levels. The Federal Reserve also indicated that it intended to continue its policy of holding longer-term agency and Treasury securities at sizeable levels to help maintain accommodative financial conditions. In September 2016, the Federal Reserve decided to keep the target range for the federal funds rate at  14 to  12 percent, noting that, while the case for an increase in the federal funds rate has strengthened, it decided to wait for further evidence of continued progress towards its objectives. The degree to which the Federal Reserve will continue its accommodative monetary policies, and the timing of any easing of those policies, will depend upon the Federal Reserve’s judgments regarding labor market conditions and the overall economic outlook, and are, therefore, subject to continuing uncertainty.

Company Factors

We have a significant concentration in loans to dental professionals, and loan concentrations within one industry may create additional risk.

Bank regulatory authorities and investors generally view significant loan concentrations within any particular industry as carrying higher inherent risk than a loan portfolio without any significant concentration in one industry. We have a significant concentration of loans to dental professionals which represented 20.46% in principal amount of our total loan portfolio at September 30, 2016 (see Note 5 in the Notes to Consolidated Financial Statements included in this Form 10-Q). While we apply credit practices which we believe to be prudent to these loans as well as all the other loans in our portfolio, due to our concentration in dental lending, we are exposed to the general risks of industry concentration, which include adverse market factors impacting that industry alone or disproportionately to other industries. In addition, bank regulatory authorities may in the future require us to limit additional lending in the dental industry if they have concerns that our concentration in that industry creates significant risks, which in turn could limit our ability to pursue new loans in an area where we believe we currently have a competitive advantage.

 

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Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.

At September 30, 2016, our nonperforming loans (which include all nonaccrual loans, net of government guarantees) were 0.54% of the loan portfolio. At September 30, 2016, our nonperforming assets (which include foreclosed real estate) were 0.90% of total assets. Nonperforming loans and assets adversely affect our net income in various ways. Until economic and market conditions improve, we expect to continue to incur losses relating to nonperforming assets. We generally do not record interest income on nonperforming loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, less estimated selling expenses, which may ultimately result in a loss. An increase in the level of nonperforming assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile. While we reduce problem assets through loan sales, workouts, and restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition, perhaps materially. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. Any significant future increase in nonperforming assets could have a material adverse effect on our business, financial condition and results of operations.

We may not have the ability to continue paying dividends on our common stock at current or historic levels.

On October 26, 2016, we announced a quarterly cash dividend of $0.11 per share, payable to shareholders on November 23, 2016. Our ability to pay dividends on our common stock depends on a variety of factors. It is possible in the future that we may not be able to continue paying quarterly dividends commensurate with historic levels, if at all. As a holding company, a substantial portion of our cash flow typically comes from dividends our bank subsidiary pays to us. Cash dividends will depend on sufficient earnings to support them and adherence to bank regulatory requirements. If the Bank is not able to pay dividends to the Company, the Company may not be able to pay dividends on its common stock. Consequently, the inability to receive dividends from the Bank could adversely affect the Company’s financial condition, results of operations and prospects.

We may be required, in the future, to recognize impairment with respect to investment securities, including the FHLB stock we hold.

Our securities portfolio contains whole loan private mortgage-backed securities and municipal securities and currently includes securities with unrecognized losses. We may continue to observe volatility in the fair market value of these securities. We evaluate the securities portfolio for any other than temporary impairment (“OTTI”) each reporting period, as required by GAAP. Future evaluations of the securities portfolio could require us to recognize impairment charges. The credit quality of securities issued by certain municipalities has deteriorated in recent quarters. Although management does not believe the credit quality of the Company’s municipal securities has similarly deteriorated, such deterioration could occur in the future. For example, it is possible that government-sponsored programs to allow mortgages to be refinanced to lower rates could materially adversely impact the yield on our portfolio of mortgage-backed securities, since a significant portion of our investment portfolio is composed of such securities.

In addition, as a condition to membership in the FHLB, we are required to purchase and hold a certain amount of FHLB stock, based on our asset size, which is assessed annually. In addition to asset based stock holding, stock is also held to support the outstanding principal balance of advances from the FHLB. At September 30, 2016, we had stock in the FHLB totaling $4,643. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. As of September 30, 2016, we did not recognize an impairment charge related to our FHLB stock holdings. Future negative changes to the financial condition of the FHLB could require us to recognize an impairment charge with respect to such holdings.

 

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If the goodwill we have recorded in connection with acquisitions becomes impaired, it could have an adverse impact on our reported earnings.

At September 30, 2016, we had $61,434 of goodwill on our consolidated balance sheet. In accordance with GAAP, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. Such evaluation is based on a variety of qualitative and quantitative factors, including macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, and other relevant entity-specific events. The last impairment test was performed at December 31, 2015. At December 31, 2015, we did not recognize an impairment charge related to our goodwill. Future evaluations of goodwill may result.

 

ITEM 2 Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

 

ITEM 3 Defaults upon Senior Securities

None

 

ITEM 4 Mine Safety Disclosures

Not applicable

 

ITEM 5 Other Information

None

 

ITEM 6 Exhibits

 

    3.1    Second Amended and Restated Articles of Incorporation, as amended on August 16, 2016.
  10.1    First Amendment to the Amended and Restated Employment Agreement for Roger Busse dated July 19, 2016
  10.2    First Amendment to the Amended and Restated Employment Agreement for Casey Hogan dated July 19, 2016
  31.1    Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer of the Registrant
  31.2    Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of the Registrant
  32*    Furnished statements of the Chief Executive Officer and Chief Financial Officer under 18 U.S.C Section 1350
101   

The following financial information from Pacific Continental Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, is formatted in XBRL; (i) the unaudited Consolidated Balance Sheets, (ii) the Unaudited Consolidated Statements of Income, (iii) the Unaudited Consolidated Statements of Comprehensive Income , (iv) the Unaudited Consolidated Statements of Changes in Shareholders’ Equity, (v) the Unaudited Consolidated Statements of Cash Flows, and (vi) the Notes to Unaudited Consolidated Financial Statements.

 

* In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibit 32 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.

 

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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.

 

      PACIFIC CONTINENTAL CORPORATION
      (Registrant)
Dated  

November 8, 2016

   

/s/ Roger Busse

      Roger Busse
      President and Chief Executive Officer
      (Duly Authorized Officer; Principal Executive Officer)
Dated  

November 8, 2016

   

/s/ Richard R. Sawyer

      Richard R. Sawyer
     

Executive Vice President and Chief Financial Officer

(Duly Authorized Officer; Principal Financial and Accounting Officer)

 

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