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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark one)

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016

 

☐	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)		(IRS 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)

Securities registered pursuant to section 12(b) of the Act:

 

Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, No par value per share		NASDAQ Global Select Market

Securities registered pursuant to section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No   ☒

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  ☒    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  ☒    No   ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ☒

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 Exchange Act. (check one)

 

Large accelerated filer		☐		Accelerated filer		☒
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  ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant at June 30, 2016 (the last business day of the most recently completed second quarter) was $287,950,930 based on the closing price as quoted on the NASDAQ Global Select Market on that date.

The number of shares outstanding of the registrant’s common stock, no par value, as of February 28, 2017, was 22,665,881.

DOCUMENTS INCORPORATED BY REFERENCE

All or a portion of Items 10 through 14 in Part III of this Form 10-K are incorporated by reference to the Registrant’s definitive proxy statement on Schedule 14A, which will be filed within 120 days after the close of the fiscal year covered by this report on Form 10-K, or if the Registrant’s Schedule 14A is not filed within such period, will be included in an amendment to this Report on Form 10-K which will be filed within such 120-day period.

 

 

 

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PACIFIC CONTINENTAL CORPORATION

FORM 10-K

ANNUAL REPORT

TABLE OF CONTENTS

 

				Page
PART I					3
ITEM 1		Business			3
ITEM 1A		Risk Factors			24
ITEM 1B		Unresolved Staff Comments			32
ITEM 2		Properties			32
ITEM 3		Legal Proceedings			32
ITEM 4		Mine Safety Disclosures			33
PART II					33
ITEM 5		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			33
ITEM 6		Selected Financial Data			36
ITEM 7		Management’s Discussion and Analysis of Financial Condition and Results of Operation			37
ITEM 7A		Quantitative and Qualitative Disclosures About Market Risk			58
ITEM 8		Financial Statements and Supplementary Data			61
ITEM 9		Changes in and Disagreements With Accountants on Accounting and Financial Disclosure			122
ITEM 9A		Controls and Procedures			122
ITEM 9B		Other Information			123
PART III					123
ITEM 10		Directors, Executive Officers and Corporate Governance			123
ITEM 11		Executive Compensation			123
ITEM 12		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			123
ITEM 13		Certain Relationships and Related Transactions and Director Independence			123
ITEM 14		Principal Accountant Fees and Services			123
PART IV					124
ITEM 15		Exhibits and Financial Statement Schedules			124
SIGNATURES					126
CERTIFICATIONS

 

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PART I

 

ITEM 1

Business

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 for 2017, factors that could impact the Company’s financial results, the expected interest rate environment, 2017 provision for loan losses and the adequacy of the allowance, the possibility of valuation write-downs on OREO, portfolio structuring, loan origination standards, liquidity and funding, large depositor relationships, 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, or the documents incorporated by reference:

 

•

Local, regional 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 strategic expansion, or combination, 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.

 

•

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 expense and my adversely affect our results of operations and future prospects.

 

•

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

 

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Additional factors that could cause actual results to differ materially from those expressed in any forward-looking statements are discussed in Risk Factors in this Form 10-K. Please take into account that forward-looking statements speak only as of the date of this report or documents incorporated by reference. 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.

General

Pacific Continental Corporation (the “Company” or the “Registrant”) is an Oregon corporation and registered bank holding company headquartered in Eugene, Oregon. The Company was organized on June 7, 1999, pursuant to a holding company reorganization of Pacific Continental Bank, its wholly owned subsidiary (the “Bank”).

The Company’s principal business activities are conducted through the Bank, an Oregon state-chartered bank with deposits insured by the Federal Deposit Insurance Corporation (the “FDIC”). The Bank has no active subsidiaries.

Results and Financial Data

All dollar amounts in the following sections are in thousands except per share amounts or where otherwise indicated.

Subsequent to the end of the year on January 9, 2017, Pacific Continental Corporation entered into a definitive agreement to merge with Columbia Banking System, Inc., headquartered in Tacoma, Washington. Upon completion of the merger, the combined company will operate under the Columbia Bank name and brand. The agreement was approved by the Board of Directors of each company. Closing of the transaction, which is expected to occur in mid-2017, is contingent on shareholder approval and receipt of necessary regulatory approvals, along with satisfaction of other customary closing conditions.

For the year ended December 31, 2016, the consolidated net income of the Company was $19,776 or $0.95 per diluted share. At December 31, 2016, the consolidated shareholders’ equity of the Company was $273,755 with 22,611,535 shares outstanding and a book value of $12.11 per share. Total assets were $2,541,437 at December 31, 2016. Loans net of allowance for loan losses and unearned fees were $1,835,313 at December 31, 2016, and represented 72.22% of total assets. Deposits totaled $2,148,103 at year-end 2016, with Company-defined core deposits representing $2,035,067, or 94.74% of total deposits. Core deposits are defined as all demand, interest checking, money market, savings and local non-public time deposits, including local non-public time deposits in excess of $100. At December 31, 2016, the Company had a Tier 1 leverage capital ratio, Common Equity Tier 1 risk-based capital ratio, Tier 1 risk-based capital ratio, and total risk-based capital ratio, of 9.01%, 9.52%, 10.08%, and 12.69%, respectively, all of which exceeded the minimum “well-capitalized” level for all capital ratios under FDIC guidelines of 5.00%, 6.50%, 8.00% and 10.00%, respectively.

On September 6, 2016, the Company completed the acquisition of Foundation Bancorp, Inc. (“Foundation Bancorp”). 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% in the form of cash and 70% in the form of Pacific Continental common stock. Pursuant to the merger agreement, total consideration included cash consideration of $19,337 and stock consideration of 2,853,362 shares of Pacific Continental common stock. Based on the closing price of Pacific Continental common stock on September 6, 2016, the aggregate consideration payable for Foundation Bancorp was valued at $47,794.

On January 9, 2017, Pacific Continental entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Columbia Banking System, Inc., a Washington corporation (“Columbia”), and a to-be-formed Oregon corporation and a wholly owned subsidiary of Columbia (“Merger Sub”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, Merger Sub will merge with and into Pacific Continental, with Pacific Continental as the surviving corporation (the “First Merger”). Immediately following the First Merger, Pacific Continental will merge with and into Columbia (the “Subsequent Merger”), with Columbia continuing as the surviving corporation (the “Surviving Corporation”). Immediately after the Subsequent Merger, the Bank will merge with and into Columbia State Bank, a Washington state-chartered bank and wholly owned subsidiary of Columbia (“Columbia State Bank”) (the “Bank Merger”, and together with the First Merger and Subsequent Merger, the “Mergers”). Consummation of the Mergers is subject to customary conditions, including, among others, approval by Pacific Continental and Columbia shareholders and receipt of required regulatory approvals. For more information regarding the Mergers, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Highlights – Merger” and the Current Report on Form 8-K filed by Pacific Continental on January 10, 2017.

 

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For more information regarding the Company’s financial condition and results of operations, see Management’s Discussion and Analysis of Financial Condition and Results of Operations and Financial Statements and Supplementary Data in Items 7 and 8 of Part II of this Form 10-K.

THE BANK

General

The Bank commenced operations on August 15, 1972. The Bank operates in three primary markets: Eugene, Oregon, Portland, Oregon / Southwest Washington and Puget Sound, Washington. At December 31, 2016, the Bank operated fifteen full-service offices in Oregon and Washington and two loan production offices in Washington and Colorado. The primary business strategy of the Bank is to operate in large commercial markets and to provide comprehensive banking and related services tailored to community-based businesses, nonprofit organizations, professional service providers and banking services for business owners. The Bank emphasizes the diversity of its product lines, high levels of personal service and convenient access through technology typically associated with larger financial institutions, while maintaining local decision-making authority and market knowledge, typical of a community bank. The Bank has developed expertise in lending to dental professionals, and during 2016 continued to expand its national dental lending program. More information on the Bank and its banking services can be found on its website (therightbank.com). Information contained on the Bank’s website is not part of this Form 10-K. The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge upon request on the Bank’s website. The reports are also available on the SEC’s website at www.sec.gov. The Bank operates under the banking laws of the State of Oregon, and the rules and regulations of the FDIC. In addition, operations at its branches and other offices in the State of Washington and Colorado are subject to various consumer protection and other laws of that state.

THE COMPANY

Primary Market Area

The Company’s primary markets consist of metropolitan Eugene, metropolitan Portland, in the State of Oregon and metropolitan Seattle in the State of Washington. During 2016, the Company expanded its lending to dental professionals, and at year-end had loans to dental professionals in 44 states, up from 39 states in 2015. The Company has five full-service banking offices in the metropolitan Portland and Southwest Washington area, seven full-service banking offices in the metropolitan Eugene area, and three full-service offices in the metropolitan Seattle area. It also operates loan production offices in Tacoma, Washington and Denver, Colorado. The Company has its headquarters and administrative office in Eugene, Oregon.

Overall, economic conditions improved in the Company’s markets during 2016 as evidenced by the increased loan demand in all three of the Company’s primary markets. In particular, larger metropolitan areas, such as Portland and Seattle, experienced higher improvement in general economic conditions and job growth than rural areas of Oregon and Washington. As has been typical in the past, the economic conditions in the Eugene market improved, but not at the levels realized in Portland and Seattle.

On a monthly basis, the University of Oregon, located in Eugene, Oregon, produces the Oregon Index of Economic Indicators using the year 1997 as its beginning base of 100. This index attempts to measure various components of the State of Oregon economy, including labor markets, capital goods orders, and consumer confidence, in order to determine if economic conditions in the state are improving or deteriorating, and provides the probability of a recession. This index indicated that economic activity for the State of Oregon fell to its lowest level during the first quarter 2009 when the index reached 85.0 and then generally trended upward. During 2016, the index continued upward on a quarterly basis, and for December 2016 was at 100.5%, an improvement of 0.5% over the prior year-end.

The unemployment rate for the State of Oregon at December 31, 2016, was 4.6%, as compared to 4.7% nationally, and has been improving since early 2009. Portland area unemployment stood at 4.3%, for this same time period, below the state average and national average. For Lane County, Oregon, which includes Eugene, Oregon, the unemployment rate was 4.8%, above both the state and national average at December 31, 2016. The unemployment rate for the State of Washington at December 31, 2016, was 5.2%, above the national averages, and has trended downward on a quarterly basis since early 2009. In King County, Washington, which includes the metropolitan Seattle area, the unemployment rate at year-end 2016 was 3.4%, below the state and national averages. The Seattle market in particular has demonstrated more economic diversity than the other primary markets in which the Company operates. All unemployment rates were provided by the U.S. Bureau of Labor Statistics.

 

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At December 31, 2016, approximately 65% of the Company’s loan portfolio in principal amount was secured by real estate, thus the condition and valuation trends of commercial and residential real estate markets in the Pacific Northwest have had a significant impact on the overall credit quality of the Company’s primary assets in that, in the event of default, the value of real estate collateral and its salability is typically the primary source of repayment. At December 31, 2016, approximately $167 million, or 9.00% of the Company’s loan portfolio, was categorized as residential and commercial construction loans, which also included land development and acquisition loans. During 2016, the Company experienced an increase in construction lending, centered in commercial real estate construction and acquisition and development construction.

Real estate markets in the Pacific Northwest, particularly the Portland and Puget Sound markets, have shown steady improvement in virtually every segment year over year. Industrial commercial real estate in both Portland and Seattle continued elevated pre-leasing activity, strong absorption rates, and increasing rental and lease rates during 2016. Industrial vacancy rates in the Puget Sound region fell to 2.6% by the end of 2016, even with the addition of over 4 million square feet of new space. In the Eugene market, vacancy trends continued to show stability through year end. The office commercial real estate market showed maturing in the Portland metropolitan region in 2016, and pre-leasing was steady, with vacancy rates remaining stable at 8%, despite over 1 million square feet being added during the year. The Puget Sound region was robust, with the regional vacancy rate remaining 8.6% despite the addition of over 4.4 million square feet added. For Eugene, demand for office space was moderate to steady, with building or refurbishing continuing, and vacancy rates remaining generally stable. With regard to multifamily commercial real estate, the diverse Eugene, Portland and Puget Sound demographics and continued inward migration with limited availability of multifamily units, led to private and institutional investment in all three regions. Rents increased, but at a more moderate pace in 2016, and the Eugene and Portland markets began to experience slower lease up, still however reflecting stable markets at year end. These multifamily vacancy rates in the Portland and Eugene markets remain generally in the 2.5% range, while the vacancy rate in the Puget Sound market is near record lows. There was some evidence of overcapacity developing in the Eugene student housing market in 2016. Residential development continued, with single-family and multi-family building permit issuance remaining solid in all of our markets, dominated primarily by the national home builders in the Portland and Puget Sound regions. Normalized to limited supply of single family residences was evident during the year. Similar trends are suggested into 2017, subject to various market and economic forces.

Residential housing prices in all three of the Company’s primary markets showed marked improvement in 2016, to the point where values have generally recovered to their pre-recession levels in each market, with some values exceeding pre-recession levels in areas of Portland and Seattle. A moderate level of new residential construction continued in each market as well due to the improving market conditions, continued low interest rates, and the slow return of bank financing to a wider range of residential developers.

Competition

Commercial banking in the States of Oregon and Washington is highly competitive. The Company competes with other banks, as well as with savings and loan associations, savings banks, credit unions, mortgage companies, investment banks, insurance companies, and other financial institutions. Banking in Oregon and Washington is dominated by several large banking institutions including U.S. Bank, Wells Fargo Bank, Bank of America, Key Bank and Chase. Together these banks account for a majority of the total commercial and savings bank deposits in Oregon and Washington. These competitors have significantly greater financial resources and offer a much greater number of branch locations. The Company offsets the advantage of the larger competitors by focusing on certain market segments, providing high levels of customization and personal service, and tailoring its technology, products and services to the specific market segments that the Company serves.

In addition to larger institutions, numerous “community” banks and credit unions operated, expanded or moved into the Company’s three primary markets and have developed a similar focus to that of the Company. These institutions have further increased competition in all three of the Company’s primary markets. This number of similar financial institutions and an increased focus by larger institutions in the Company’s primary markets has led to intensified competition in all aspects of the Company’s business. During 2016, the Company saw increased competition, specifically regarding loan pricing. The Company saw competitors willing to accept yields or terms not desirable to the Company and some deals were lost due to the Company’s unwillingness to compromise on deal pricing. The Company remained diligent in its underwriting standards during the year and did not loosen credit standards to achieve growth.

 

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The adoption of the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) led to further intensification of competition in the financial services industry. The GLB Act eliminated many of the barriers to affiliation among providers of various types of financial services and has permitted business combinations among financial service providers such as banks, insurance companies, securities or brokerage firms and other financial service providers. Additionally, the rapid adoption of financial services through the Internet has reduced or even eliminated many barriers to entry by financial service providers physically located outside our market areas. For example, remote deposit services allow depository companies physically located in other geographical markets to service local businesses with minimal cost of entry. Although the Company has been able to compete effectively in the financial services business in its markets to date, it may not be able to continue to do so in the future.

The financial services industry has experienced widespread consolidation over the last decade. Following consolidation due to FDIC failures between 2008 and 2011, the banking industry began to see acquisition consolidation in 2012. Beginning in 2012, consolidation continued in the form of bank acquisitions throughout the Northwest. The Company anticipates consolidation among financial institutions in its market areas will continue. In addition, with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), smaller financial institutions may find it difficult to continue to operate due to higher anticipated regulatory costs. The Dodd-Frank Act also authorized nationwide de novo branching by national and state banks and certain foreign banks operating in the U.S., which could also result in new entrants to the markets served by the Bank.

As of June 30, 2016, the most recent FDIC Summary of Deposit survey indicated, the Company had 17.08% of the Lane County deposit market share, which currently is serviced by seven branches in the Eugene community. This was the highest deposit market share of any bank in Lane County. In Multnomah County, which is serviced by three of the Company’s offices in the Portland Market, the Company had 1.42% of the deposit market share, ranking ninth in the Multnomah County, Oregon Market. In King County, Washington, the Company had 0.27% of the deposit market share, serviced by the Seattle and Bellevue offices, ranking 22^rd in the King County Market as of June 30, 2016.

In addition, the Company anticipates more competitive pressure for new loans in its markets. While the Bank’s loan demand improved throughout 2016, healthy banks with ample capital and liquidity are expected to aggressively seek new loan customers. This may cause pressure on loan pricing and make it more difficult to retain existing loan customers or attract new ones and may create compression in the Company’s net interest margin.

Services Provided

The Company offers a wide array of financial service products to meet the banking needs of its targeted segments in the market areas served. The Company regularly reviews the profitability and desirability of various product offerings, particularly new product offerings, in an effort to assure ongoing viability.

Deposit Services

The Company offers a wide range of deposit services that are typically available in most banks and other financial institutions including checking, savings, money market accounts and time deposits. The transaction accounts and time deposits are tailored to the Company’s primary markets and market segments at rates competitive with those offered in the area. Additional deposits are generated through national networks for institutional deposits. All deposit accounts are insured by the FDIC to the maximum amount permitted by law, currently $250 per depositor. The Company provides online cash management, remote deposit capture and banking services to businesses and consumers. The Company also allows 24-hour customer access to deposit and loan information via telephone and online cash management products.

Lending Activities

The Company emphasizes specific areas of lending within its primary markets. Commercial loans are made primarily to professionals, community-based businesses and nonprofit organizations. These loans are available for general operating purposes, acquisition of fixed assets, purchases of equipment and machinery, financing of inventory and accounts receivable and other business purposes. The Company also originates U.S. Small Business Administration (“SBA”) loans and is a national SBA preferred lender.

Within its primary markets, the Company also originates construction and permanent loans financing commercial facilities, including investor and owner-occupied projects. The Company also originates pre-sold, custom and, on a limited basis, speculative home construction. The major thrust of residential construction lending is smaller in-fill construction projects in

 

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inner-city urban neighborhoods, and consisting of single-family residences. During 2016, as commercial real estate prices continued to stabilize and improve, the Company expanded construction financing activity in commercial real estate and multifamily residential construction financing. During 2016, the housing markets in Portland and Seattle experienced very low inventory and high rates of appreciation, thus the Company was selective in financing single-family housing projects in both of these markets.

Due to the Company’s concentration in real estate secured loans, the Company strategically focuses on increasing its commercial and industrial (“C & I”) loan lending. In particular, the Company has developed a specialty in C & I lending to dental professionals. Loans to dental professionals include loans for such purposes as starting up a practice, acquisition of a practice, equipment financing, owner-occupied facilities, and working capital. Loans for dental office startups are typically SBA loans as these loans represent additional risk. During 2016, the Company continued to expand its national dental lending program. At year-end 2016, the Company had active dental loans in 44 states which totaled $377,478, of which $227,210 were located outside of the Company’s primary markets in Oregon and Washington. Since inception of the national dental lending program, lending has been limited to loans to dental professionals for acquisition of practices by experienced dental professionals, owner-occupied commercial real estate or seasoned practice refinance loans.

The Company makes secured and unsecured loans to individuals for various purposes, including purchases of automobiles, mobile homes, boats, and other recreational vehicles, home improvements, education, and personal investment.

Inter-agency guidelines adopted by federal bank regulators mandate that financial institutions establish real estate lending policies with maximum allowable real estate loan-to-value limits, subject to an allowable amount of non-conforming loans as a percentage of capital. The Board of Directors has approved specific lending policies and procedures for the Company, and management is responsible for implementation of these policies. The lending policies and procedures include guidelines for loan term, loan-to-value ratios that are within established federal banking guidelines, collateral appraisals, and cash flow coverage. The loan policies also vest varying levels of loan authority in management, the Company’s Loan Committee and the Board of Directors. Company management monitors lending activities through management meetings, loan committee meetings, monthly reporting, and periodic review of loans by third-party contractors.

Merchant and Card Services

In December 2013, the Company entered into an agreement with Vantiv, a third-party provider of merchant services, to outsource all merchant processing for the Bank’s clients. The agreement provides for a portion of the revenue generated from existing and new clients to be shared with the Company. Through the agreement, the Company’s existing merchant portfolio was converted onto the Vantiv platform.

Wealth Management

During 2015, the Company began offering wealth management services through a strategic partnership with Transamerica Financial Advisors (“TFA”) and World Financial Group (“WFG”). This partnership provides for employees of the Bank to also be Investment Advisors, Registered Representatives, and/or Agents with TFA and WFG. The products available include: individual investment advisory services, Company retirement plans, employee benefits programs, mutual funds, unit investment trusts, fixed and variable annuities, fixed and variable life insurance, long term care, and disability. The products and services are provided by TFA/WFG and the over 100 other financial institutions with which TFA/WFG has selling agreements. Through referral relationships, WFG is also able to provide estate planning documents, and business & personal property solutions.

Other Services

The Company provides other traditional commercial and consumer banking services, including cash management products for businesses, online banking, safe deposit services, debit and automated teller machine (“ATM”) cards, automated clearing house (“ACH”) transactions, cashier’s checks, notary services and others. The Company is a member of numerous ATM networks and utilizes an outside processor for the processing of these automated transactions. The Company has an agreement with MoneyPass, an ATM provider, which permits Company customers to use MoneyPass ATMs located throughout the country at no charge to the customer.

 

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Employees

At December 31, 2016, the Company employed 374 FTE employees with 61 FTE employees in the Puget Sound market, 75 FTE employees in the Portland market, and 79 FTE employees in the Eugene market as well as 159 FTE employees in administrative functions primarily located in Eugene, Oregon. None of these employees are represented by labor unions, and management believes that the Company’s relationship with its employees is good. The Company emphasizes a positive work environment for its employees, which is validated by recognition from independent third-parties.

During 2016, the Company was recognized for the seventeenth consecutive year by Oregon Business magazine as one of the 100 Best Companies to Work For in Oregon. Also, the Company was recognized by Seattle Business magazine as one of Washington’s “100 Best Companies to Work For.” The Portland Business Journal named the Company as one of Oregon’s most admired companies. This was the sixth time the Company was recognized as a top-ten company in the “Financial Services” classification. Additionally, Seattle Business magazine named the Company “Business of the Year,” in the small business category. The Company was recognized by Raymond James as one of the top performing community banks in the country with its prestigious Community Bankers Cup. The award recognizes the top 10 percent of community banks nationally, based on various profitability, operational efficiency and balance sheet metrics.

Management continually strives to retain and attract top talent as well as provide career development opportunities to enhance skill levels. A number of benefit programs are available to eligible employees, including group medical plans, paid sick leave, paid vacation, group life insurance, 401(k) plans, deferred compensation plans, and equity compensation plans.

Supervision and Regulation

General

The following discussion provides an overview of certain elements of the extensive bank regulatory framework applicable to the Company and the Bank. This regulatory framework is primarily designed for the protection of depositors and other customers of banks, the federal deposit insurance fund and the banking system as a whole, rather than specifically for the protection of shareholders or other investors in the securities of banking organizations in the United States. Due to the breadth and growth of this regulatory framework, our costs of compliance continue to increase in order to monitor and satisfy these requirements.

To the extent that this section describes statutory and regulatory provisions, it is qualified by reference to those provisions. These statutes and regulations, as well as related policies, are subject to change by Congress, state legislatures and federal and state regulators. Changes in statutes, regulations or regulatory policies applicable to us, including the interpretation or implementation thereof, could have a material adverse effect on our business and operations. In light of the financial crisis, which began in 2008 and 2009, numerous changes to the statutes, regulations or regulatory policies applicable to the Company and other banks generally have been made or proposed. The full extent to which these changes will impact our business is not yet known. However, our continued efforts to monitor and comply with new regulatory requirements add to the complexity and cost of our business.

Federal and State Bank Holding Company Regulation

General. The Company is a bank holding company under the Bank Holding Company Act of 1956, as amended (“BHCA”), and is therefore subject to regulation, supervision and examination by the Federal Reserve. In general, the BHCA limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to banking. The Company must file reports with and provide to the Federal Reserve such additional information as it may require. Under the GLB Act, a bank holding company may apply to the Federal Reserve to become a financial holding company, and thereby engage (directly or through a subsidiary) in certain expanded activities deemed financial in nature, such as securities and insurance underwriting. The Company has not applied to the Federal Reserve to become a financial holding company and has no plans to do so.

Holding Company Bank Ownership. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5 percent of such shares; (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.

 

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Holding Company Control of Non-Banks. With some exceptions, the BHCA also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5 percent of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities that, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks.

Transactions with Affiliates. Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities, and on the use of their securities as collateral for loans to any borrower. These restrictions prevent the Company from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Company are limited individually to 10 percent of the Bank’s capital stock and surplus and in the aggregate to 20 percent of the Bank’s capital stock and surplus. The Federal Reserve Act also provides that extensions of credit and other transactions between the Bank and the Company must be on terms and conditions, including credit standards, that are substantially the same or at least as favorable to the Bank as those prevailing at the time for comparable transactions involving other non-affiliated companies, or, in the absence of comparable transactions, on terms and conditions, including credit standards, that in good faith would be offered to, or would apply to, non-affiliated companies. These regulations and restrictions may limit the Company’s ability to obtain funds from the Bank for its cash needs, including funds for payment of dividends, interest, and operational expenses.

Tying Arrangements. The Company is prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Company nor its subsidiaries may condition an extension of credit to a customer on either (i) a requirement that the customer obtain additional services provided by us; or (ii) an agreement by the customer to refrain from obtaining other services from a competitor.

Support of Subsidiary Banks. Under Federal Reserve policy and the Dodd-Frank Act, the Company is required to act as a source of financial and managerial strength to the Bank. This means that the Company is required to commit, as necessary, resources to support the Bank. However, the contribution of additional capital to an under-capitalized subsidiary bank may be required at times when a bank holding company may not have the resources to provide such support. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.

State Law Restrictions. As an Oregon corporation, the Company is subject to certain limitations and restrictions under applicable Oregon corporate law. For example, state law restrictions and limitations in Oregon include indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records and minutes, and observance of certain corporate formalities.

Federal and State Regulation of Pacific Continental Bank

General. The Bank is an Oregon commercial bank operating in Oregon and Washington with deposits insured by the FDIC. As an Oregon state bank that is not a member of the Federal Reserve System, the Bank is subject to supervision and regulation by the Oregon Department of Consumer and Business Services (the “Oregon Department”) and the FDIC. These agencies have the authority to prohibit banks from engaging in what they believe constitute unsafe or unsound banking practices. Additionally, the Bank’s branches in Washington are subject to supervision and regulation by the Washington Department of Financial Institutions and must comply with applicable Washington laws regarding community reinvestment, consumer protection, fair lending, and intrastate branching.

Consumer Protection. The Bank is subject to a variety of federal and state consumer protection laws and regulations that govern its relationship with consumers, including laws and regulations that mandate certain disclosure requirements and regulate the manner in which we take deposits, make and collect loans, and provide other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.

Community Reinvestment. The Community Reinvestment Act of 1977 (“CRA”) requires that, in connection with examinations of financial institutions within their jurisdiction, the FDIC evaluate the record of the financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods, consistent with the

 

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safe and sound operation of the institution. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and the CRA into account when regulating and supervising other activities, and in evaluating whether to approve applications for permission to engage in new activities or for acquisitions of other banks or companies or de novo branching. An unsatisfactory CRA rating may be the basis for denying the application. In the most current CRA examination report dated February 24, 2014, the Bank’s compliance with CRA was rated “Satisfactory”.

Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act and the regulations of the Federal Reserve on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, and follow credit underwriting procedures that are at least as stringent as those prevailing at the time for comparable transactions with persons not covered above and who are not employees; and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to insiders. A violation of these restrictions may result in the assessment of substantial civil monetary penalties, regulatory enforcement actions, and other regulatory sanctions.

Regulation of Management. Federal law (i) sets forth circumstances under which officers or directors of a bank may be removed by the institution’s federal supervisory agency; (ii) places restraints on lending by a bank to its executive officers, directors, principal shareholders and their related interests; and (iii) generally prohibits management personnel of a bank from serving as a director or in other management positions of another financial institution which assets exceed a specified amount or which has an office within a specified geographic area.

Safety and Soundness Standards. Certain non-capital safety and soundness standards are also imposed upon banks. These standards cover internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution that fails to meet these standards may be subject to regulatory sanctions.

Customer Information Security. The federal bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. The guidelines require each financial institution to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Bank has adopted a customer information security program.

Privacy. The GLB Act requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the statute requires explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the banks’ policies and procedures. The Bank implemented a privacy policy, which provides that all of its existing and new customers will be notified of the Bank’s privacy policies. State laws and regulations designed to protect the privacy and security of customer information also apply to us.

Interstate Banking and Branching

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”), together with the Dodd-Frank Act, relaxed prior interstate branching restrictions under federal law by permitting, subject to regulatory approval, state and federally chartered commercial banks to establish branches in states where the laws permit banks chartered in such states to establish branches. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area. Federal banking agency regulations prohibit banks from using their interstate branches primarily for deposit production, and the federal banking agencies have implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition. The Dodd-Frank Act also authorized nationwide de novo branching by national and state banks and certain foreign banks operating in the U.S., which could also result in new entrants to the markets served by the Bank.

 

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Dividends

The principal source of the Company’s cash is from dividends received from the Bank, which are subject to government regulation and limitations. In addition, capital raises may provide another source of cash. Regulatory authorities may prohibit banks and bank holding companies from paying dividends in a manner that would constitute an unsafe or unsound banking practice or would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. The Oregon Bank Act and the Federal Deposit Insurance Corporation Improvement Act of 1991 also limit a bank’s ability to pay cash dividends to its parent company. A bank may not pay cash dividends if that payment would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. In addition, under the Oregon Bank Act, the amount of the dividend paid by the Bank may not be greater than net unreserved retained earnings, after first deducting, to the extent not already charged against earnings or reflected in a reserve, all bad debts, which are debts on which interest is unpaid and past due at least six months unless the debt is fully secured and in the process of collection; all other assets charged-off as required by Oregon bank regulators or a state or federal examiner; and all accrued expenses, interest and taxes of the Bank. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve’s view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. Payment of cash dividends by the Company and the Bank will depend on sufficient earnings to support them and adherence to bank regulatory requirements.

Capital Adequacy

Regulatory Capital Rules. Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies. The Federal Reserve Board and the other U.S. federal banking agencies have 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 current international regulatory capital accord (“Basel III”) of the Basel committee on Banking Supervision (the “Basel Committee”). The Basel Committee is a committee of banking supervisory authorities from major countries in the global financial system which formulates broad supervisory standards and guidelines relating to financial institutions for implementation on a country-by-country basis. These rules replace the U.S. federal banking agencies’ general risk-based capital rules, advanced approaches rule, market-risk rule, and leverage rules, in accordance with certain transition provisions. Banks, such as Pacific Continental Bank, became subject to the new rules on January 1, 2015. The new rules generally 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 capital conservation buffers 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 new 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% (which is 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%. While earlier proposals would have required that trust preferred securities be phased out of Tier 1 capital, the new rules exempt depository institution holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, from this requirement. These capital instruments, if issued prior to May 19, 2010, and currently in Tier 1 capital, are grandfathered in Tier 1 capital, subject to certain limits.

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 on 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 phase in from January 1, 2014 to December 31, 2017.

In January 2014, the Basel Committee issued an updated version of its leverage ratio and disclosure guidance (the “Basel III Leverage Ratio”). The Basel Committee guidance continues to set a minimum Basel III Leverage Ratio of 3%. In April 2016, the Basel Committee proposed, among other things, that for purposes of calculating the denominator of the leverage ratio, off-balance sheet exposures of banks to securitization transactions should be treated the same as such exposures are treated under the Basel Committee revisions to its securitization framework for risk-based capital. The Basel III Leverage Ratio will be subject to further calibration until 2017, with final implementation expected by January 2018. The Basel Committee is

 

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expected to collect data during this observation period to assess whether a minimum leverage ratio of 3% is appropriate over a full credit cycle and for various types of business models and to assess the impact of using either common equity Tier 1 capital or total regulatory capital as the numerator.

The implementation of these new rules could have an adverse impact on our financial position and future earnings due to the inclusion of Tier 1 capital as a core capital component and because of the heightened minimum capital requirements. These capital rules could restrict our ability to grow during favorable market conditions, or require us to raise additional capital and liquidity, generally increase our cost of doing business, and impose other restrictions on our operations. The application of more stringent capital requirements would, among other things, result in lower returns on invested capital and result in regulatory sanctions if we were unable to comply with these requirements. As a result, our business, results of operations, financial condition or prospects could be adversely affected. We expect that we will be able to satisfy the minimum capital requirements adopted by the Federal Reserve and the other U.S. banking agencies within the prescribed implementation timelines. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” in this Form 10-K.

Prompt Corrective Action. Under the guidelines, a bank is assigned to one of five capital categories ranging from “well-capitalized” to “critically under-capitalized.” Institutions that are “under-capitalized” or lower are subject to certain mandatory supervisory corrective actions. At each successively lower capital category, an insured bank is subject to increased restrictions on its operations. Failure to meet regulatory capital guidelines can result in a bank being required to raise additional capital. An “under-capitalized” bank must develop a capital restoration plan and its parent holding company must guarantee compliance with the plan subject to certain limits. During challenging economic times, the federal banking regulators have actively enforced these provisions.

At December 31, 2016, the Company and the Bank each exceeded the required risk-based capital ratios for classification as “well capitalized” as well as the required minimum leverage ratios for the Bank, and we believe we will meet the minimum capital ratios plus the fully phased-in conservation buffer as implemented. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” in this Form 10-K.

Regulatory Oversight and Examination

The Federal Reserve conducts periodic inspections of bank holding companies, which are performed both onsite and offsite. The supervisory objectives of the inspection program are to ascertain whether the financial strength of the bank holding company is being maintained on an ongoing basis and to determine the effects or consequences of transactions between a holding company or its non-banking subsidiaries and its subsidiary banks. For holding companies under $10 billion in assets, such as the Company, the inspection type and frequency varies depending on asset size, complexity of the organization and the holding company’s rating at its last inspection.

The Federal Reserve also has extensive enforcement authority over all bank holding companies, such as the Company. Such enforcement powers include the power to assess civil money penalties against any bank holding company violating any provision of the BHCA or any regulation or order of the Federal Reserve Board under the BHCA and the power to order termination of activities or ownership of nonbank subsidiaries of the holding company if it determines that there is reasonable cause to believe that the activities or ownership of the non-bank subsidiaries constitutes a serious risk to the financial safety, soundness or stability of banks owned by the bank holding company. Knowing violations of the BHCA or regulations or orders of the Federal Reserve Board can also result in criminal penalties for the Company and any individuals participating in such conduct.

Banks are subject to periodic examinations by their primary regulators. Bank examinations have evolved from reliance on transaction testing in assessing a bank’s condition to a risk-focused approach. These examinations are extensive and cover the entire breadth of operations of the Bank. Generally, safety and soundness examinations occur on an 18-month cycle for banks under $500 million in total assets that are well-capitalized and without regulatory issues, and on a 12-month cycle otherwise. Examinations alternate between the federal and state bank regulatory agency and may occur on a combined schedule. The frequency of consumer compliance and CRA examinations is linked to the size of the institution and its compliance and CRA ratings at its most recent examinations. However, the examination authority of the FDIC allows it to examine supervised banks as frequently as deemed necessary based on the condition of the Bank or as a result of certain triggering events. Neither the Company nor the Bank is party to a formal or informal agreement with the FDIC, the Federal Reserve or the Oregon Department.

 

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Corporate Governance and Accounting

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the “Act”) addresses, among other things, corporate governance, auditing and accounting, enhanced and timely disclosure of corporate information, and penalties for non-compliance. Generally, the Act (i) requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the Securities and Exchange Commission (the “SEC”), (ii) imposes specific and enhanced corporate disclosure requirements, (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies, (iv) requires companies to adopt and disclose information about corporate governance practices, including whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert,” and (v) requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings.

As a publicly reporting company, we are subject to the requirements of the Act and related rules and regulations issued by the SEC and NASDAQ. After enactment, we updated our policies and procedures to comply with the Act’s requirements and have found that such compliance, including compliance with Section 404 of the Act relating to internal control over financial reporting, has resulted in significant additional expense for the Company. We anticipate that we will continue to incur such additional expense in our ongoing compliance.

Anti-terrorism and Anti-Money Laundering

USA Patriot Act of 2001. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”), intended to combat terrorism, was renewed with certain amendments in 2006 . Certain provisions of the Patriot Act were made permanent and other sections were made subject to extended “sunset” provisions. The Patriot Act, in relevant part, (i) prohibits banks from providing correspondent accounts directly to foreign shell banks; (ii) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals; (iii) requires financial institutions to establish an anti-money laundering compliance program; and (iv) eliminates civil liability for persons who file suspicious activity reports.

In recent years, the federal bank regulators have announced regulatory enforcement actions against a number of large bank holding companies and banks arising from deficiencies in processes, procedures and controls involving anti-money laundering measures and compliance with the economic sanctions that affect transactions with designated foreign countries, nationals and others as provided for in the regulations of the Office of Foreign Assets Control of the U.S. Treasury Department. These actions evidence an intensification of the U.S. government’s expectations for compliance with these regulatory regimes on the part of banks operating in the U.S., including the Bank, and may result in increased compliance costs and increased risks of regulatory sanctions.

Financial Services Modernization

The GLB Act, which became law in 1999, brought about significant changes to the laws affecting banks and bank holding companies. Generally, the GLB Act (i) repealed historical restrictions on preventing banks from affiliating with securities firms; (ii) provided a uniform framework for the activities of banks, savings institutions and their holding companies; (iii) broadened the activities that may be conducted by national banks and banking subsidiaries of bank holding companies; (iv) provided an enhanced framework for protecting the privacy of consumer information and requires notification to consumers of bank privacy policies; and (v) addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions. Bank holding companies that qualify and elect to become financial holding companies can engage in a wider variety of financial activities than permitted under previous law, particularly with respect to insurance and securities underwriting activities.

Deposit Insurance

The Bank’s deposits are insured under the Federal Deposit Insurance Act, up to the maximum applicable limits, and are subject to deposit insurance assessments designed to tie what banks pay for deposit insurance more closely to the risks they pose. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole. As required by the Dodd-Frank Act, the FDIC adopted a comprehensive, long-range “restoration” plan for the deposit insurance fund to better ensure the adequacy of the fund’s reserves relative to total insured deposits in the U.S. The ultimate effect on our business of these legislative and regulatory developments relating to the deposit insurance fund cannot be predicted with any certainty. There can be no assurance that the FDIC will not impose special assessments or increase annual assessments in the future.

 

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The FDIC may terminate the deposit insurance of any insured depository institution if it determines that the institution has engaged in or is engaging in unsafe and unsound banking practices, is in an unsafe or unsound condition or has violated any applicable law, regulation or order or any condition imposed in writing by, or pursuant to, any written agreement with the FDIC. The termination of deposit insurance for the Bank could have a material adverse effect on our financial condition and results of operations due to the fact that the Bank’s liquidity position would likely be adversely affected by deposit withdrawal activity.

The Federal Deposit Insurance Act provides that, in the event of the liquidation or other resolution of an insured depository institution, the claims of its depositors (including claims by the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as receiver would be afforded a priority over other general unsecured claims against such an institution. If an insured depository institution fails, insured and uninsured depositors along with the FDIC will be placed ahead of unsecured, non-deposit creditors, in order of priority of payment.

If any insured depository institution becomes insolvent and the FDIC is appointed its conservator or receiver, the FDIC may, in most cases, disaffirm or repudiate any contract to which such institution is a party, if the FDIC determines that performance of the contract would be burdensome, and that disaffirmance or repudiation of the contract would promote the orderly administration of the institution’s affairs. In addition, the FDIC as conservator or receiver may enforce most contracts entered into by the institution notwithstanding any provision providing for termination, default, acceleration or exercise of rights upon or solely by reason of insolvency of the institution, appointment of a conservator or receiver for the institution, or exercise of rights or powers by a conservator or receiver for the institution.

Other Legislation

Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act , enacted in 2010, has resulted in sweeping changes to the U.S. financial system. Among other provisions, the Dodd-Frank Act (1) created the Consumer Financial Protection Bureau with broad powers to regulate consumer financial products such as credit cards and mortgages, (2) created the Financial Stability Oversight Council (comprised of the Secretary of the Treasury, heads of the federal bank regulatory agencies and the SEC, and certain other officials) to provide oversight of all risks created within the U.S. economy from the activities of financial services companies, (3) has led to new capital requirements from federal banking agencies, (4) placed new limits on electronic debit card interchange fees, and (5) required the SEC and national stock exchanges to adopt significant new corporate governance and executive compensation reforms. As discussed below, many of the law’s provisions have been implemented by rules and regulations of the federal banking agencies, but certain provisions of the law are yet to be implemented. As a result, the full scope and impact of the law on banking institutions generally and on our business and operations cannot be fully determined at this time. However, the Dodd-Frank Act is expected to have a significant impact on our business operations, including increasing the cost of doing business, as its provisions continue to take effect. Some of the provisions of the Dodd-Frank Act that may impact our business are summarized below.

Corporate Governance. The Dodd-Frank Act requires publicly traded companies to provide their shareholders with (1) a non-binding shareholder vote on executive compensation, (2) a non-binding shareholder vote on the frequency of such vote, (3) disclosure of “golden parachute” arrangements in connection with specified change in control transactions, and (4) a non-binding shareholder vote on golden parachute arrangements in connection with these change in control transactions. Except with respect to “smaller reporting companies” and participants in the Troubled Asset Relief Program (“TARP”), the new rules applied to proxy statements relating to annual meetings of shareholders held after January 20, 2011.

Prohibition Against Charter Conversions of Troubled Institutions. The Dodd-Frank Act generally prohibits a depository institution from converting from a state to federal charter, or vice versa, while subject to an enforcement action, unless the bank seeks prior approval from its regulator and complies with specified procedures to ensure compliance with the enforcement action.

Overdraft and Interchange Fees. The Federal Reserve has adopted amendments under its Regulation E that imposed new restrictions on banks’ abilities to charge overdraft services and fees. The rule prohibits financial institutions from charging fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The opt-in provision established requirements for clear disclosure of fees and terms of overdraft services for ATM and one-time debit card transactions. Since a percentage of the Bank’s service charges on deposits are in the form of overdraft fees on point-of-sale transactions, this has had an adverse impact on our noninterest income.

 

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The Dodd-Frank Act, through a provision known as the Durbin Amendment, required the Federal Reserve to establish standards for interchange fees that are “reasonable and proportional” to the cost of processing the debit card transaction and imposes other requirements on card networks. Under the final rule, effective in October 2011, the maximum permissible interchange fee that a bank may receive is the sum of $0.21 per transaction and five basis points multiplied by the value of the transaction, with an additional upward adjustment of no more than $0.01 per transaction if a bank develops and implements policies and procedures reasonably designed to achieve fraud-prevention standards set by regulation. The Federal Reserve’s regulation on charges for overdraft services and interchange fees on debit card transactions reduces the fee revenues that banks receive from the business of processing debit card transactions. While the restrictions on interchange fees do not apply to banks that, together with their affiliates, have assets of less than $10 billion, the rule could affect the competitiveness of debit cards issued by smaller banks.

Consumer Financial Protection Bureau. The Dodd-Frank Act created a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”). The CFPB has broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws for banks and thrifts with greater than $10 billion in assets. Among the CFPB’s responsibilities are implementing and enforcing federal consumer financial protection laws, reviewing the business practices of financial services providers for legal compliance, monitoring the marketplace for transparency on behalf of consumers and receiving complaints and questions from consumers about consumer financial products and services. The Dodd-Frank Act added prohibitions on unfair, deceptive or abusive acts and practices to the scope of consumer protection regulations overseen and enforced by the CFPB. Institutions with less than $10 billion in assets, such as the Company, are subject to rules promulgated by the CFPB but will continue to be examined and supervised by their federal banking regulators for compliance purposes.

Repeal of Demand Deposit Interest Prohibition. The Dodd-Frank Act repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

Proposed Legislation

Proposed legislation that may affect the Company and the Bank is introduced in almost every legislative session, both federal and state. Certain of such legislation could dramatically affect the regulation of the banking industry and significantly change the competitive and operating environment in which we operate. We cannot predict if any such legislation will be adopted or, if it is adopted, how it would affect the business of the Bank or the Company. Past history has demonstrated that new legislation or changes to existing laws or regulations usually results in a greater compliance burden and therefore generally increases our cost of doing business.

Effects of Government Monetary Policy

Our earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve implements national monetary policy for such purposes as curbing inflation and combating recession. Its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the Federal Reserve, and establishment of reserve requirements against certain deposits, influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. For the past several years, 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 measures, 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. In December 2016, the Federal Reserve raised the target range for the federal funds rate to  ¹⁄₂ percent. The Federal Reserve indicated that the increase notwithstanding, the stance of monetary policy remains accommodative, thereby supporting a policy aimed at further strengthening in the labor market and a return to two percent inflation. The Federal Reserve further indicated that it expects economic conditions to evolve in a manner which will warrant only gradual further increases in the federal funds rate. 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.

 

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Statistical Information

All dollar amounts in the following sections, except per common share data, are in thousands of dollars, except where otherwise indicated.

Selected Quarterly Information

The following chart contains data for the prior eight quarters.

 

YEAR		2016																2015
QUARTER		Fourth				Third				Second				First				Fourth				Third				Second				First
		(in thousands, except per share data)
Interest income		$	27,044			$	22,662			$	20,284			$	19,953			$	19,877			$	19,450			$	18,840			$	16,069
Interest expense			2,060				1,891				1,137				1,144				1,055				1,142				1,144				1,095
Net interest income			24,984				20,771				19,147				18,809				18,822				18,308				17,696				14,974
Provision for loan loss			1,875				1,380				1,950				245				520				625				550				—
Noninterest income			2,344				1,919				1,747				1,807				2,008				1,714				1,627				1,276
Noninterest expense			15,829				13,825				14,932				12,007				11,706				11,182				11,030				11,972
Net income			6,860				4,851				2,606				5,459				5,528				5,325				5,095				2,803
PER COMMON
SHARE DATA
Earnings per share- (basic)		$	0.30			$	0.24			$	0.13			$	0.29			$	0.28			$	0.27			$	0.26			$	0.16
Earnings per share- (diluted)		$	0.30			$	0.23			$	0.13			$	0.29			$	0.28			$	0.27			$	0.26			$	0.16
Regular cash dividends		$	0.11			$	0.11			$	0.11			$	0.11			$	0.11			$	0.11			$	0.10			$	0.10
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic			22,606,539				20,511,392				19,697,314				19,607,106				19,598,484				19,591,666				19,562,363				18,232,076
Diluted			22,822,395				20,676,964				19,868,967				19,782,282				19,765,852				19,816,770				19,788,885				18,444,971

 

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Investment Portfolio

The following chart contains information regarding the Company’s investment portfolio. All of the Company’s investment securities are accounted for as available-for-sale and are reported at estimated fair value. Temporary differences between estimated fair value and amortized cost, net of deferred taxes, are recorded as a separate component of shareholders’ equity. Credit-related other-than-temporary impairment is recognized against earnings as a realized loss in the period in which it is identified.

INVESTMENT PORTFOLIO

ESTIMATED FAIR VALUE

 

		December 31,
		2016				2015				2014				2013				2012
		(dollars in thousands)
Obligations of U.S. government agencies		$	25,620			$	44,623			$	39,185			$	30,847			$	17,844
Obligations of states and political subdivisions			110,739				97,151				83,981				78,795				81,501
Private label mortgage-backed securities			1,937				2,789				3,816				5,314				8,600
Mortgage-backed securities			290,036				185,370				205,390				223,720				281,940
SBA pools			42,664				35,772				19,574				8,710				—
Corporate securities			—				893				—				—				—
Total		$	470,996			$	366,598			$	351,946			$	347,386			$	389,885

The following chart presents the fair value of each investment category by maturity date and includes a weighted average yield for each period. Mortgage-backed and private label mortgage-backed securities have been classified based on their December 31, 2016, projected average lives.

SECURITIES AVAILABLE-FOR-SALE

 

		December 31, 2016
		One Year or Less								After One Year Through Five Years								After Five Years Through Ten Years								After Ten Years
		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
		(dollars in thousands)
Obligations of U.S. government agencies		$	—				—			$	6,656				2.50	%		$	18,964				2.36	%		$	—				—
Obligations of states and political subdivisions			951				3.97	%			62,712				2.99	%			47,076				2.32	%			—				—
Private label mortgage-backed securities			403				—				795				5.65	%			739				5.37	%			—				—
Mortgage-backed securities			4,088				2.64	%			166,949				2.50	%			102,271				2.44	%			16,728				2.80	%
SBA variable rate pools			—				—				22,665				1.80	%			19,999				1.99	%			—				—
Corporate securities			—				—				—				—				—				—				—				—
Total		$	5,442				3.04	%		$	259,777				2.57	%		$	189,049				2.40	%		$	16,728				2.80	%

 

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Loan Portfolio

The following table contains period-end information related to the Company’s loan portfolio for each of the five years ended December 31.

LOAN PORTFOLIO

 

		December 31,
		2016				2015				2014				2013				2012
		(dollars in thousands)
Commercial and other loans		$	639,716			$	508,556			$	408,011			$	391,229			$	326,716
Real estate loans			1,049,338				785,737				560,171				500,752				461,240
Construction loans			167,811				108,368				73,967				98,910				79,720
Consumer loans			2,922				3,351				3,862				3,878				3,581
			1,859,787				1,406,012				1,046,011				994,769				871,257
Deferred loan origination fees, net			(2,020	)			(1,530	)			(990	)			(924	)			(841	)
			1,857,767				1,404,482				1,045,021				993,845				870,416
Allowance for loan losses			(22,454	)			(17,301	)			(15,637	)			(15,917	)			(16,345	)
		$	1,835,313			$	1,387,181			$	1,029,384			$	977,928			$	854,071

The following table presents loan portfolio information by loan category related to maturity and repricing sensitivity. Variable rate loans are fully floating and can adjust at any time. Adjustable rate loans are fixed for a certain time period, but will adjust at a point in the future, prior to maturity. Variable and adjustable rate loans are included in the time frame in which the interest rate on the loan could be first adjusted. At December 31, 2016, the Company had approximately $50,501 of variable rate loans at their floors and $510,842 of adjustable rate loans at their floors that are included in the analysis below. These loans are included in the category of their next available repricing date.

MATURITY AND REPRICING DATA FOR LOANS

 

		December 31, 2016
		Commercial and Other				Real Estate				Construction				Consumer				Total
		(dollars in thousands)
Three months or less		$	157,313			$	72,954			$	92,561			$	2,512			$	325,340
Over three months through 12 months			8,291				96,088				37,426				23				141,828
Over 1 year through 3 years			47,399				278,316				8,505				137				334,357
Over 3 years through 5 years			76,931				350,397				4,345				118				431,791
Over 5 years through 15 years			349,782				245,043				24,974				132				619,931
Thereafter			—				6,540				—				—				6,540
Total loans		$	639,716			$	1,049,338			$	167,811			$	2,922			$	1,859,787

 

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Loan Concentrations

At December 31, 2016, loans to dental professionals totaled $377,478 and represented approximately 20.30% of outstanding loans. Approximately 65% of the Company’s loans were secured by real estate at December 31, 2016.

Nonperforming Assets

The following table presents period-end nonperforming loans and assets for the years ended December 31, 2016, 2015, 2014, 2013 and 2012:

NONPERFORMING ASSETS

 

		December 31,
		2016				2015				2014				2013				2012
		(dollars in thousands)
Nonaccrual loans		$	11,833			$	5,509			$	2,695			$	5,343			$	9,361
90 or more days past due and still accruing			—				—				—				—				—
Total nonperforming loans			11,833				5,509				2,695				5,343				9,361
Government guarantees			(2,354	)			(2,790	)			(706	)			(735	)			(905	)
Net nonperforming loans			9,479				2,719				1,989				4,608				8,456
Other real estate owned			12,068				11,747				13,374				16,355				17,972
Total nonperforming assets		$	21,547			$	14,466			$	15,363			$	20,963			$	26,428
Nonperforming assets as a percentage of total assets			1.13	%			0.76	%			1.02	%			1.45	%			1.92	%

If interest on nonaccrual loans had been accrued, such income would have been approximately $375, $194, $100, $421 and $708, respectively, for the years ended December 31, 2016, 2015, 2014, 2013 and 2012.

 

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Allowance for Loan Losses

The following chart presents information about the Company’s allowance for loan losses. Management and the Board of Directors evaluate the allowance monthly and consider the amount to be adequate to absorb possible loan losses.

ALLOWANCE FOR LOAN LOSSES

 

		December 31,
		2016				2015				2014				2013				2012
						(dollars in thousands)
Balance at beginning of year		$	17,301			$	15,637			$	15,917			$	16,345			$	14,941
Charges to the allowance
Commercial and other loans			(716	)			(630	)			(610	)			(1,658	)			(1,401	)
Real estate loans			—				(61	)			(58	)			(407	)			(1,190	)
Construction loans			—				—				(155	)			—				(1,054	)
Consumer loans			(9	)			(9	)			(12	)			(23	)			(19	)
Total charges to the allowance			(725	)			(700	)			(835	)			(2,088	)			(3,664	)
Recoveries against the allowance
Commercial and other loans			207				562				348				982				1,917
Real estate loans			55				76				186				360				55
Construction loans			163				16				16				60				1,188
Consumer loans			3				15				5				8				8
Total recoveries against the allowance			428				669				555				1,410				3,168
Provisions			5,450				1,695				—				250				1,900
Balance at end of the year		$	22,454			$	17,301			$	15,637			$	15,917			$	16,345
Net charge offs as a percentage of total average loans			0.02	%			0.00	%			0.30	%			0.70	%			0.06	%
Allowance for loan losses as a percentage of gross loans			1.21	%			1.23	%			1.49	%			1.60	%			1.88	%

The following table sets forth the allowance for loan losses allocated by loan type:

 

		December 31,
		2016								2015								2014								2013								2012
		(dollars in thousands)
		Amount				Percent of loans in each category to total loans				Amount				Percent of loans in each category to total loans				Amount				Percent of loans in each category to total loans				Amount				Percent of loans in each category to total loans				Amount				Percent of loans in each category to total loans
Commercial and other loans		$	8,614				34.39	%		$	6,349				36.17	%		$	5,733				39.00	%		$	5,113				39.30	%		$	3,846				37.50	%
Real estate loans			10,872				56.43	%			8,297				55.88	%			7,494				53.50	%			7,668				50.40	%			9,456				53.00	%
Construction loans			1,781				9.02	%			1,258				7.71	%			1,077				7.10	%			1,493				10.00	%			1,987				9.10	%
Consumer loans			41				0.16	%			46				0.24	%			54				0.40	%			68				0.30	%			70				0.40	%
Unallocated			1,146				N/A				1,351				N/A				1,279				N/A				1,575				N/A				986				N/A
Allowance for loan losses		$	22,454				100.00	%		$	17,301				100.00	%		$	15,637				100.00	%		$	15,917				100.00	%		$	16,345				100.00	%

 

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During 2016 and 2015, the Company recorded loan losses provision of $5,450 and $1,695, respectively. At December 31, 2016, the Company’s recorded investment in impaired loans, net of government guarantees, was $10,567, with a specific allowance of $736 provided for in the ending allowance for loan losses. See Note 5 in the Notes to Consolidated Financial Statements in this Form 10-K for additional information regarding the Company’s allowance for loan losses.

While the Company saw improvement with regard to the overall credit quality of the loan portfolio in 2016, management cannot predict the level of the provision for loan losses, the level of the allowance for loan losses, or the level of nonperforming assets in future quarters as a result of continuing uncertain economic conditions. At December 31, 2016, and as shown above, the Company’s unallocated reserves were $1,146 or 5.10% of the total allowance for loan losses at year-end. Management believes that the allowance for loan losses at December 31, 2016, was adequate and that this level of unallocated reserves was prudent in light of the economic conditions and uncertainty that exists in the Northwest markets that the Company serves and the concentration in loans to dental professionals. See Note 6 in the Notes to Consolidated Financial Statements in this Form 10-K for additional information regarding the dental loan portfolio.

Deposits

Average balances and average rates paid by category of deposit are included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K. The chart below details period-end information related to the Company’s time deposits at December 31, 2016. The Company did not have any foreign deposits at December 31, 2016. Variable rate deposits are listed by first repricing opportunity.

TIME DEPOSITS

 

		December 31, 2016
		Time of $100 or more				Time of less than $100				Total Time
		(dollars in thousands)
<3 Months		$	2,544			$	49,003			$	51,547
3-6 Months			2,197				12,452				14,649
6-12 Months			2,729				18,777				21,506
>12 Months			2,624				88,557				91,181
		$	10,094			$	168,789			$	178,883
Percentage of time deposits to total deposits			0.47	%			7.86	%			8.33	%

Borrowings

The Company uses short-term borrowings to fund fluctuations in deposits and loan demand. The Bank has access to both secured and unsecured overnight borrowing lines. The secured borrowing lines are collateralized by loans. At December 31, 2016, the Company had secured borrowing lines with the Federal Home Loan Bank of Des Moines (the “FHLB”) and the Federal Reserve Bank of San Francisco (the “FRB”). At December 31, 2016, the FHLB borrowing line was limited by the amount of collateral pledged, which limited total borrowings to $632,202. The borrowing line with the FRB is limited by the value of discounted collateral pledged, which at December 31, 2016, was $80,784. At December 31, 2016, the Company also had unsecured borrowing lines with various correspondent banks totaling $154,000. At December 31, 2016, the Company had no overnight borrowings outstanding on its unsecured borrowing lines. Borrowings include interest at the then stated rate. At December 31, 2016, there was $801,986 available on secured and unsecured borrowing lines with the FHLB, the FRB, and various correspondent banks.

 

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SHORT-TERM BORROWINGS

 

		December 31,
		2016				2015				2014
		(dollars in thousands)
Federal funds purchased, FHLB cash management advance, FRB, & short-term advances
Average interest rate
At year end			0.70	%			0.34	%			0.48	%
For the year			0.47	%			0.18	%			0.40	%
Average amount outstanding for the year		$	164,615			$	129,665			$	121,016
Maximum amount outstanding at any month-end		$	183,500			$	117,000			$	168,500
Amount outstanding at year-end		$	57,000			$	47,000			$	68,500

In addition to the Company’s $57,000 in short-term borrowings outstanding at December, 31, 2016, the Company had $8,000 in long term FHLB borrowing, for a total of $65,000. The combined short and long-term borrowings had a weighted average interest rate of 1.01% and a remaining average maturity of approximately 1.87 years. More information on the Company’s long-term borrowings can be found in Note 13 in the Notes to Consolidated Financial Statements in this Form 10-K.

The Company’s other long-term borrowings consisted of two junior subordinated debentures. The first totals $8,248 was issued on November 28, 2005, and matures on January 7, 2036. The interest rate on the debentures was 6.27% until January 2012 after which it was converted to a floating rate of three-month LIBOR plus 135 basis points. In April 2013, the Company entered into a swap agreement with a third party, which fixed the rate on its $8,000 of trust preferred securities at 2.73% for seven years. The second was acquired September 6, 2016 following the acquisition of Foundation Bank. In third quarter 2016, 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 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 Company also recognized its $186 investment in the Foundation Statutory Trust I, which is recorded among “Other Assets” in its consolidated balance sheet at December 31, 2016 and 2015.

In June 2016, in a regional public offering the Company issued $35,000 in aggregate principal amount of fixed-to-floating rate subordinated debentures (the “Notes”). The Notes are callable at par after five years, have a stated maturity of June 30, 2026 and bear interest at a fixed annual rate of 5.875% per year, from and including June 27, 2016 but excluding June 30, 2021. From and including June 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.

 

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ITEM 1A

Risk Factors

We are subject to numerous risks and uncertainties, including but not limited to, the following information:

Industry Factors

The continued challenges in the U.S. and our region’s economies could have a material adverse effect on our future results of operations or market price of our stock; there can be no assurance that U.S. governmental measures responding to these challenges will successfully address these circumstances; the U.S. government continues to face significant fiscal and budgetary challenges which, if not resolved, may further exacerbate U.S. economic conditions.

The national economy and the financial services sector in particular are still facing challenges. A large percentage of our loans are to businesses in western Washington and Oregon, markets facing many of the same challenges as the national economy, including elevated unemployment and weakness in commercial and residential real estate values. Although some economic indicators are improving both nationally and in the markets we serve, there remains uncertainty regarding the strength of the economic recovery. A continued slow economic recovery could result in the following consequences, any of which could have an adverse impact, which may be material, on our business, financial condition, results of operations and prospects, and could also cause the market price of our stock to decline:

 

•

Economic conditions may not stabilize, increasing the likelihood of credit defaults by borrowers.

 

•

Loan collateral values, especially as they relate to commercial and residential real estate, may decline, thereby increasing the severity of loss in the event of loan defaults.

 

•

Demand for banking products and services may decline, including loan products and services for low cost and noninterest-bearing deposits.

 

•

Changes and volatility in interest rates may negatively impact the yields on earning assets and the cost of interest-bearing liabilities.

Our earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. Refer to “Supervision and Regulation” in Item 1 of Part I of this Form 10-K for discussion of certain of these measures. In response to the adverse financial and economic developments that have, in the past decade, impacted the U.S. and global economies and financial markets, and presented challenges for the banking and financial services industry and for our Company, various significant economic and monetary stimulus measures were implemented by the U.S. Congress. Also, the Federal Reserve has pursued a highly accommodative monetary policy aimed at keeping interest rates at historically low levels although the Federal Reserve has begun to taper down certain aspects of this policy and has recently raised short-term interest rates. See “— Fluctuating interest rates could adversely affect our profitability”. U.S. economic activity has shown improvement, but there can be no assurance that this progress will continue or will not reverse. If the U.S. economy were to deteriorate, or its recovery were to slow, this would present significant challenges for the U.S. banking and financial services industry and for our Company.

The challenges to the level of economic activity in the U.S., and, therefore, to the banking industry, have also been exacerbated at times in recent years by extensive political disagreements regarding the statutory debt limit on U.S. federal government obligations and measures to address the substantial federal deficits. These political disagreements led to the downgrade in the long-term sovereign credit rating on the U.S. to “AA+” from “AAA” although other credit rating agencies did not take such action. Certain compromises between the Republican Congress and the Obama Administration were eventually reached which alleviated to some degree the concerns about U.S. sovereign debt. However, there can be no assurance that the earlier political disagreements regarding the federal budget and the substantial federal deficits will not occur again in the future. Any such future disagreements, if not resolved, could result in further downgrades by the rating agencies with respect to the obligations of the U.S. federal government. Any such further downgrades could increase over time the U.S. federal government’s cost of borrowing which may worsen its fiscal challenges, as well as generating upward pressure on interest rates generally in the U.S. which could, in turn, have adverse consequences for borrowers and the level of business activity.

 

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The outcome and impact of these developments cannot be predicted with any certainty, but could have further adverse consequences for the credit ratings of U.S. debt and also present additional challenges for the U.S. economy and for the U.S. banking industry in general and for our business prospects as well. Any of the foregoing developments could generate further uncertainties and challenges for the U.S. economy which, in turn, could adversely affect the prospects of the banking industry in the U.S. and our business.

Tightening of credit markets and liquidity risk could adversely affect our business, financial condition and results of operations.

A tightening of the credit markets or any inability to obtain adequate funds at an acceptable cost for continued loan growth could adversely affect our asset growth and liquidity position and, therefore, our earnings capability. In addition to core deposit growth, maturity of investment securities, and loan payments, the Company also relies on wholesale funding sources including unsecured borrowing lines with correspondent banks, secured borrowing lines with the Federal Home Loan Bank of Seattle and the Federal Reserve Bank of San Francisco, public time certificates of deposits, and out-of-area and brokered time certificates of deposit. Our ability to access these funding sources could be impaired by deterioration in our financial condition as well as factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations for the financial services industry or serious dislocation in the general credit markets. In the event such disruption should occur, our ability to access these funding sources could be adversely affected, both as to price and availability, which would limit, or potentially raise the cost of, the funds available to the Company.

The FDIC has increased insurance premiums to rebuild and maintain the federal deposit insurance fund and there may be additional future premium increases and special assessments which would adversely affect our results of operations.

The Bank’s deposits are insured under the Federal Deposit Insurance Act, up to the maximum applicable limits, and are subject to deposit insurance assessments designed to tie what banks pay for deposit insurance more closely to the risks they pose. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole. As required by the Dodd-Frank Act, the FDIC adopted a comprehensive, long-range “restoration” plan for the deposit insurance fund to better ensure the adequacy of the fund’s reserves relative to total deposits in the U.S. See “Supervision and Regulation- Deposit Insurance” in this Form 10-K. The ultimate effect on our business of these legislative and regulatory developments relating to the deposit insurance fund cannot be predicted with any certainty.

Despite the FDIC’s actions to restore the deposit insurance fund, the fund may suffer additional losses in the future due to failures of insured institutions. There may be additional significant deposit insurance premium increases, special assessments or prepayments in order to restore the insurance fund’s reserve ratio. Any significant premium increases or special assessments could have a material adverse effect on the Company’s financial condition and results of operations.

In the past decade, levels of market volatility were unprecedented and we cannot predict whether they will return.

From time-to-time over the past decade, the capital and credit markets have experienced volatility and disruption at unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If similar levels of market disruption and volatility return, we could experience an adverse effect, which may be material, on our ability to access capital and funding and on our business, financial condition and results of operations.

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.

As discussed more fully in the section entitled “Supervision and Regulation” in this Form 10-K, we are subject to extensive regulation, supervision and examination by federal and state banking authorities. In addition, as a publicly traded company, we are subject to regulation by the SEC. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on us and our operations. Additional legislation and regulations that could significantly affect our powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations. New legislation and regulations are likely to increase the overall costs of regulatory compliance and, in many ways, have increased, or may increase in the future, the cost of doing business and present other challenges to the financial services industry.

 

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Regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws or regulations by financial institutions and bank holding companies in the performance of their supervisory and enforcement duties. In recent years, these powers have been utilized more frequently due to the serious national, regional and local economic conditions we are facing. The exercise of regulatory authority may have a negative impact on our financial condition and results of operations.

Following the financial crisis, the Federal Reserve 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. For additional information, see “Supervision and Regulation – Capital Adequacy” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” in this Form 10-K.

The need to maintain more and higher quality capital under the banking agencies capital rules, as well as greater liquidity, could limit our business activities, including lending, and our ability to expand, either organically or through acquisitions. It could also result in the Company taking steps to increase its capital or being limited in its ability to pay dividends or otherwise return capital to its shareholders, or selling or refraining from acquiring assets. In addition, the regulatory liquidity standards could require the Company to increase its holdings of highly liquid short-term investments, thereby reducing our ability to invest in longer-term or less liquid assets even if more desirable from a balance sheet management perspective.

The capital rules of the U.S. federal banking agencies as well as the various other regulations referred to above, along with other regulations which may be adopted in the future, may also generally increase our cost of doing business or lead us to stop, reduce or modify our offerings of various products.

We cannot accurately predict the ultimate effects of recent legislation or the various governmental, regulatory, monetary and fiscal initiatives which have been and may be enacted on the financial markets, on the Company and on the Bank. The terms and costs of these activities, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity and a continuation or worsening of current financial market and economic conditions, could materially and adversely affect our business, financial condition, results of operations and the trading price of our common stock.

The Administration of newly-elected President Donald J. Trump has yet to promulgate detailed proposals with respect to the oversight and regulation of the financial services industry. There could be significant changes in existing laws and regulations relevant to the industry or the introduction of new laws and regulations. In addition, substantial reform of the federal corporate taxation system in the U.S., including a reduction in corporate and personal tax rates, has been mentioned by representatives of the new Administration as an important objective. While such reform could have positive effects on corporate profitability which could benefit the Company and its customers, there could be other potential adverse consequences for the economy and the business climate, such as a large increase in federal deficits and increasing interest rates generally, including for the federal government’s borrowing costs. The potential long-term impact of these possible developments remains uncertain.

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 December 31, 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. For the past several years, 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 2016, the Federal Reserve raised the target range for the federal funds rate to  ³⁄₄ percent and indicated that the increase notwithstanding, the stance of monetary policy remains accommodative, thereby supporting a policy aimed at further strengthening in the labor market and a return to two percent inflation. The Federal Reserve further indicated that it expects economic conditions to evolve in a manner which will warrant only gradual further increases in the federal funds rate. The Federal Reserve also indicated that it intended to continue its policy of holding longer-

 

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term agency and Treasury securities at sizeable levels to help maintain accommodative financial conditions. 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

Our allowance for loan losses may not be adequate to cover actual loan losses, which could adversely affect our earnings.

We maintain an allowance for loan losses in an amount that we believe is adequate to provide for losses inherent in our loan portfolio. While we strive to carefully manage and monitor credit quality and to identify loans that may be deteriorating, at any time there are loans included in the portfolio that may result in losses, but that have not yet been identified as potential problem loans. Through established credit practices, we attempt to identify deteriorating loans and adjust the loan loss reserve accordingly. However, because future events are uncertain, there may be loans that deteriorate in an accelerated time frame. As a result, future additions to the allowance at elevated levels may be necessary. Because the loan portfolio contains a number of commercial real estate loans with relatively large balances, deterioration in the credit quality of one or more of these loans may require a significant increase to the allowance for loan losses. Future additions to the allowance may also be required based on changes in the financial condition of borrowers, such as have resulted due to the current, and potentially worsening, economic conditions. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses would have an adverse effect, which may be material, on our financial condition and results of operations.

Concentration in real estate loans and further deterioration in the real estate markets we serve could require material increases in our allowance for loan losses and adversely affect our financial condition and results of operations.

We have a high degree of concentration in loans secured by real estate (see Note 5 in the Notes to Consolidated Financial Statements included in this Form 10-K). Further deterioration in the local economies we serve could have a material adverse effect on our business, financial condition and results of operations due to a weakening of our borrowers’ ability to repay these loans, higher default rates, and a decline in the value of the collateral securing these loans. In light of the continuing effects of the economic downturn, real estate values have been adversely affected. As we have experienced, significant declines in real estate collateral can occur quite suddenly as new appraisals are performed in the normal course of monitoring the credit quality of the loan. Significant declines in the value of real estate collateral due to new appraisals can occur due to declines in the real estate market, changes in methodology applied by the appraiser, and/or using a different appraiser than was used for the prior appraisal. Our ability to recover on these loans by selling or disposing of the underlying real estate collateral is adversely impacted by declining real estate values which increases the likelihood we will suffer losses on defaulted loans secured by real estate beyond the amounts provided for in the allowance for loan losses. This, in turn, could require material increases in our allowance for loan losses and adversely affects our financial condition and results of operations, perhaps materially.

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 20.30% in principal amount of our total loan portfolio at December 31, 2016 (see Note 5 in the Notes to Consolidated Financial Statements included in this Form 10-K). 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 December 31, 2016, our nonperforming loans (which include all nonaccrual loans, net of government guarantees) were 0.51% of the loan portfolio. At December 31, 2015, our nonperforming assets (which include foreclosed real estate) were 0.85% 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 January 26, 2017, we announced a quarterly cash dividend of $0.11 per share, payable to shareholders on February 23, 2017. For the year ended December 31, 2016, the Company paid $0.44 per share in dividends and has historically declared dividends quarterly. 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.

Changes in accounting standards could materially impact our financial statements.

From time to time, the Financial Accounting Standards Board (“FASB”) and the SEC change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements or new interpretations of existing standards emerge as standard industry practice. These changes can be very difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, resulting in our restating prior period financial statements.

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. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. At December 31, 2016, we had stock in the FHLB totaling $5,423. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. As of December 31, 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 December 31, 2016, we had $61,401 of goodwill on our 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, 2016. At December 31, 2016, we did not recognize an impairment charge related to our goodwill. Future evaluations of goodwill may result in findings of impairment and write-downs, which would impact our operating results and could be material.

We face strong competition from financial services companies and other companies that offer financial services.

Our three major markets are in Oregon and Washington. The banking and financial services businesses in our market area are highly competitive, and increased competition may adversely impact the level of our loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. These competitors include national banks, foreign banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including savings and loan associations, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products and services provided, including new technology-driven products and services. We have also seen an increase in competition relative to our national dental lending program. If we are unable to attract and retain banking customers, we may be unable to develop loan growth or maintain our current level of deposits, which could adversely affect our business, financial condition and results of operations.

A failure in our operational systems or infrastructure, or those of third-parties, could impair our liquidity, disrupt our businesses, result in the unauthorized disclosure of confidential information, damage our reputation and cause financial losses.

We are dependent on third-parties and their ability to process and monitor, on a daily basis, a large number of transactions, many of which are highly complex, across numerous and diverse markets. These transactions, as well as the information technology services we provide to clients, often must adhere to client-specific guidelines, as well as legal and regulatory standards. Due to the breadth of our client base and our geographical reach, developing and maintaining our operational systems and infrastructure is challenging, particularly as a result of rapidly evolving legal and regulatory requirements and technological shifts. Our financial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, such as electrical, internet or telecommunications outages, a spike in transaction volume, a cybersecurity attack or other unforeseen catastrophic events, which may adversely affect our ability to process these transactions or provide services.

In addition, our operations rely on the secure processing, storage, transmission and reporting of personal, confidential and other sensitive information or data on our computer systems, networks and business applications. Although we take numerous protective measures to maintain the confidentiality, integrity and availability of our and our clients’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks may be vulnerable to breaches, unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cybersecurity attacks and other events that could have an adverse security impact and significant negative consequences to us. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third-parties, such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or the threats may originate from within our organization. These events could result in litigation or financial losses that are either not insured against or not fully covered by insurance, regulatory consequences or reputational harm, any of which could harm our competitive position, operating results and financial condition. These types of incidents can remain undetected for extended periods of time, thereby increasing the associated risks. We may also be required to expend significant resources to modify our protective measures or to investigate and remediate vulnerabilities or exposures arising from cybersecurity risks.

 

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We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third-parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.

Other financial institutions have been the target of various denial-of-service or other cyberattacks as part of what appears to be a coordinated effort to disrupt the operations of financial institutions and potentially test their cybersecurity in advance of future and more advanced cyberattacks. These denial-of-service attacks require substantial resources to defend, and may affect customer satisfaction and behavior. In addition, there have been increasing efforts on the part of third parties to breach data security at financial institutions as well as the other types of companies, such as large retailers, or with respect to financial transactions, including through the use of social engineering schemes such as “phishing”. The ability of our customers to bank remotely, including online and through mobile devices, requires secure transmissions of confidential information and increase the risk of data security breaches which would expose us to financial claims by customers or others and which could adversely affect our reputation. Even if cyberattacks and similar tactics are not directed specifically at the Bank, such attacks on other large financial institutions could disrupt the overall functioning of the financial systems and undermine consumer confidence in banks generally, to the detriment of other financial institutions, including the Bank.

Under the applicable Federal regulatory guidance, financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. In addition, the financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyberattack involving destructive malware. A financial institution is also expected to develop appropriate processes that enable recovery of data and business operations and that address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyberattack. A financial institution which fails to observe the regulatory guidance could be subject to various regulatory sanctions, including financial sanctions.

The Federal bank regulators have also issued a cybersecurity assessment tool, the output of which can assist a financial institution’s senior management and board of directors in assessing the institution’s cybersecurity risk and preparedness. The first part of the assessment tool is the inherent risk profile, which aims to assist management in determining an institution’s level of cybersecurity risk. The second part of the assessment tool is cybersecurity maturity, which is designed to help management assess whether their controls provide the desired level of preparedness. The Federal bank regulators utilize the assessment tool as part of their examination process when evaluating financial institutions’ cybersecurity preparedness in information technology and safety and soundness examinations and inspections. Failure to effectively utilize this tool could result in regulatory criticism. Significant resources may be required to adequately implement the tool and address any assessment concerns regarding preparedness. Management conducted an initial cyber-security assessment using this tool and expects to perform additional periodic assessments to facilitate the identification and remediation of any concerns regarding our cyber-security preparedness.

To date we have not experienced any material losses relating to a cybersecurity incident or other information security breaches, but there can be no assurance that we will not suffer such losses or information security breaches in the future. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, as well as our clients’ or other third-parties’, operations which could result in damage to our reputation, substantial costs, regulatory penalties and/or client dissatisfaction or loss. Potential costs of a cybersecurity incident may include, but would not be limited to, remediation costs, increased protection costs, lost revenue from the unauthorized use of proprietary information or the loss of current and/or future customers, and litigation.

We maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems. However, we cannot assure that this policy would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should we experience any one or more of our or a third-party’s systems failing or experiencing attack.

 

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Our business and financial results could be impacted materially by adverse results in legal or regulatory proceedings.

As is the case with other banking institutions, we are from time to time subject to claims and proceedings related to our present or previous operations. In addition, we may be the subject of governmental investigations and other forms of regulatory inquiry from time to time. The results of these legal proceedings and governmental investigations and inquiries could lead to significant monetary damages or penalties, restrictions on the way in which we conduct our business, or reputational harm, and could involve significant defense or other costs. Although we establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss. In addition, amounts accrued may not represent the ultimate loss to us from the legal proceedings in question. Thus, our ultimate losses may be higher or lower, and possibly significantly so, than the amounts accrued for legal loss contingencies. To mitigate the cost of some of these claims, we maintain insurance coverage in amounts and with deductibles that we believe are appropriate for our operations. However, our insurance coverage does not cover any civil money penalties or fines imposed by government authorities and may not cover all other claims that have been or might be brought against us, or continue to be available to us at a reasonable cost. As a result, we may be exposed to substantial uninsured liabilities, which could adversely affect our business, prospects, results of operations and financial condition.

Risks associated with potential acquisitions and expansion activities or divestitures may disrupt our business and adversely affect our operating results.

We regularly evaluate potential acquisitions and expansion opportunities. We have in the past, and may in the future, seek to expand our business by acquiring other businesses which we believe will enhance our business. We cannot predict the frequency, size or timing of our acquisitions, as this will depend on the availability of prospective target opportunities at valuation levels we find attractive and the competition for such opportunities from other parties. There can be no assurance that our acquisitions will have the anticipated positive results, including results related to: the total cost of integration; the retention of key personnel; the time required to complete the integration; the amount of longer-term cost savings; continued growth; or the overall performance of the acquired company or combined entity. We also may encounter difficulties in obtaining required regulatory approvals and unexpected contingent liabilities can arise from the businesses we acquire or other business combinations we enter into. Further, the asset quality or other financial characteristics of a business or assets we may acquire may deteriorate after an acquisition agreement is signed or after an acquisition closes, which could result in impairment or other expenses and charges which would reduce our operating results. Integration of an acquired business can be complex and costly. If we are not able to integrate successfully past or future acquisitions, there is a risk that results of operations could be adversely affected. To the extent that we grow through acquisitions, there is a risk that we will not be able to adequately or profitably manage this growth. In addition, we may sell or restructure portions of our business. Any divestitures or restructuring may result in significant expenses and write-offs, which would have a material adverse effect on our business, results of operations and financial condition, and may involve additional risks, including difficulties in obtaining any required regulatory approvals, the diversion of management’s attention from other business concerns, the disruption of our business and the potential loss of key employees. We may not be successful in addressing these or any other significant risks encountered in connection with any acquisition or divestitures we might make.

We may issue additional capital in the future, which could dilute the holders of our outstanding common stock and may adversely affect the market price of our common stock.

From time to time, particularly in the current uncertain economic environment, we may consider alternatives for raising capital when opportunities present themselves, in order to further strengthen our capital and/or better position ourselves to take advantage of identified or potential opportunities that may arise in the future. Such alternatives may include issuance and sale of common or preferred stock, or borrowings by the Company, with proceeds contributed to the Bank. Any such capital raising alternatives could dilute the holders of our outstanding common stock and may adversely affect the market price of our common stock.

Anti-takeover provisions in our amended and restated articles of incorporation and bylaws and Oregon law could make a third-party acquisition of us difficult.

Our amended and restated articles of incorporation contain provisions that could make it more difficult for a third-party to acquire us (even if doing so would be beneficial to our shareholders) and for holders of our common stock to receive any related takeover premium for their common stock. We are also subject to certain provisions of Oregon law that could delay, deter or prevent a change in control of us. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

 

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ITEM 1B

Unresolved Staff Comments

None

 

ITEM 2

Properties

The principal properties of the Company are comprised of the banking facilities owned by the Bank. At December 31, 2016 the Bank operated 15 full-service facilities and two loan production offices. The Bank owns a total of eight buildings and, with the exception of three of those buildings, owns the land on which these buildings are situated. Significant properties owned by the Bank are as follows:

 

1)	Three-story building and land with approximately 35,000 square feet located on Olive Street in Eugene, Oregon.

 

2)	Building with approximately 4,000 square feet located on West 11th Avenue in Eugene, Oregon. The building is on leased land.

 

3)	Building and land with approximately 8,000 square feet located on High Street in Eugene, Oregon.

 

4)	Three-story building and land with approximately 36,000 square feet located in Springfield, Oregon. The Company occupies approximately 5,500 square feet of the first floor and approximately 10,763 square feet on the second floor and leases, or is seeking to lease, the remaining space.

 

5)	Building and land with approximately 4,000 square feet located in Beaverton, Oregon.

 

6)	Building and land with approximately 2,000 square feet located in Junction City, Oregon.

 

7)	Building and land with approximately 5,000 square feet located near the Convention Center in Portland, Oregon.

 

8)	Building with approximately 7,000 square feet located at the Nyberg Shopping Center in Tualatin, Oregon. The building is on leased land.

The Bank leases facilities for branch offices in Eugene, Oregon, Portland, Oregon, Seattle, Washington, Bellevue, Washington, and Vancouver, Washington. The Company also leases facilities for a loan production office in Tacoma, Washington. In addition, the Company leases a portion of an adjoining building to the High Street office in Eugene, Oregon for administrative and training functions. Management considers all owned and leased facilities adequate for current use.

 

ITEM 3

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 PCB, Fred “Jack” W. Holcomb, Holcomb Family Limited Partnership, Jones & Roth, P.C., and Umpqua Bank, as defendants. The lawsuit asserts that PCB 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, 2015, 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).

In addition to seeking an award of punitive damages, the trustee is asserted fraudulent transfer law and unjust enrichment in an effort to recover payments made by Berjac to Century Bank and PCB. Among other claims for relief, the trustee is sought 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 PCB 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 asserted a claim for alleged aiding and abetting of breaches of duties owed to Berjac. The complaint in the Trustee’s Lawsuit indicated the range of damages sought by the trustee which included, 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 PCB.

 

 

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On November 16, 2016, 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, PCB reached a tentative settlement of the Class Action and the Trustee’s Lawsuit. Per the December 2, 2016 Trustee’s Motion and Notice of Intent to Settle and Compromise Adversary Proceeding (“Motion”), and subsequently ordered by District Court Judge Aiken on December 6, the settlement and compromise between PCB and the Trustee was to be deemed effective without further order within 23 days unless a written objection to the Trustee’s Motion was filed and served on the Trustee. No written objection was filed, and PCB is informed that no written objection was served on the Trustee. Accordingly, final approval of the settlement of the Trustee’s Action was effective December 29, 2016. The state Circuit Court gave final approval of the settlement of the Class Action at a hearing on January 6, 2017. The settlement is not expected to have a material adverse effect on PCC’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.

 

ITEM 4

Mine Safety Disclosures

Not applicable.

PART II

 

ITEM 5

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information and Shareholders

The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol “PCBK”. At February 28, 2017, the Company had 22,665,881 shares of common stock outstanding held by approximately 3,181 beneficial shareholders.

The high, low and closing sales prices (based on daily closing price) for the last eight quarters are shown in the table below.

 

YEAR		2016																2015
QUARTER		Fourth				Third				Second				First				Fourth				Third				Second				First
Market value:
High		$	22.05			$	16.85			$	17.02			$	16.39			$	16.11			$	13.63			$	13.95			$	13.81
Low			16.50				14.48				15.03				13.78				13.10				12.63				12.74				12.64
Close			21.85				16.82				15.71				16.13				14.88				13.31				13.53				13.22

Dividends

The Company has generally paid cash dividends on a quarterly basis. Cash dividends, when and if declared, are typically declared and announced simultaneously with the Company’s quarterly earnings releases in January, April, July, and October each year with dividends, if any, to be paid in February, May, August, and November. 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, and concentrations of loans as a percentage of capital, as well as growth projections. The Board also considers dividend payout ratios, dividend yield, and other financial metrics in setting the quarterly dividend. Regulatory authorities may prohibit the Company from paying dividends in a manner that would constitute an unsafe or unsound banking practice or would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. Current guidance from the Federal Reserve provides, among other things, that dividends per share generally should not exceed earnings per share, measured over the previous four fiscal quarters.

 

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YEAR		2016																2015
QUARTER		Fourth				Third				Second				First				Fourth				Third				Second				First
Cash dividend		$	0.11			$	0.11			$	0.11			$	0.11			$	0.11			$	0.11			$	0.10			$	0.10
Dividend payout ratio			36.67	%			47.83	%			84.62	%			37.93	%			39.29	%			40.74	%			38.46	%			62.50	%

Equity Compensation Plan Information

 

		Year Ended December 31, 2016
		Number of shares to be issued upon exercise of outstanding options, warrants and rights (2)				Weighted-average exercise price of outstanding options, warrants and rights (2) (3)				Number of shares remaining available for future issuance under equity compensation plans (2)
Equity compensation plans approved by security holders(1)			664,952			$	13.92				408,474
Equity compensation plans not approved by security holders			—				—				—
Total			664,952			$	13.92				408,474

 

(1)

Under the Company’s respective equity compensation plans, the Company may grant incentive stock options and non-qualified stock options, restricted stock, restricted stock units and stock appreciation rights to its employees and directors; however, only employees may receive incentive stock options.

(2)	Amounts have been adjusted to reflect stock splits and stock dividends subsequent to initial issuance of instruments.

(3)	Weighted average exercise price is based on equity grants which have an exercise price.

Share Repurchase Plan

On July 27, 2015, the Company adopted a repurchase plan providing for authority to purchase up to five percent of the Company’s outstanding shares. There were no shares repurchased under the plan during the twelve months ended December 31, 2016.

 

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Performance Graph

The information contained in the following chart entitled “Total Return Performance” is not considered to be “soliciting material,” or “filed,” or incorporated by reference in any past or future filing by the Company under the Securities Exchange Act of 1934 or the Securities Act of 1933 unless and only to the extent that the Company may specifically incorporate it by reference.

 

 

		Period Ended
Index		12/31/11				12/31/12				12/31/13				12/31/14				12/31/15				12/31/16
Pacific Continental Corporation			100.00				113.77				197.85				184.82				200.12				302.06
Russell 2000			100.00				116.35				161.52				169.43				161.95				196.45
SNL Bank $1B-$5B			100.00				123.31				179.31				187.48				209.86				301.92

The above graph and following table compares the total cumulative shareholder return on the Company’s Common Stock, based on reinvestment of all dividends, to the cumulative total returns of the Russell 2000 Index and SNL Securities $1 Billion to $5 Billion Bank Asset Size Index. The graph assumes $100 invested on December 31, 2011, in the Company’s Common Stock and each of the indices.

 

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ITEM 6

Selected Financial Data

Selected financial data for the past five years is shown in the table below.

(Dollars in thousands, except for per share data)

 

		For the year ended December 31,
		2016				2015				2014				2013				2012
		(in thousands, except per share data)
Net interest income		$	83,711			$	69,800			$	57,448			$	56,139			$	50,076
Provision for loan losses			5,450				1,695				—				250				1,900
Noninterest income			7,817				6,625				4,995				5,826				5,741
Noninterest expense			56,593				45,890				37,729				40,732				35,105
Income tax expense			9,709				10,089				8,672				7,216				6,159
Net income			19,776				18,751				16,042				13,767				12,653
Cash dividends			8,983				8,041				12,308				13,050				5,588
Per common share data
Net income:
Basic		$	0.96			$	0.97			$	0.90			$	0.77			$	0.70
Diluted			0.95				0.97				0.89				0.76				0.69
Regular cash dividends		$	0.44			$	0.42			$	0.40			$	0.36			$	0.24
Special cash dividends			—				—				0.29				0.37				0.07
Total dividends		$	0.44			$	0.42			$	0.69			$	0.73			$	0.31
Book value		$	12.11			$	11.15			$	10.39			$	10.01			$	10.28
Tangible book value(1)			8.99				8.94				9.07				8.69				9.05
Market value, end of year			21.85				14.88				14.18				15.94				9.73
At year end
Assets		$	2,541,437			$	1,909,478			$	1,504,325			$	1,449,726			$	1,373,487
Gross loans (2)			1,857,767				1,404,482				1,045,021				993,845				870,416
Allowance for loan losses			(22,454	)			(17,301	)			(15,637	)			(15,917	)			(16,345	)
Available-for-sale securities			470,996				366,598				351,946				347,386				389,885
Core deposits (3)			2,035,067				1,533,942				1,110,861				990,315				938,629
Total deposits			2,148,103				1,597,093				1,209,093				1,090,981				1,046,154
Shareholders’ equity			273,755				218,491				184,161				179,184				183,381
Tangible equity (1)			203,373				175,332				160,666				155,568				161,350
Average for the year
Assets		$	2,159,411			$	1,782,832			$	1,477,060			$	1,433,213			$	1,317,094
Earning assets			2,006,472				1,653,898				1,372,407				1,323,281				1,214,719
Gross loans (2)			1,573,331				1,270,129				1,025,889				959,873				832,787
Allowance for loan losses			(18,999	)			(16,142	)			(15,707	)			(16,492	)			(16,132	)
Available-for-sale securities			416,138				378,747				348,049				365,889				384,810
Core deposits (3)			1,705,556				1,406,168				1,031,140				967,592				877,256
Total deposits			1,794,194				1,475,815				1,132,428				1,074,166				972,854
Interest-paying liabilities			1,211,517				1,049,248				913,018				912,022				833,680
Shareholders’ equity			240,205				208,500				181,762				180,857				181,475
Financial ratios
Return on average:
Assets			0.92	%			1.05	%			1.09	%			0.96	%			0.96	%
Equity			8.23	%			8.99	%			8.83	%			7.61	%			6.97	%
Tangible equity (1)			10.50	%			11.14	%			10.14	%			8.75	%			7.94	%
Avg shareholders’ equity / avg assets			11.12	%			11.69	%			12.31	%			12.62	%			13.78	%
Dividend payout ratio			46.32	%			43.30	%			77.53	%			96.05	%			44.93	%
Regulatory Capital
Tier I capital (to leverage assets)			9.01	%			9.93	%			11.33	%			11.49	%			12.33	%
Common equity tier I capital (to risk weighted assets)(4)			9.52	%			10.97	%			NA				NA				NA
Tier I capital (to risk weighted assets)			10.08	%			11.47	%			14.48	%			14.90	%			16.90	%
Total capital (to risk weighted assets)			12.69	%			12.58	%			15.73	%			16.15	%			18.15	%

 

(1)

Tangible book value per share and tangible equity exclude goodwill and core deposit intangibles related to acquisitions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” - “Results of Operations Overview” in this Form 10-K for a reconciliation of non-GAAP financial measures.

(2)	Outstanding loans include loans held for sale and net deferred fees.

(3)	Core deposits include all demand, interest checking, money market, savings and local non-public time deposits, including local non-public time deposits in excess of $100.

(4)	The Common equity Tier I capitl ratio was established under the Basel Committee’s final rules. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations”—“Capital Resources”, and “Business”— Supervision regarding the final Basel III rules.

 

 

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ITEM 7

Management’s Discussion and Analysis of Financial Condition and Results of Operation

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 audited financial statements and the notes included later in this Form 10-K. All dollar amounts, except per share data, are expressed in thousands of dollars.

HIGHLIGHTS

 

		2016				2015				% Change 2016 vs. 2015				2014				% Change 2015 vs. 2014
		(in thousands, except per share data)
Net income		$	19,776			$	18,751				5.47	%		$	16,042				16.89	%
Operating revenue (1)			91,528				76,425				19.76	%			62,443				22.39	%
Earnings per share
Basic		$	0.96			$	0.97				-1.03	%		$	0.90				7.78	%
Diluted		$	0.95			$	0.97				-2.06	%		$	0.89				8.99	%
Assets, period-end		$	2,541,437			$	1,909,478				33.10	%		$	1,504,325				26.93	%
Gross loans, period-end (2)			1,859,787				1,406,012				32.27	%			1,046,011				34.42	%
Core deposits, period-end (3)			2,035,067				1,533,942				32.67	%			1,110,861				38.09	%
Deposits, period-end			2,148,103				1,597,093				34.50	%			1,209,093				32.09	%
Return on average assets			0.92	%			1.05	%							1.09	%
Return on average equity			8.23	%			8.99	%							8.83	%
Return on average tangible equity (4)			10.50	%			11.14	%							10.14	%
Avg shareholders’ equity / avg assets			11.12	%			11.69	%							12.31	%
Dividend payout ratio			46.32	%			43.30	%							77.53	%
Net interest margin (5)			4.29	%			4.32	%							4.27	%
Efficiency ratio			61.13	%			59.22	%							59.41	%

 

(1)	Operating revenue is defined as net interest income plus noninterest income.

(2)	Excludes net deferred fees and allowance for loan losses.

(3)	Defined by the Company as demand, interest checking, money market, savings and local non-public time deposits, including local non-public time deposits in excess of $100.

(4)	Tangible equity excludes goodwill and core deposit intangibles related to acquisitions.

(5)	Presentation of net interest margin for all periods reported has been adjusted to a tax- equivalent basis using a 35% tax rate.

Merger

On January 9, 2017, Pacific Continental entered into a definitive agreement to merge with Columbia Banking System, Inc., headquartered in Tacoma, Washington. Upon completion of the merger, the combined company will operate under the Columbia Bank name and brand. The agreement was approved by the Board of Directors of each company. Closing of the transaction, which is expected to occur in mid-2017, is contingent on shareholder approval and receipt of necessary regulatory approvals, along with satisfaction of other customary closing conditions.

Results of Operations—Overview

The Company recorded net income of $19,776 for the year ended 2016, an improvement of $1,025 or 5.47% over the prior year. The results for 2016 and 2015 included $4,934 and $1,836, respectively, in merger-related expenses associated with the 2016 acquisition of Foundation Bank Bancorp, Inc. (“Foundation”) and the 2015 acquisition of Capital Pacific Bancorp. Improvement in 2016 net income over 2015 was due to increased revenues, specifically net interest income. A portion of the improvement in net interest income was offset by increased loan loss provision, higher noninterest expenses, primarily personnel expense, and merger-related expenses. The Company recorded $5,450 in provision for loan losses in 2016 compared to $1,695 in 2015. This increase was primarily due to a high level of growth in organic loans, however the bank did experience some small credit deterioration, related to a downgrade of one dental relationship.

 

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The Company recorded net income of $18,751 for the year ended 2015, an improvement of $2,709 or 16.89% over the prior year. The results for 2015 and 2014 included $1,836 and $470, respectively, in merger-related expenses associated with the acquisition of Capital Pacific Bancorp. Improvement in 2015 net income over 2014 was due to increased revenues, specifically net interest income. The increase in net interest income was attributable to an increase in organic loans and improvement in the yield on the securities portfolio. The Company made $1,695 in provision for loan losses in 2015 compared to no provision in 2014. This increase was primarily attributable to portfolio growth as the bank experienced a reduction in classified assets and nonperforming loans.

Year-end assets at December 31, 2016, were $2,541,437, up $631,959 or 33.10% from December 31, 2015, asset totals. Growth in assets was mainly due to an increase in outstanding gross loans of $453,775, which included $270,533 of loans acquired in the Foundation acquisition. Total assets also grew $27,223 due to the goodwill and core deposit intangible associated with the Foundation acquisition. The Company experienced a typical seasonal core deposit pattern in 2016 with deposit outflows occurring during the first half of the year followed by growth in core deposits during the second half of the year. Outstanding core deposits were $2,035,067 at December 31, 2016, up $501,125 or 32.67% over the prior year-end. A portion of this growth was related to the Foundation acquisition, with acquired core deposits totaling $396,509 at September 6, 2016. The remainder of the core deposit growth was due to new relationships or growth in existing relationships in the bank’s current markets. Growth in the Company’s demand deposits accounted for $290,308 of the increase in core deposits and was up 51.05% over December 31, 2015, outstanding demand deposits.

During 2016, the Company believes the following factors could impact our financial results, in addition to those described in “Risk Factors” and elsewhere in this Form 10-K:

 

•

Changes and volatility in interest rates could negatively impact yields on earning assets and the cost of interest-bearing liabilities, thus negatively affecting the Company’s net interest margin and net interest income.

 

•

Global economic weakness and a rise in short-term interest rates could lead to a slowdown of economic growth, thus negatively affecting loan demand, causing a decline in banking industry revenues.

 

•

Increased market competition for quality loans could cause a reduction in loan yields.

 

•

The ability to manage noninterest expense growth in light of regulatory compliance cost.

 

•

The competition to attract and retain qualified and experienced bankers in our markets.

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 Financial Statements and Supplementary Data in this Form 10-K.

The Company presents a computation of tangible equity and tangible assets 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.

 

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The following table presents a reconciliation of total shareholders’ equity to tangible equity.

 

		December 31,
		2016				2015				2014
		(in thousands, except per share data)
Total shareholders’ equity		$	273,755			$	218,491			$	184,161
Subtract:
Goodwill			(61,401	)			(39,255	)			(22,881	)
Core deposit intangibles			(8,981	)			(3,904	)			(614	)
Tangible shareholders’ equity (non-GAAP)		$	203,373			$	175,332			$	160,666
Book value		$	12.11			$	11.15			$	10.39
Tangible book value (non-GAAP)		$	8.99			$	8.94			$	9.07
		December 31,
		2016				2015				2014
Average Total shareholders’ equity		$	241,721			$	209,943			$	181,762
Subtract:
Average goodwill			(46,304	)			(35,216	)			(22,881	)
Average core deposit intangibles			(5,459	)			(3,467	)			(674	)
Average Tangible shareholders’ equity (non-GAAP)		$	189,958			$	171,260			$	158,207
Return on average equity			8.23	%			8.99	%			8.83	%
Return on average tangible equity (non-GAAP)			10.50	%			11.14	%			10.14	%

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 measure 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.

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 FASB finalized the Codification effective for periods ending on or after September 15, 2009. Prior FASB Statements, Interpretations, Positions, EITF consensuses, and AICPA Statements of Position are no longer being issued by the FASB. The Codification does not change how the Company accounts for its transactions or the nature of related disclosures made. However, when referring to guidance issued by the FASB, the Company refers to topics in the ASC rather than the specific FASB statement. We have updated references to GAAP in this report to reflect the guidance in the Codification.

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 this Form 10-K. Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements 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

 

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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.

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 troubled debt restructurings can be found in Note 5 of the Notes to Consolidated Financial Statements in this Form 10-K.

Goodwill and Intangible Assets

At December 31, 2016, the Company had a recorded balance of $61,401 in goodwill from the November 30, 2005, acquisition of Northwest Business Financial Corporation (“NWBF”), the February 1, 2013, acquisition of Century Bank, the March 6, 2016 acquisition of Capital Pacific Bank and the September 6, 2016 acquisition of Foundation Bank. In addition, at December 31, 2016, the Company had $8,981 of core deposit intangible assets resulting from the acquisition of Century Bank, Capital Pacific Bank and Foundation Bank. The Century Bank core deposit intangible was determined to have an expected life of seven years, and is being amortized over that period using the straight-line method. The Century Bank core deposit intangible will be fully amortized in January 2020. The Capital Pacific Bank core deposit intangible was determined to have an expected life of ten years, and is being amortized over that period using the straight-line method. The Capital Pacific Bank core deposit intangible will be fully amortized in February 2025. The Foundation Bank core deposit intangible 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 August 2026. In accordance with GAAP, the Company does not amortize goodwill or other intangible assets with indefinite lives but instead periodically tests these assets 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, 2016, at which time no impairment was determined to exist.

Share-based Compensation

Consistent with the provisions of FASB ASC 718, Stock Compensation, a revision to the previously issued guidance on accounting for stock options and other forms of equity-based compensation, we recognize expense 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 restricted stock unit is calculated using the stock closing price on the grant date with the expense recognized over the service period of the equity award. Additional information is included in Note 1 of the Notes to Consolidated Financial Statements in this Form 10-K.

 

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Fair Value Measurements

Generally accepted accounting principles define 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.

Recent Accounting Pronouncements

Recent accounting pronouncements are discussed in Note 1 of the Notes to Consolidated Financial Statements in this Form 10-K. None of these pronouncements are expected to have a significant effect on the Company’s financial condition or results of operations.

RESULTS OF OPERATIONS

Net Interest Income

The largest component of the Company’s earnings is net interest income. Net interest income is the difference between interest income derived from earning assets, principally loans, and the 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.

The following two tables follow which analyze the changes in net interest income for the years 2016, 2015 and 2014. Table I, “Average Balance Analysis of Net Interest Income,” provides information with regard to average balances of assets and liabilities as well as associated dollar amounts of interest income and interest expense, relevant average yields or rates, and net interest income as a percent of average earning assets. Net interest income and the net interest margin for all periods reported have been adjusted to a tax-equivalent basis using a 35.00% tax rate. Table II, “Analysis of Changes in Interest Income and Interest Expense,” shows the increase (decrease) in the dollar amount of interest income and interest expense and the differences attributable to changes in either volume or rates.

 

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Table I

Average Balance Analysis of Net Interest Income

(dollars in thousands)

 

		Twelve Months Ended												Twelve Months Ended												Twelve Months Ended
		December 31, 2016												December 31, 2015												December 31, 2014
		Average Balance				Interest Income or (Expense)				Average Yields or Rates				Average Balance				Interest Income or (Expense)				Average Yields or Rates				Average Balance				Interest Income or (Expense)				Average Yields or Rates
Interest-earning assets
Federal funds sold and interest-bearing deposits		$	30,032			$	154				0.51	%		$	13,869			$	34				0.25	%		$	3,926			$	10				0.25	%
Federal Home Loan Bank stock			5,970				141				2.36	%			7,294				50				0.69	%			10,250				10				0.10	%
Securities available-for-sale:
Taxable			341,832				7,601				2.22	%			305,850				6,482				2.12	%			276,625				6,181				2.23	%
Tax-exempt (1)			74,306				2,988				4.02	%			72,898				3,040				4.17	%			71,424				3,032				4.25	%
Loans, net of deferred fees and allowance (2)
Taxable			1,497,320				77,735				5.19	%			1,223,763				64,557				5.28	%			1,004,438				53,627				5.34	%
Tax-exempt (3)			57,012				3,645				6.39	%			30,224				1,749				5.79	%			5,744				350				6.09	%
Total interest-earning assets			2,006,472				92,264				4.60	%			1,653,898				75,912				4.59	%			1,372,407				63,210				4.61	%
Non earning assets
Cash and due from banks			27,974												22,536												18,506
Premises and equipment			19,167												17,822												18,324
Goodwill & intangible assets			51,842												40,183												23,556
Interest receivable and other			53,956												48,393												44,267
Total nonearning assets			152,939												128,934												104,653
Total assets		$	2,159,411											$	1,782,832											$	1,477,060
Interest-bearing liabilities
Money market and NOW accounts		$	866,683			$	(2,281	)			-0.26	%		$	747,918			$	(1,956	)			-0.26	%		$	543,116			$	(1,491	)			-0.27	%
Savings deposits			72,012				(157	)			-0.22	%			60,185				(74	)			-0.12	%			51,164				(67	)			-0.13	%
Time deposits—core			65,724				(245	)			-0.37	%			79,798				(309	)			-0.39	%			60,685				(326	)			-0.54	%
Total interest-bearing core deposits (4)			1,004,419				(2,683	)			-0.27	%			887,901				(2,339	)			-0.26	%			654,965				(1,884	)			-0.29	%
Non-core time deposits			88,638				(1,164	)			-1.31	%			69,647				(975	)			-1.40	%			101,288				(1,368	)			-1.35	%
Interest-bearing repurchase agreements			655				—				0.00	%			—				—				0.00	%			—				—				0.00	%
Federal funds and overnight funds purchased			776				(8	)			-1.03	%			1,555				(11	)			-0.71	%			2,053				(14	)			-0.68	%
Federal Home Loan Bank borrowings			90,313				(954	)			-1.06	%			81,897				(885	)			-1.08	%			146,464				(1,088	)			-0.74	%
Subordinated debentures			17,506				(1,143	)			-6.53	%			—				—				0.00	%			—				—				0.00	%
Junior subordinated debenture			9,210				(279	)			-3.03	%			8,248				(226	)			-2.74	%			8,248				(225	)			-2.73	%
Total interest-bearing wholesale funding			207,098				(3,548	)			-1.71	%			161,347				(2,097	)			-1.30	%			258,053				(2,695	)			-1.04	%
Total interest-bearing liabilities			1,211,517				(6,231	)			-0.51	%			1,049,248				(4,436	)			-0.42	%			913,018				(4,579	)			-0.50	%
Noninterest-bearing liabilities
Demand deposits			701,137												518,267												376,175
Interest payable and other			6,552												6,817												6,105
Total noninterest liabilities			707,689												525,084												382,280
Total liabilities			1,919,206												1,574,332												1,295,298
Shareholders’ equity			240,205												208,500												181,762
Total liabilities and shareholders’ equity		$	2,159,411											$	1,782,832											$	1,477,060
Net interest income						$	86,033											$	71,476											$	58,631
Net interest margin (1)(3)							4.29	%											4.32	%											4.27	%

 

(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 $1,046, $1,064, and $1,061 for the twelve months ended December 31, 2016, 2015, and 2014, respectively. Net interest margin was positively impacted by 5, 6 and 8 basis points, respectively.

(2)	Interest income includes recognized loan origination fees of $1,091, $702, and $574 for the twelve months ended December 31, 2016, 2015, and 2014, 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 $1,276, $612, and $122 for the twelve months ended December 31, 2016, 2015, and 2014, respectively. Net interest margin was positively impacted by 6, 4, and 1 basis points, respectively.

(4)	Defined by the Company as interest checking, money market, savings and local non-public time deposits, including local non-public time deposits in excess of $100.

 

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Table II

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

 

		2016 compared to 2015												2015 compared to 2014
		Increase (decrease) due to												Increase (decrease) due to
		Volume				Rate				Net				Volume				Rate				Net
Interest earned on:
Federal funds sold and interest-bearing deposits		$	40			$	80			$	120			$	25			$	(1	)		$	24
Federal Home Loan Bank stock			(9	)			100				91				(3	)			43				40
Securities available-for-sale:
Taxable			763				356				1,119				653				(352	)			301
Tax-exempt (1)			59				(111	)			(52	)			63				(55	)			8
Loans, net of deferred fees and allowance
Taxable			14,431				(1,253	)			13,178				11,710				(780	)			10,930
Tax-exempt (2)			1,551				345				1,896				1,492				(93	)			1,399
Total interest-earning assets		$	16,835			$	(483	)		$	16,352			$	13,940			$	(1,238	)		$	12,702
Interest paid on:
Money market and NOW accounts		$	311			$	14			$	325			$	562			$	(97	)		$	465
Savings deposits			15				68				83				12				(5	)			7
Time deposits—core (3)			(54	)			(10	)			(64	)			103				(120	)			(17	)
Total interest-bearing core deposits			272				72				344				677				(222	)			455
Non-core time deposits			266				(77	)			189				(427	)			34				(393	)
Interest-bearing repurchase agreements			—				—				—				—				—				—
Federal funds and overnight funds purchased			(6	)			3				(3	)			(3	)			—				(3	)
Federal Home Loan Bank borrowings			91				(22	)			69				(480	)			277				(203	)
Subordinated debentures			—				1,143				1,143				—				—				—
Junior subordinated debenture			26				27				53				—				1				1
Total interest-bearing wholesale funding			377				1,074				1,451				(910	)			312				(598	)
Total interest-bearing liabilities			649				1,146				1,795				(233	)			90				(143	)
Net interest income		$	16,186			$	(1,629	)		$	14,557			$	14,173			$	(1,328	)		$	12,845

 

(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 $1,046, $1,064, and $1,061 for the twelve months ended December 31, 2016, 2015, and 2014, respectively. Net interest margin was positively impacted by 5, 6 and 8 basis points, 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 $1,276, $612, and $122 for the twelve months ended December 31, 2016, 2015, and 2014, respectively. Net interest margin was positively impacted by 6, 4, and 1 basis points, respectively.

(3)	Defined by the Company as interest checking, money market, savings and local non-public time deposits, including local non-public time deposits in excess of $100.

 

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Core Margin, non-GAAP

To better understand the Bank’s results of operations we have provided the following non-GAAP financial metric, which removes nonrecurring interest income and accretion income relating to the Bank’s acquired loan portfolio fair value discounts to provide a “core net interest margin.” While management believes the presentation of this non-GAAP financial measure provides additional insight into our operating performance, readers of this report are urged to review the GAAP results as presented in the Financial Statements and Supplementary Data in this Form 10-K.

Reconciliation of Adjusted Net Interest Income to Net Interest Income

 

		December 31,
		2016				2015				2014
		(in thousands, except per share data)
Tax equivalent net interest income (1)		$	86,033			$	71,476			$	58,631
Subtract
Century Bank accretion			125				341				527
Capital Pacific Bank accretion			1,090				1,950				—
Foundation Bank accretion			2,471				—				—
Interest recoveries on nonaccrual loans			—				—				100
Prepayment penalties on loans			737				133				187
Prepayment penalties on brokered deposits			(61	)			(54	)			—
Adjusted net interest income (non-GAAP)		$	81,671			$	69,106			$	57,817
Average earning assets		$	2,006,472			$	1,653,898			$	1,372,407
Net interest margin			4.29	%			4.32	%			4.27	%
Core net interest margin (non-GAAP)			4.07	%			4.18	%			4.21	%

 

(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 $2,322, $1,676 and $1,183 for the twelve months ended December 31, 2016, 2015, and 2014, respectively.

Nonrecurring items outlined above added 22 and 14 basis points to the 2016 and 2015 net interest margins, respectively. When comparing non-GAAP core net interest margin, we saw a decrease of 11 basis points from 4.18% in 2015 to 4.07% in 2016.

2016 Compared to 2015

The net interest margin for the year 2016 was 4.29%, representing a decrease of 3 basis points from the 4.32% net interest margin reported for 2015. The decrease was primarily attributable to a decrease in the yield on earning assets in addition to an increase in the cost of wholesale deposits.

The yield on taxable loans dropped 8 basis points from 2015 to 2016, which is after the inclusion of $1,952 in nonrecurring interest income, primarily attributable to accretion on the acquired loan portfolios. Without the inclusion of the nonrecurring interest income, the yield on our taxable loan portfolio would have been 5.06%, which represented a reduction of 21 basis points from the prior year. Accretion income relating to the acquired portfolios is recognized in interest income using the interest method for amortizing loans, and on a straight-line basis for lines of credit. It is typical for accretion income to be higher toward the beginning of an acquired portfolio’s life and begin to reduce as loans pay off, refinance, or balances reduce due to standard amortization. At December 31, 2016, the acquired loan portfolios had a remaining balance of $11,297 related to the purchased fair value discount for credit and interest rate. In addition to a decrease in the taxable portion of the loan portfolio, we saw an increase in the yield on tax exempt loans. The increase was primarily attributable to the Company’s involvement with the Oregon SNAP bond program financing, which in many cases has fixed rate financing for a ten year period. This extended maturity led to an increase in the yield on the tax exempt portfolio.

 

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During 2016 the cost of interest-bearing core deposits increased by 1 basis point, which was primarily attributable to the increased cost of the Foundation acquired deposits. Typically, following an acquisition the Bank will grant temporary rate variances to allow bankers time to determine which variances, if any need to remain. In addition, the Bank saw an increase in the cost of wholesale funding of 0.41%. The increase was attributable to the cost of the subordinated debenture, which was issued at the end of June 2016, in conjunction with the planned acquisition of Foundation Bank and the acquisition of Foundation Bank’s junior subordinated debenture.

The year ended December 31, 2016, rate/volume analysis in Table II shows that interest income including loan fees increased by $16,351 over 2015. Higher volume, primarily higher loan volume, resulted in an increase of $16,834 in interest income in 2016, which was partially offset by a $483 decline in interest income due to lower rates on loans. The reduction in income due to lower rates would have been greater if the Bank did not recognize accretion income of $3,686, as a result of the three prior acquisitions. The rate/volume analysis shows that interest expense for the year 2016 increased by $1,798. An increase in the interest paid on wholesale funding of $1,454 was primarily attributable to interest expense on the subordinated debenture, which was entered into in June 216. Overall, changes in the volume mix increased interest expense by $649 in 2016, while higher rates on interest-bearing liabilities increased interest expense by $1,146.

2015 Compared to 2014

The net interest margin for the year 2015 was 4.32%, representing an increase of 5 basis points from the 4.27% net interest margin reported for 2014. Table I shows earning asset yields declined by 3 basis points from 4.61% in 2014 to 4.59% in 2015, which was more than offset by the decrease in the cost of interest bearing liabilities from 0.50% in 2014 to 0.42% in 2015.

The yield on taxable loans dropped 6 basis points from 2014 to 2015, which is after the inclusion of $2,424 in nonrecurring interest income, primarily attributable to accretion on the acquired loan portfolios. Without the inclusion of the nonrecurring interest income, the yield on our taxable loan portfolio would have been 5.08%, which represents a reduction of 26 basis points from the prior year.

The 2015 net interest margin benefitted from a decline in the cost of interest-bearing liabilities. The cost of interest-bearing core deposits declined by 3 basis points, which was partially offset by an increase in the cost of interest-bearing wholesale funding of 26 basis points. The Bank saw an increase in demand deposits of $142,092 over the prior year, which helped to reduce the average balance of wholesale funding by $96,706 from $258,053 in 2014 to $161,347 in 2015. Therefore, even though the cost of wholesale funding increased during the period, the impact of that increase was minimal as only 15.38% of interest bearing liabilities relate to non-core funding.

 

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Provision for Loan Losses

Management provides for possible loan losses by maintaining an allowance. The level of the allowance is determined based upon judgments regarding the size and nature of the loan portfolio, historical loss experience, the financial condition of borrowers, the level of nonperforming loans, and current general economic conditions. Additions to the allowance are charged to expense. Loans are charged against the allowance when management believes the collection of principal is unlikely.

The Company made $5,450 in provision for loan losses in 2016, compared to $1,695 in 2015. The increase in the 2016 provision was due to loan growth, and some credit deterioration associated with a few customer relationships. The Bank’s organic loan portfolio grew by $183,242 during 2016, which is excluding the $270,533 of loans acquired in the Foundation Bank acquisition, which are purchased net of their credit and interest fair value adjustments and only included in our provision to the extent their reserve exceeds the remaining credit related fair value discount. Of the $5,450 in 2016 provision for loan losses, $783 was allocated to the acquired portfolios. Net loan charge offs for the year 2016 were $297 compared to $31 in 2015.

 

		December 31,
		2016				2015				2014
Substandard contingent liabilities		$	1,026			$	726			$	562
Impaired loans (less government guarantees)			18,074				8,451				6,032
Substandard loans (less government guarantees)			24,821				23,834				22,451
Classified securities			1,338				1,517				1,879
Other real estate owned			12,068				11,747				13,374
Classified Assets		$	57,327			$	46,275			$	44,298
Tier 1 Capital		$	221,346			$	183,600			$	164,864
Allowance for Loan Losses			22,454				17,301				15,637
		$	243,800			$	200,901			$	180,501
Classified Asset Ratio			23.51	%			23.03	%			24.54	%

When comparing December 31, 2016 to December 31, 2015, the Bank saw an increase in classified assets of $13,029, which translated into a classified asset ratio increase of 0.48%. This increase primarily related to the acquisition of Foundation Bank, which added approximately $20,256 in classified assets at the close of the acquisition. The Bank’s organic loan portfolio continued to see resolutions of classified assets. When excluding the acquired substandard loans the Bank’s organic substandard loans decreased by $9,204. This trend is indicative of past years where the classified asset totals are temporarily raised following an acquisition, but through resolution efforts by the Bank’s special assets group totals begin to lower following the acquisition.

 

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Nonperforming Assets

At December 31, 2016, the Company had $21,547 in nonperforming assets, net of government guarantees, or 0.85% of total assets, compared to $14,466 or 0.76% of total assets at December 31, 2015. The schedule below provides a more detailed breakdown of nonperforming assets by loan type:

NONPERFORMING ASSETS

 

		December 31,
		2016				2015
Nonaccrual loans
Real estate secured loans:
Permanent loans:
Multi-family residential		$	—			$	—
Residential 1-4 family			1,294				733
Owner-occupied commercial			1,605				2,369
Nonowner-occupied commercial			3,374				790
Total permanent real estate loans			6,273				3,892
Construction loans:
Multi-family residential			—				—
Residential 1-4 family			—				53
Commercial real estate			—				—
Commercial bare land and acquisition & development			—				—
Residential bare land and acquisition & development			—				—
Total real estate construction loans			—				53
Total real estate loans			6,273				3,945
Commercial loans			5,560				1,564
Consumer loans			—				—
Total nonaccrual loans			11,833				5,509
90 days past due and accruing interest			—				—
Total nonperforming loans			11,833				5,509
Nonperforming loans guaranteed by government			(2,354	)			(2,790	)
Net nonperforming loans			9,479				2,719
Other real estate owned			12,068				11,747
Total nonperforming assets, net of guaranteed loans		$	21,547			$	14,466
Net nonperforming loans to net outstanding loans			0.51	%			0.19	%
Net nonperforming assets to total assets			0.85	%			0.76	%

Nonperforming assets at December 31, 2016, consisted of $9,479 of nonaccrual loans (net of $2,354 in government guarantees) and $12,068 of other real estate owned. Total nonperforming assets at December 31, 2016, were up $7,081 from nonperforming assets at December 31, 2015, as the Company acquired nonperforming assets in the Foundation Bank acquisition. At December 31, 2016, dental nonperforming assets totaled $2,067, up $1,554 from the $513 reported at December 31, 2015. The increase in dental nonperforming assets is primarily attributable to one large relationship, which was placed on nonaccrual during the third quarter of 2016. This relationship is being monitored and reviewed by the Bank’s special assets group and will continue to be evaluated for potential impairment.

 

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Other real estate owned at December 31, 2016, consisted of seven properties, including two properties valued at $1,103 acquired through the Foundation Bank acquisition. Two properties, a commercial land development loan, which contains two separate parcels, a commercial real estate property, and a residential vacation home valued at $9,839, $960 and $1,013 respectively, made up 97.88% of total other real estate owned at December 31, 2016. Subsequent to the end of the year the Company closed a sale of one of its OREO properties, which was valued at $1,013, generating a gain on sale of $3. In addition, the Company is currently under contract for the sale of one of the two parcels of the large commercial real estate property. Timing or completion of the sale cannot currently be determined, however closing is anticipated prior to the end of 2017. While the Company is actively marketing all properties, the location and type of these properties make them susceptible to possible valuation write-downs as new appraisals become available.

The allowance for loan losses at December 31, 2016, was $22,454 (1.21% of gross outstanding loans) compared to $17,301 (1.23% of loans) and $15,637 (1.49% of loans) at the years ended 2015 and 2014, respectively. The reduction in the allowance for loan losses to total loans ratio was primarily due to loans acquired in the Foundation Bank and the Capital Pacific Bank acquisitions, which were booked net of fair value adjustments, including the fair value adjustment for credit and potential losses. At December 31, 2016, the Company had also reserved $548 for possible losses on unfunded loan commitments, which was classified in other liabilities. The 2016 ending allowance included $736 in specific allowance for $12,568 in impaired loans. At December 31, 2015, the Company had $8,800 in impaired loans with a specific allowance of $175 assigned.

The dental allowance for loan losses at December 31, 2016, was $4,713 or 1.25% of dental loans. This is a decrease from the dental allowance of $4,022 or 1.18% of dental loans at December 31, 2015. The increase is primarily attributable to a specific reserve associated with one dental relationship. Historically, the allowance for dental loans was lower than the Bank’s non-dental loans due to a historically low loss experience in the portfolio. For additional information on the dental portfolio statistics, please see Note 6 of the Consolidated Financial Statement in this Form 10-K.

While the Company saw some positive credit trends in 2016, with the exception of the classified assets acquired from Foundation Bank, management cannot predict with certainty the level of the provision for loan losses, the level of the allowance for loans losses, nor the level of nonperforming assets in future quarters. At December 31, 2016, and as shown in this Form 10-K under Note 5 of the Notes to Consolidated Financial Statements, the Company had unallocated reserves of $1,146, representing 5.10% of the total allowance for loan losses. Management believes that the allowance for loan losses at December 31, 2016, is adequate and this level of unallocated reserves was prudent in light of the economic conditions that exist in the Northwest markets the Company serves and the increased growth experienced in the portfolio during the last three quarters of 2016.

Noninterest Income

Noninterest income is derived from sources other than fees and interest on earning assets. The Company’s primary sources of noninterest income are service charge fees on deposit accounts, merchant bankcard activity, and business credit card interchange fees. Below is a summary of noninterest income for 2016, 2015 and 2014.

 

		Years Ended																Year Ended
		December 31,																December 31,
		2016				2015				change $				change %				2014				change $				change %
Service charges on deposit accounts		$	2,876			$	2,644			$	232				8.77	%		$	2,134			$	510				23.90	%
Bankcard Income			1,214				1,029				185				17.98	%			951				78				8.20	%
Bank-owned life insurance income			702				592				110				18.58	%			473				119				25.16	%
Net gain (loss) on sale of investment securities			373				672				(299	)			-44.49	%			(34	)			706				-2076.47	%
Impairment losses on investment securities (OTTI)			(21	)			(22	)			1				-4.55	%			—				(22	)			NA
Other noninterest income			2,673				1,710				963				56.32	%			1,471				239				16.25	%
		$	7,817			$	6,625			$	1,192				17.99	%		$	4,995			$	1,630				32.63	%

2016 Compared to 2015

Noninterest income for the year 2016 was up $1,192 or 17.99% from the same period last year. The increase in noninterest income in 2016 when compared to the prior year was due to 1) increased service charge revenue from the full year impact of the Capital Pacific acquisition, and the additional service charge earned from the Foundation Bank acquisition, 2) increased bankcard income through our Vantiv partnership and 3) increase in other income. The other income category increase was due to many factors, including $327 gain on the early liquidation of a cash flow hedge tied to FHLB borrowing, which was terminated during the fourth quarter. The Bank also booked $157 in other income tied to legal and collection expense incurred by Capital Pacific Bank, prior to the acquisition, which was reimbursed to the Bank. In addition, we experienced a $124

 

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increase in business credit card interchange, primarily tied to increased client usage. In 2016, the Bank changed its business MasterCard product and began offering rewards, which increased users use of the card and interchange revenue.

2015 Compared to 2014

Noninterest income for the year 2015 was up $1,630 or 32.63% from the same period last year. The increase in noninterest income in 2015 when compared to the prior year was due to gains on sales in the securities portfolio, an increase in service charge and increased earnings on bank owned life insurance. During 2015, the Bank sold $52,119 of securities generating a net gain of $672. The security sales were primarily related to a repositioning of the portfolio, which resulted in a gain. The increase in service charges on deposit accounts is partially attributable to an increase in outstanding deposits through the acquisition of Capital Pacific Bank in March 2015 and an increase in account analysis fees effective April 1, 2015. The increase in BOLI earnings related to the BOLI policies acquired through the Capital Pacific Bank acquisition, not an increase in the overall BOLI yield. When comparing 2014 and 2015, the yield on BOLI declined from 2.89% at December 31, 2014, to 2.75% at December 31, 2015, which was reflective of a decrease in the asset yields associated with the policies. The tax equivalent yield on the BOLI policies for the periods ended December 31, 2015 and 2014 were 4.23% and 4.45%, respectively.

Noninterest Expense

Noninterest expense represents all expenses other than the provision for loan losses and interest costs associated with deposits and other interest-bearing liabilities. It incorporates personnel, premises and equipment, data processing and other operating expenses. Below is a summary of noninterest income for 2016, 2015 and 2014.

 

		Years Ended																Year Ended
		December 31,																December 31,
		2016				2015				change $				change %				2014				change $				change %
Salaries and employee benefits		$	31,873			$	27,501			$	4,372				15.90	%		$	23,555			$	3,946				16.75	%
Property and equipment			4,742				4,347				395				9.09	%			3,735				612				16.39	%
Data processing			3,709				3,259				450				13.81	%			2,720				539				19.82	%
Business development			2,049				1,640				409				24.94	%			1,531				109				7.12	%
Legal and professional services			3,297				1,924				1,373				71.36	%			1,252				672				53.67	%
FDIC insurance assessment			1,089				1,051				38				3.62	%			868				183				21.08	%
Merger-related expense			4,934				1,836				3,098				168.74	%			470				1,366				290.64	%
Other real estate expense			(36	)			346				(382	)			-110.40	%			449				(103	)			-22.94	%
Other noninterest expense			4,936				3,986				950				23.83	%			3,149				837				26.58	%
		$	56,593			$	45,890			$	10,703				23.32	%		$	37,729			$	8,161				21.63	%

2016 Compared to 2015

During 2016 the Bank experienced a significant increase in noninterest expense, in every category, with the exception of other real estate income/expense. The largest area of increase related to salaries and benefits, which was up $4,372 or 15.90% over 2015. The increase was attributable to the full year impact of the 19 FTEs retained through the Capital Pacific acquisition, who were only included in 2015 from the close date of March 6, 2015 through year end. The acquisition of Foundation Bank’s 33 employees were also included in the 2016 salaries and benefits totals from the acquisition close on September 6, 2016, through year end. The Bank also incurred $150 of stock based compensation expense associated with liability based stock awards tied to the Company’s stock price. As the stock price increased significantly during the year, it was necessary to increase the liability. Apart from employee related expenses the Bank saw an increase in legal and professional expenses associated with increased legal expense related to pending litigation and continued legal expense related to the expansion of the Bank’s national dental footprint. The Bank also saw an increase in merger-related expense of $3,098 due to the full cost of the Foundation Bank acquisition being incurred in 2016, compared to a portion of the expenses associated with Capital Pacific Bank posting in 2015.

2015 Compared to 2014

For the year 2015, noninterest expense was up $8,161 or 21.63% from the prior year. When merger expenses relating to the acquisition of Capital Pacific Bank of $1,836 recorded in 2016, and $470 recorded in 2014, are excluded from noninterest expense, the 2016 expense was up $6,795 or 18.24% over 2015. The largest noninterest expense fluctuation was related to salary and benefits expense, which increased $3,946 or 16.75% over the prior year. Of the overall increase in salaries and benefits, $2,606 is attributable to increases in base salary expense associated with 34 FTE positions added during 2016,

 

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including 19 employees retained after the Capital Pacific Bank acquisition. The Bank also saw an increase in legal and professional services expense of $672 over the prior year, which was due in part, to a legal recovery booked during 2015 of $300. The Bank also saw an increase in property and equipment of $612, primarily attributable to the addition of the Capital Pacific Bank’s Fox Tower location to the Company’s office network.

BALANCE SHEET

Securities Available-for-Sale

At December 31, 2016, the balance of securities available-for-sale was $470,996, up $104,398 over December 31, 2016. The increase in the securities portfolio during 2016 was primarily due to the acquisition of Foundation Bank, which added approximately $89,000 to the securities total. At December 31, 2016, the portfolio had an unrealized pre-tax loss of $3,886 compared to an unrealized pre-tax gain of $4,341, at December 31, 2016. The decline in the unrealized gain or market value of the securities portfolio during 2016 was due to an increase in the short term interest rates and the market widening of spreads in virtually all investment products. The average life and duration of the portfolio at December 31, 2016, was 4.9 years and 4.4 years respectively, up from 4.1 years and 3.7 years, respectively, at December 31, 2015. At December 31, 2016, securities with an estimated fair value of $28,836 were pledged as collateral for public deposits in Oregon and Washington and for repurchase agreements.

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 $51,730 in cash flow 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.

At December 31, 2016, $1,937, or 0.41% of the total securities portfolio was composed of private-label mortgage-backed securities. During 2016, management booked $21 in other than temporary impairment on this portion of the portfolio. In total, the private label mortgage backed portfolio had a cumulative balance of $270 in other than temporary impairments at December 31, 2016.

In management’s opinion, the remaining securities in the portfolio in an unrealized loss position are considered only temporarily impaired. The Company has no intent, nor is it more likely than not that it will be required, to sell its impaired securities before their recovery. The impairment is 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, management does not currently anticipate the need to book any other-than-temporary impairment.

Loans

At December 31, 2016, outstanding gross loans were $1,859,787, up $453,775 over outstanding loans at December 31, 2015. A summary of outstanding loans by market, including national health care loans, for the years ended December 31, 2016, and December 31, 2015, follows:

 

		December 31,								2016 vs. 2015
		2016				2015				$ Increase				% Increase
Eugene market gross loans, period-end		$	442,556			$	379,048			$	63,508				16.75	%
Portland market gross loans, period-end			747,037				667,995				79,042				11.83	%
Puget Sound market gross loans, period-end			405,843				142,104				263,739				185.60	%
National health care gross loans, period end			264,351				216,865				47,486				21.90	%
Total gross loans, period-end		$	1,859,787			$	1,406,012			$	453,775				32.27	%

During 2016, all of the Company’s markets showed growth in outstanding loans over the prior year. Loan growth was strongest in the Puget Sound market, due to the acquisition of Foundation Bank, which added $270,533 to outstanding gross loans and another $183,242 in organic loan growth during 2016. Growth in the Eugene market was primarily concentrated in construction lending, with advances on large owner-occupied construction projects occurring during 2016. Growth in national healthcare loans accounted for $47,486 of the organic loan growth recorded during 2016. At December 31, 2016, the

 

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Company had national healthcare loans in 44 states. The Company defines national healthcare loans as loans to healthcare professionals, primarily dentists located outside of the Company’s primary market area. The Company’s defined 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, Oregon; Portland, Oregon; and Seattle, Washington. National health care loans, loans east of the Cascade Mountain Range and outside Oregon and Washington, are maintained and serviced by personnel located in the Portland market.

Outstanding loans to dental professionals, which are comprised of both local and national loans, at December 31, 2016, totaled $377,478 or 20.30% of the loan portfolio. Gross dental loans were up $37,316 over December 31, 2015, however the dental concentration decreased from the prior period due to growth in non-dental loans. Growth in national loans of $32,865 was partially offset by a $4,451 contraction in the local market dental loans. The more seasoned local dental loan portfolio experienced higher prepayment speeds due to competitive refinancing pricing offered. In addition, given the credit quality of dental loans in general, the Company encountered very competitive pricing in the national market. At December 31, 2016, $5,641 or 1.49% 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, owner-occupied facilities, and working capital. National dental loans are limited to acquisition financing and owner-occupied facilities. Additional data on the Company’s dental loan portfolio and the credit quality of this portfolio can be found in Note 6 of the Notes to Consolidated Financial Statements in this report. Additional information regarding loan concentrations is included in Part II, Item 1A “Risk Factors” of this report under the heading “We have a significant concentration in loans to dental professionals, and loan concentrations within one industry may create additional risk.”

Detailed credit quality data on the entire loan portfolio can be found in Note 5 and Note 6 of the Notes to Consolidated Financial Statements in this report.

Goodwill

At December 31, 2016, the Company had a recorded balance of $61,401 in goodwill from the November 30, 2005, acquisition of NWB Financial Corporation and its wholly owned subsidiary, Northwest Business Bank (“NWBF”), the February 1, 2013, acquisition of Century Bank, the March 6, 2015, acquisition of Capital Pacific Bank and the September 6, 2016 acquisition of Foundation Bank. In accordance with GAAP, the Company does not amortize goodwill or other intangible assets with indefinite lives, but instead periodically tests these assets for impairment. Management performed an impairment analysis at December 31, 2016, based on the reporting unit level and determined there was no impairment of the goodwill at the time of the analysis.

Deferred Tax Assets

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. At December 31, 2016, the Company had a net deferred tax asset of $12,722. This includes the addition of the deferred tax assets of Foundation Bank, which included a large Federal net operating loss. The Company worked with outside accountants to conduct an IRC 382 analysis on loss and credit carryforwards. As a result of this analysis, the Bank has determined it is currently forecasted to utilize all of Foundation’s NOL carryforward by 2020, however there is an annual limitation due to prior Foundation Bank ownership changes. Deferred tax assets acquired from Foundation Bank have been adjusted for the effective rate differential between the Company and Foundation Bank. Any adjustment to the acquired deferred tax asset has affected the goodwill associated with the acquisition. Deferred tax assets are reviewed for recoverability and valuation allowances are provided, when necessary, to reduce deferred tax assets to the amounts expected to be realized. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefit, or that future deductibility is uncertain. In light of the Company’s performance, management anticipates that the deferred tax assets will be fully utilized to offset future income taxes and that no valuation allowance is required. Additional disclosures regarding the components of the net deferred tax asset are included in Note 16 of the Notes to Consolidated Financial Statements in this Form 10-K.

Deposits

Outstanding deposits at December 31, 2016, were $2,148,103, an increase of $551,010 over outstanding deposits of $1,597,093 at December 31, 2015. Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and local non-public time deposits, including local non-public time deposits in excess of $100, were

 

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$2,035,067, up $501,125 or 32.67% over outstanding core deposits of $1,533,942 at December 31, 2015. At December 31, 2016, and 2015, core deposits represented 94.74% and 96.05%, respectively, of total deposits. Year-to-date December 31, 2016, average core deposits, a measurement that removes daily volatility, were $1,705,556, an increase of $229,388 or 21.29% over average core deposits of $1,406,168 for the year 2015.

A summary of outstanding deposits by market for the years 2016 and 2015 follows:

 

										2016 vs. 2015
		December 31,								$ Increase				% Increase
		2016				2015				(Decrease)				(Decrease)
Eugene market core deposits, period-end		$	815,674			$	787,521			$	28,153				3.57	%
Portland market core deposits, period-end			630,806				552,283				78,523				14.22	%
Puget Sound market core deposits, period-end			588,587				194,138				394,449				203.18	%
Total core deposits, period-end			2,035,067				1,533,942				501,125				32.67	%
Public and brokered deposits, period-end			113,036				63,151				49,885				78.99	%
Total deposits, period-end		$	2,148,103			$	1,597,093			$	551,010				34.50	%

All three of the Company’s primary markets showed an increase in core deposits during 2016. The Puget Sound market saw the largest growth, which included $396,509 in core deposits acquired through the Foundation Bank acquisition. All markets successfully acquired new deposit relationships and deepened deposit relationships with existing clients, however overall growth was tempered by the loss of a few large deposit clients. Mergers and acquisitions occurring in our market were the primary driver of deposits, as two large businesses sold, and deposits left the bank as a result of an out-of-state buyer. Because of its strategic focus on business banking and banking for nonprofits, the Company attracts a number of large depositors that account for a relatively significant portion of the core deposit base. Large depositor balances are subject to significant daily volatility. At December 31, 2016, large depositors, generally defined as relationships with $2,000 or more in deposits, accounted for $989,118 of the Company’s total core deposit base and represented 48.60% of outstanding core deposits, compared to $684,519 or 44.62% of outstanding core deposits at December 31, 2015. For more information on the Company’s large depositors and management of these relationships, see the “Liquidity and Cash Flows” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K. Additional information on deposits may also be found in Note 10 of the Notes to Consolidated Financial Statements in this
Form 10-K.

Public and Brokered 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. A portion of the long-term brokered deposits have a call feature, which provides the Company the option to redeem the deposits on a quarterly basis, allowing the Company to refinance long-term funding at lower rates should market rates fall. Below is a schedule detailing public and brokered deposits by type, including weighted average rate and weighted average maturity.

 

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Non-Core Deposit Summary

 

		December 31, 2016												December 31, 2015
		Balance				Weighted average rate				Weighted average maturity				Balance				Weighted average rate				Weighted average maturity
		(dollars in thousands)												(dollars in thousands)
<3 Months		$	30,149				0.84	%			53 days			$	30,000				0.37	%			55 days
3-6 Months			290				0.27	%			106 days				300				0.36	%			108 days
6-12 Months			3,181				0.91	%			300 days				235				0.40	%			331 days
>12 Months			79,416				1.28	%			3.22 years				32,616				1.94	%			5.37 years
		$	113,036											$	63,151

During 2016, the Company saw an increase in usage of non-core funding, primarily related to additional brokered deposits. The expansion was tied to loan growth but also assisted in lengthening the Bank’s liabilities to help mitigate interest rate risk.

 

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Borrowings

The Company has both secured and unsecured borrowing lines with the Federal Home Loan Bank, Federal Reserve Bank 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 with interest rates payable at then stated rates. See Notes 11 and 12 of the Notes to Consolidated Financial Statements in Item 8 of this report for additional information on borrowings.

 

		SHORT-TERM BORROWINGS
		December 31,
		2016				2015				2014
		(dollars in thousands)
Federal funds purchased, FHLB cash management advance, FRB, & short-term advances
Average interest rate
At year end			0.70	%			0.34	%			0.48	%
For the year			0.47	%			0.18	%			0.40	%
Average amount outstanding for the year		$	164,615			$	129,665			$	121,016
Maximum amount outstanding at any month-end		$	183,500			$	117,000			$	168,500
Amount outstanding at year-end		$	57,000			$	47,000			$	68,500

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. Included in the proceeds from the debenture were various expenses including underwriting discount and commission, legal expenses, accounting expenses and various filing and trustee expenses. The total of the issuance cost was $951 and will be amortized over the life of the debt as an increase to interest expense. As of December 31, 2016, the subordinated debenture had a net book balance, including unamortized issuance cost of $34,096.

Junior Subordinated Debentures

The Company had $8,248 in junior subordinated debentures outstanding at December 31, 2016, which were issued in conjunction with the 2005 acquisition of NWBF. The junior subordinated debentures had an interest rate of 6.27% that was fixed through January 2011. In January 2011, the rate on the junior subordinated debentures 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 trust preferred payment, swapping the variable interest rate for a fixed rate of 2.73% for a seven-year period. At December 31, 2016, the fair value of the interest rate swap on the Company’s subordinated debentures was $91, compared to $82 at December 31, 2015. At December 31, 2016, the $8,000 of the junior subordinated debentures qualified as Tier 1 capital under regulatory capital guidelines.

Following the acquisition of Foundation Bank in third quarter 2016, 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 Company also recognized its $186 investment in the trust, which is recorded among “Other Assets” in its consolidated balance sheet at December 31, 2016.

 

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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, recently 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 in Part I, Item 1 “Business – Supervision and Regulation” and Part I, Item 1A “Risk Factors” of the report 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 15 of the Notes to Consolidated Financial Statements in Item 8 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 December 31, 2016, was $273,755, up $55,264 from December 31, 2015. The increase in shareholders’ equity was primarily due to the issuance of 2,853,362 shares of Company stock valued at $47,794 in conjunction with the acquisition of Foundation Bank during the third quarter 2016, combined with retention of a portion of income earned during 2016.

On July 27, 2016, the Company’s Board of Directors authorized the repurchase of up to 5.00% of the Company’s outstanding shares, or 892,500 shares, with the purchases to take place over a 12-month period. During 2016, the Company did not repurchase any shares as the strike price was below the current share value. Throughout 2016, the Company has used a combination of regular dividends, special dividends, and share repurchases to maintain capital levels comparable with year-end December 31, 2011, capital levels. For additional details regarding the changes in equity, review the Consolidated Statements of Changes in Shareholders’ Equity in Item 8 of this report.

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 have 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, 2016 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 final 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 capital conservation buffers 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 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% (which is 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 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 will begin January 1, 2016, and 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, 2015 to December 31, 2017. The 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 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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For additional information regarding the Company’s regulatory capital levels, see Note 24 in Notes to Consolidated Financial Statements in Item 8 of this report.

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 12.69%, 10.08%, 9.52% and 9.01%, respectively, at December 31, 2016, with all capital ratios for the Company above the minimum regulatory “well capitalized” designations.

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, and 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.

During 2016, the Company paid regular dividends totaling $0.44. The fourth quarter dividend represents a dividend payout of 36.67% of net income. Subsequent to the end of the year, on January 26, 2017, the Board of Directors approved a regular quarterly cash dividend to $0.11 per share payable to shareholders on February 23, 2017.

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 December 31, 2016, the Company had $352,361 in commitments to extend credit, up $63,205 from $289,156 reported 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 December 31, 2016, the Company had $987 in letters of credit and financial guarantees written.

The Company has certain other financial commitments. These future financial commitments at December 31, 2016, are outlined below:

 

						Less than One Year				1-3 Years				3-5 Years				More than 5 Years
		Total
Junior subordinated debentures		$	11,311			$	—			$	—			$	—			$	11,311
Subordinated debentures			34,096				—				—				—				34,096
FHLB borrowings			65,000				60,000				3,000				—				2,000
Time deposits			178,883				87,701				53,689				25,128				12,365
Operating lease obligations			11,002				1,755				3,190				1,978				4,079
Deferred compensation agreements			742				34				—				—				708
Employment contracts			840				840				—				—				—
		$	301,874			$	150,330			$	59,879			$	27,106			$	64,559

 

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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 prepares a Liquidity Contingency Plan at least semi-annually that is strategic in nature and forward-looking to test the ability of the Company to fund a liquidity shortfall arising from various escalating events. The Liquidity Contingency Plan is presented and reviewed by the Company’s Asset and Liability Committee.

Core deposits at December 31, 2016, were $2,035,067 and represented 94.74% of total deposits. Core deposits at December 31, 2016, were up $501,125 over December 31, 2015. The acquisition of Foundation Bank during the third quarter 2016 accounted for approximately $397,000 of deposit growth during 2016, while organic growth accounted for the remaining increase in total deposits.

The Company experienced an increase in outstanding loans of $453,775 during 2016, which included organic growth and loans acquired in the Foundation Bank acquisition. Organic loan growth was funded primarily by growth in core deposits, but a portion was funded by growth in brokered deposits. It is anticipated that core deposit growth and cash flows from the securities portfolio will provide a significant portion of the funding during 2017, as loans are expected to continue to increase. The securities portfolio represented 18.53% of total assets at December 31, 2016. At December 31, 2016, $29,256 of the securities portfolio was pledged to support public deposits and repurchase agreements, leaving $441,740 of the securities portfolio unencumbered and available-for-sale. In addition, at December 31, 2016, the Company had $25,477 of government guaranteed loans that could be sold in the secondary market to support the Company’s liquidity position.

Due to its strategic focus, 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 and Company officers. 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 and officers maintain close relationships and hold regular meetings with its large depositors to assist in management of these relationships. The Company generally expects to maintain these relationships, believes it has sufficient sources of liquidity to mitigate the loss of one or more of these clients and regularly tests its ability to mitigate the loss of multiple large depositor relationships in its Liquidity Contingency Plan. The Company had five deposit relationships rated a 10, the highest risk, with outstanding deposit balances of approximately $95,000 as of December 31, 2016. The Company currently maintains sufficient short-term liquidity to cover any potential volatility in these relationships and is working on a longer term funding strategy in the event these deposits need to be replaced in the future. However, there can be no assurance that this deposit relationship or 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 December 31, 2016, the Company had secured borrowing lines with the FHLB and the FRB, along with unsecured borrowing lines with various correspondent banks, totaling $866,986. The Company’s secured lines with the FHLB and FRB were limited by the amount of collateral pledged. At December 31, 2016, the Company had pledged $632,202 in discounted collateral value in commercial real estate loans, first and second lien single-family residential loans, and multi-family loans, to the FHLB. Additionally, certain commercial loans with a discounted value of $80,784 were pledged to the FRB under the Company’s Borrower-In-Custody program. The Company’s unsecured correspondent bank lines totaled $154,000. At December 31, 2016, the Company had $65,000 in borrowings outstanding from the FHLB, no borrowings outstanding with the FRB, and no funds outstanding on its overnight correspondent bank lines, leaving a total of $801,986 available on its secured and unsecured borrowing lines as of such date.

 

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As disclosed in the Consolidated Statements of Cash Flows in the Consolidated Financial Statements in this Form 10-K, net cash provided by operating activities was $31,513 for the year 2016. The difference between cash provided by operating activities and net income largely consisted of depreciation and amortization of $6,986. Net cash of $169,899 was used in investing activities for the year 2016, consisting principally of net loan originations of $184,498 and securities purchases of $179,174, which was offset by proceeds from maturities of investment securities of $150,669. Cash provided by financing activities was $168,824 for the year 2016, primarily due to an increase in deposits of $154,502. See the Consolidated Statements of Cash Flows in this form 10-K for further information.

INFLATION

Substantially all of the assets and liabilities of the Company are monetary. Therefore, inflation has a less significant impact on the Company than does fluctuation in market interest rates. Inflation can lead to accelerated growth in noninterest expenses, which could impact net earnings. During the last several years, inflation, as measured by the Consumer Price Index, did not change significantly. The effects of inflation have not had a material impact on the Company.

 

ITEM 7A

Quantitative and Qualitative Disclosures About Market Risk

The Company’s results of operations are largely dependent upon its ability to manage market risks. Changes in interest rates can have a significant effect on the Company’s financial condition and results of operations. Although permitted by its funds management policy, the Company does not presently use derivatives, such as forward and futures contracts, options or interest rate swaps, to manage interest rate risk. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.

Interest rate risk generally arises when the maturity or repricing structure of the Company’s assets and liabilities differ significantly. Asset and liability management, which among other things addresses such risk, is the process of developing, testing and implementing strategies that seek to maximize net interest income while maintaining sufficient liquidity. This process includes monitoring contractual maturity and prepayment expectations together with expected repricing of assets and liabilities under different interest rate scenarios. Generally, the Company seeks a structure that insulates net interest income from large deviations attributable to changes in market rates.

Interest rate risk is managed through the monitoring of the Company’s balance sheet by utilizing two key measurement tools; 1) Economic Value of Equity (EVE), and 2) Net Interest Income (NII). Economic Value of Equity is a measurement of net present value of assets less liabilities. Net interest income is a measurement of interest income less interest expense over a specified time horizon (usually 12, 24 and/or 36 months). Both measurements incorporate instantaneous parallel rate shocks of -100, +100, +200, +300, and +400 basis points. Key assumptions are applied to the analysis covering asset prepayments, liability decays and betas, and repricing characteristics. Other interest rate risk analysis includes stress-testing, back-testing, and forecast. Stress-testing the model provides a measurement of worst-case analysis and a degree of tolerance to the base model. Back-testing analysis provides a degree of validity of the base model as compared to actual results. Forecast provides management the what-if scenarios with predetermined balance and rate growth assumptions. In addition, forecasting takes into account growth in loans and deposits and management strategies that could be employed to maximize the net interest margin and net interest income.

The Company has recently outsourced its quarterly interest rate risk analysis to a third party vendor- Pacific Coast Bankers Bank. Pacific Coast Bankers Bank’s process and modeling software uses key internal assumptions for beta, decay, and prepayment speeds, as well as established policy limits, in order to determine the effect changes in interest rates have on Economic Value of Equity and Net Interest Income. Economic Value of Equity provides a long-term risk profile while Net Interest Income provides a short-term risk profile of the balance sheet. Although certain assets and liabilities may have similar repricing characteristics, they may not react correspondingly to changes in market interest rates. In the event of a change in interest rates, prepayment of loans and early withdrawal of time deposits would likely deviate from those previously assumed. Increases in market rates may also affect the ability of certain borrowers to make scheduled principal payments.

The models attempt to account for such limitations by imposing weights on the differences between repricing assets and repricing liabilities within each time segment. These weights are based on the ratio between the amount of rate change of each category of asset or liability and the amount of change in the federal funds rate. Certain non-maturing liabilities, such as checking accounts and money market deposit accounts, are allocated among the various repricing time segments to meet local competitive conditions and management’s strategies.

 

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At December 31, 2016, the Company was slightly asset sensitive to neutral, meaning that in a rising rate environment, the net interest margin and net interest income would be positively impacted. The Company’s interest rate risk position was primarily due to the frequency of loan repricing due to amortization and maturities, liquidity within the investment portfolio, and the concentration of low cost deposits.

There are numerous critical assumptions in the modeling of interest rate sensitivity, including the deposit decay rate (the rate at which non-maturing deposits run off over time) and the beta factor (the projected change in rates paid on non-maturing deposits for every 100 basis point increase or decrease in market interest rates). Critical assumptions are based on historical behaviors and current market conditions. Due to the critical nature of these assumptions on the overall calculated interest rate risk position, actual results and changes in net interest income and the net interest margin in the event of an increase or decrease of market interest rates may be materially different from projections.

The following table shows the estimated impact on Net Interest Income at one, two, and three year time horizons and Economic Value of Equity with instantaneous parallel rate shocks of -100, +100, +200, +300, and +400 basis points. Due to the various assumptions used for this modeling and potential balance sheet strategies management may implement to mitigate interest rate risk, no assurance can be given that projections will reflect actual results.

Interest Rate Shock Analysis

Net Interest Income and Economic Value of Equity Measurement

($ in thousands)

 

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		1st Year Net Interest Income
Interest Rate Shocks		$ Estimated Value				$ Change From Base				% Change From Base
400			100,629				520				0.52	%
300			100,606				497				0.50	%
200			100,483				374				0.37	%
100			100,290				181				0.18	%
Base			100,109				-				-
-100			96,854				(3,255	)			-3.25	%
		2nd Year Net Interest Income
Interest Rate Shocks		$ Estimated Value				$ Change From Base				% Change From Base
400			113,074				14,164				14.32	%
300			109,738				10,828				10.95	%
200			106,273				7,363				7.44	%
100			102,701				3,791				3.83	%
Base			98,910				-				-
-100			91,401				(7,509	)			-7.59	%
		3rd Year Net Interest Income
Interest Rate Shocks		$ Estimated Value				$ Change From Base				% Change From Base
400			124,281				25,785				26.18	%
300			118,031				19,535				19.83	%
200			111,686				13,190				13.39	%
100			105,219				6,723				6.83	%
Base			98,496				-				-
-100			88,295				(10,201	)			-10.36	%
		Economic Value of Equity
Interest Rate Shocks		$ Estimated Value				$ Change From Base				% Change From Base
400			521,778				3,288				0.63	%
300			522,948				4,458				0.86	%
200			523,913				5,423				1.05	%
100			521,491				3,001				0.58	%
Base			518,490				-				-
-100			491,539				(26,951	)			-5.20	%

 

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ITEM 8

Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

Pacific Continental Corporation and Subsidiary

We have audited the accompanying consolidated balance sheets of Pacific Continental Corporation and Subsidiary (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. We also have audited the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control -Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.

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

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

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pacific Continental Corporation and Subsidiary as of December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with generally accepted accounting principles in the United States of America. Also in our opinion, Pacific Continental Corporation and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ Moss Adams LLP

Portland, Oregon

March 13, 2017

 

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Pacific Continental Corporation and Subsidiary

Consolidated Balance Sheets

(In thousands, except share amounts)

 

		December 31,
		2016				2015
ASSETS
Cash and due from banks		$	30,154			$	23,819
Interest-bearing deposits with banks			36,959				12,856
Total cash and cash equivalents			67,113				36,675
Securities available-for-sale			470,996				366,598
Loans, net of deferred fees			1,857,767				1,404,482
Allowance for loan losses			(22,454	)			(17,301	)
Net loans			1,835,313				1,387,181
Interest receivable			7,107				5,721
Federal Home Loan Bank stock			5,423				5,208
Property and equipment, net of accumulated depreciation			20,208				18,014
Goodwill and intangible assets			70,382				43,159
Deferred tax asset			12,722				5,670
Other real estate owned			12,068				11,747
Bank-owned life insurance			35,165				22,884
Other assets			4,940				6,621
Total assets		$	2,541,437			$	1,909,478
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing demand		$	858,996			$	568,688
Savings and interest-bearing checking			1,110,224				889,802
Core time deposits			65,847				75,452
Total core deposits			2,035,067				1,533,942
Other time deposits			113,036				63,151
Total deposits			2,148,103				1,597,093
Securities sold under agreements to repurchase			1,966				71
Federal Home Loan Bank borrowings			65,000				77,500
Subordinated debentures			34,096				—
Junior subordinated debentures			11,311				8,248
Accrued interest and other payables			7,206				8,075
Total liabilities			2,267,682				1,690,987
Commitments and contingencies (Note 22)
Shareholders’ equity
Common stock, no par value, shares authorized: 50,000,000; shares issued and outstanding: 22,611,535 at December 31, 2016 and 19,604,182 at December 31, 2015			205,584				156,099
Retained earnings			70,486				59,693
Accumulated other comprehensive income			(2,315	)			2,699
			273,755				218,491
Total liabilities and shareholders’ equity		$	2,541,437			$	1,909,478

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Operations

(In thousands, except per share amounts)

 

		Years Ended December 31,
		2016				2015				2014
Interest and dividend income
Loans		$	80,104			$	65,694			$	53,855
Taxable securities			7,743				6,532				6,191
Tax-exempt securities			1,942				1,976				1,971
Federal funds sold & interest-bearing deposits with banks			154				34				10
			89,943				74,236				62,027
Interest expense
Deposits			3,848				3,314				3,252
Federal Home Loan Bank & Federal Reserve borrowings			954				885				1,088
Subordinated debentures			1,143				—				—
Junior subordinated debentures			279				226				225
Federal funds purchased			8				11				14
			6,232				4,436				4,579
Net interest income			83,711				69,800				57,448
Provision for loan losses			5,450				1,695				—
Net interest income after provision for loan losses			78,261				68,105				57,448
Noninterest income
Service charges on deposit accounts			2,876				2,644				2,134
Bankcard income			1,214				1,029				951
Bank-owned life insurance income			702				592				473
Net gain (loss) on sale of investment securities			373				672				(34	)
Impairment losses on investment securities (OTTI)			(21	)			(22	)			—
Other noninterest income			2,673				1,710				1,471
			7,817				6,625				4,995
Noninterest expense
Salaries and employee benefits			31,873				27,501				23,555
Property and equipment			4,742				4,347				3,735
Data processing			3,709				3,259				2,720
Legal and professional services			3,297				1,924				1,252
Business development			2,049				1,640				1,531
FDIC insurance assessment			1,089				1,051				868
Merger related expense			4,934				1,836				470
Other real estate (income) expense			(36	)			346				449
Other noninterest expense			4,936				3,986				3,149
			56,593				45,890				37,729
Income before income tax provision			29,485				28,840				24,714
Income tax provision			9,709				10,089				8,672
Net income		$	19,776			$	18,751			$	16,042
Earnings per share
Basic		$	0.96			$	0.97			$	0.90
Diluted		$	0.95			$	0.97			$	0.89

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Comprehensive Income

(In thousands)

 

		Years Ended December 31,
		2016				2015				2014
Net income		$	19,776			$	18,751			$	16,042
Other comprehensive (loss) income:
Available-for-sale securities:
Unrealized (loss) gain arising during the year			(7,877	)			(1,064	)			6,266
Reclassification adjustment for (gains) losses realized in net income			(373	)			(672	)			34
Other than temporary impairment			21				22				—
Income tax benefit (expense)			3,210				668				(2,457	)
Derivative instrument—cash flow hedge
Unrealized gain (loss) arising during the year			336				(94	)			(230	)
Reclassification adjustment for gains realized in net income			(327	)			—				—
Income tax (expense) benefit			(4	)			37				90
Total other comprehensive (loss) income, net of tax			(5,014	)			(1,103	)			3,703
Total comprehensive income		$	14,762			$	17,648			$	19,745

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

(In thousands, except share amounts)

 

		Number of Shares				Common Stock				Retained Earnings				Accumulated Other Comprehensive Income (loss)				Total
Balance, December 31, 2013			17,891,687			$	133,835			$	45,250			$	99			$	179,184
Net income											16,042								16,042
Other comprehensive loss, net of tax															3,703				3,703
Comprehensive income																			19,745
Stock issuance and related tax benefit			93,069				203												203
Stock repurchase			(267,080	)			(3,600	)											(3,600	)
Share-based compensation expense							1,454												1,454
Vested employee RSUs and SARs surrendered to cover tax consequences							(517	)											(517	)
Cash dividends ($0.69 per share)											(12,308	)							(12,308	)
Balance, December 31, 2014			17,717,676			$	131,375			$	48,984			$	3,802			$	184,161
Net income											18,751								18,751
Other comprehensive income, 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											19,776								19,776
Other comprehensive loss, net of tax															(5,014	)			(5,014	)
Comprehensive income																			14,762
Stock issuance and related tax benefit			153,991				734												734
Stock issued through acquisition			2,853,362				47,794												47,794
Share-based compensation expense							1,853												1,853
Vested employee RSUs and SARs surrendered to cover tax consequences							(896	)											(896	)
Cash dividends ($0.44 per share)											(8,983	)							(8,983	)
Balance, December 31, 2016			22,611,535			$	205,584			$	70,486			$	(2,315	)		$	273,755

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Cash Flows

(In thousands)

 

		Years Ended December 31,
		2016				2015				2014
Cash flows from operating activities:
Net income		$	19,776			$	18,751			$	16,042
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net of accretion			6,985				7,138				6,834
Valuation adjustment on foreclosed assets			162				129				82
(Gain) loss on sale of other real estate owned			(410	)			2				(7	)
Provision for loan losses			5,450				1,695				—
Deferred income tax provision			(694	)			1,153				2,766
BOLI income			(702	)			(592	)			(473	)
Share-based compensation			2,003				1,650				1,528
Excess tax benefit of stock options exercised			(43	)			(9	)			(14	)
Other than temporary impairment on investment securities			21				22				—
(Gain) loss on sale of investment securities			(373	)			(672	)			34
Change in:
(Increase) decrease in interest receivable			(452	)			(401	)			(70	)
Deferred loan fees			491				538				66
Accrued interest payable and other liabilities			(843	)			60				598
Income taxes (receivable) payable			(892	)			(1,461	)			80
Decrease (increase) in other assets			1,038				2,010				(3,328	)
Net cash provided by operating activities			31,517				30,013				24,138
Cash flows from investing activities:
Proceeds from maturities, sales and paydowns available-for-sale investment securities			150,668				106,332				71,622
Purchase of available-for-sale investment securities			(179,174	)			(101,500	)			(75,184	)
Net loan principal originations			(184,498	)			(156,746	)			(53,447	)
Purchase of property and equipment			(3,175	)			(1,434	)			(428	)
Proceeds on sale of foreclosed assets			2,104				2,463				4,831
Redemption of FHLB stock			317				5,438				406
Cash consideration paid, net of cash acquired in merger			43,855				(3,249	)			—
Net cash used by investing activities			(169,903	)			(148,696	)			(52,200	)
Cash flows from financing activities:
Change in deposits			154,502				160,033				118,113
Change in repurchase agreements			1,895				(22	)			—
Increase in federal funds purchased and FHLB short-term borrowings			0				(18,500	)			(69,150	)
FHLB term advances paid-off			(12,500	)			—				—
Proceeds from stock options exercised			691				86				189
Redemption of Capital Pacific Bell State Bank debt			—				(3,344	)			—
Excess tax benefit of stock options exercised			43				9				14
Dividends paid			(8,983	)			(8,042	)			(12,308	)
Repurchase of common stock			—				—				(3,600	)
Vested SARs and RSUs surrendered by employees to cover tax consequence			(896	)			(649	)			(517	)
Proceeds from subordinated debt issuance			34,072				—				—
Net cash provided by financing activities			168,824				129,571				32,741
Net increase (decrease) in cash and cash equivalents			30,438				10,888				4,679
Cash and cash equivalents, beginning of year			36,675				25,787				21,108
Cash and cash equivalents, end of year		$	67,113			$	36,675			$	25,787
Supplemental information:
Noncash investing and financing activities:
Transfers of loans to other real estate owned		$	958			$	967			$	1,925
Change in fair value of securities, net of deferred income taxes		$	5,019			$	1,046			$	3,843
Acquisitions:
Assets acquired		$	428,671			$	257,924			$	—
Liabilities assumed		$	402,252			$	232,698			$	—
Cash paid during the year for:
Income taxes		$	11,271			$	8,423			$	8,701
Interest		$	6,194			$	4,410			$	4,540

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Notes to Consolidated Financial Statements

In preparing these consolidated financial statements, the Company has evaluated events and transactions subsequent to the balance sheet date for potential recognition or disclosure. All dollar amounts in the following notes are expressed in thousands, except per share data.

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Principles of Consolidation – The 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 Service Corporation (which previously owned and operated bank-related real estate but is currently inactive) and PCB Loan Services Corporation (which previously owned and operated certain repossessed or foreclosed collateral but is currently inactive). The Bank provides commercial banking, financing, mortgage lending and other services through 15 offices located in Western Oregon and Western Washington. The Bank also operates two loan production offices in Tacoma, Washington and Denver, Colorado. All significant intercompany accounts and transactions have been eliminated in consolidation.

In November 2005, the Company formed a wholly owned Delaware statutory business trust subsidiary, Pacific Continental Corporation Capital Trust (the “Trust”) which issued $8,248 of guaranteed undivided beneficial interests in Pacific Continental’s Junior Subordinated Deferrable Interest Debentures (“Trust Preferred Securities”). Pacific Continental has not consolidated the accounts of the Trust in its consolidated financial statements in accordance with generally accepted accounting principles, (“GAAP”). As a result, the junior subordinated debentures issued by Pacific Continental to the issuer trust, totaling $8,248, are reflected on Pacific Continental’s consolidated balance sheet at December 31, 2016, and 2015, under the caption “Junior Subordinated Debentures.” Pacific Continental also recognized its $248 investment in the Trust, which is recorded among “Other Assets” in its consolidated balance sheet at December 31, 2016, and 2015.

On September 6, 2016, the Company completed the acquisition of Foundation Bancorp, Inc. 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 $6,186 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, reflected on Pacific Continental’s balance sheet at December 31, 2016, and acquired at an acquisition date fair value of $3,013. The Company also recognized its $186 investment in the trust, which is recorded among “Other Assets” in its consolidated balance sheet at December 31, 2016.

Use of Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimations made by management involve fair value calculations pertaining to financial assets and liabilities, the calculation of the allowance for loan losses, and the impairment assessment for goodwill.

Cash and Cash Equivalents – For purposes of reporting cash flows, cash and cash equivalents includes cash on hand, amounts due from or deposited with banks, interest-bearing balances due from banks, and federal funds sold, all with maturities of three months or less. Generally, federal funds are sold for one-day periods.

Securities Available-for-Sale – Securities available-for-sale are held for indefinite periods of time and may be sold in response to movements in market interest rates, changes in the maturity or mix of Company assets and liabilities or demand for liquidity. Management determines the appropriate classification of securities at the time of purchase. The Company classified all of its securities as available-for-sale throughout 2016 and 2015.

 

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Securities classified as available-for-sale are reported at estimated fair value based on available market prices. Net unrealized gains and losses are included in other comprehensive income or loss on an after-tax basis. Impaired securities are assessed quarterly for the presence of other-than-temporary impairment (“OTTI”). OTTI is considered to have occurred, (1) if we intend to sell the security, (2) if it is “more likely than not” we will be required to sell the security before recovery of its amortized cost basis, or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. The “more likely than not” criteria is a lower threshold than the “probable” criteria used under previous guidance.

When OTTI is identified, the amount of the impairment is bifurcated into two components: the amount representing credit loss and the amount related to all other factors. The amount representing credit loss is recognized against earnings as a realized loss and the amount representing all other factors is recognized in other comprehensive income as an unrealized loss. The cost basis of an other-than-temporarily impaired security is written down by the amount of impairment recognized in earnings. The new cost basis is not adjusted for subsequent recoveries in fair value. However, the difference between the new amortized cost basis and the cash flows expected to be collected is accreted as interest income. Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Interest income on securities available-for-sale is included in income using the level yield method.

Loans, Income Recognition, and the Allowance for Loan Losses – Loans are stated at the amount of unpaid principal net of loan premiums or discounts for purchased loans, net 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.

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.

Purchased Credit Impaired Loans (“PCI Loans”)

Loans acquired with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, formerly SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer. In situations where such loans have similar risk characteristics, loans are aggregated into pools to estimate cash flows. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. Expected cash flows at the acquisition date in excess of the fair value of loans are considered to be accretable yield, which is recognized as interest income over the life of the loan pool using a level yield method if the timing and amount of the future cash flows of the pool is reasonably estimable. Subsequent to the acquisition date, any increases in cash flow over those expected at purchase date in excess of fair value are recorded as interest income prospectively. Any subsequent decreases in cash flow over those expected at purchase date due to credit deterioration are recognized by recording an allowance for losses on purchased credit impaired loans. Any disposals of loans, including sales of loans, payments in full or foreclosures result in the removal of the loan from the loan pool at the carrying amount.

Allowance for Loan Losses Methodology

Management provides for possible loan losses by maintaining an allowance. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance when management believes the collection of principal or interest is unlikely. The allowance is an amount that management considers adequate to absorb possible losses on existing loans based on its evaluation of the collectability of those loans and prior loss experience. Management’s evaluations take into consideration such factors as changes in the size and nature of the loan portfolio, the overall portfolio quality, the financial condition of borrowers, the level of nonperforming loans, the Company’s historical loss experience, the estimated value of underlying collateral, and current economic conditions that may affect the borrower’s ability to pay. This evaluation is inherently subjective as it requires estimates that are susceptible to significant subsequent revision as more information becomes available.

 

 

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The allowance consists of general, specific and unallocated components. The general component covers all loans not specifically identified for impairment testing. The specific component relates to loans that are individually assessed for impairment. The combined general and specific components of the allowance constitute the Company’s allocated allowance for loan losses. An unallocated allowance may be maintained to provide for credit losses inherent in the loan portfolio that may not have been contemplated in the general risk factors or the specific allowance analysis.

The Company performs regular credit reviews of the loan portfolio to determine the credit quality of the portfolio and the Company’s adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the terms of the loans through the credit review process. The risk rating categories constitute a primary factor in determining an appropriate amount for the general allowance for loan losses. The general allowance is calculated by applying risk factors to pools of outstanding loans. Risk factors are assigned based on management’s evaluation of the losses inherent within each identified loan category. Loan categories with greater risk of loss are therefore assigned a higher risk factor. The Company’s Asset and Liability Committee (“ALCO”) and Board of Directors are responsible for, among other things, regularly reviewing the allowance for loan losses methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles.

Regular credit reviews of the portfolio are performed to identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALCO Committee, which reviews loans recommended for impairment. 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 a loan is deemed to be impaired, the amount of the impairment is measured using discounted cash flows except when the sole remaining source of the repayment is the liquidation of the collateral. In these cases, the current fair value of the collateral, less selling costs, is used. Impairment is recognized as a specific component within the allowance for loan losses if the value of the impaired loan is less than the recorded investment in the loan. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. Loans specifically reviewed for impairment are excluded from the general allowance calculation to prevent double-counting the loss exposure. The Company’s ALCO Committee reviews loans recommended for impaired status and those recommended to be removed from impaired status. The Company’s ALCO Committee and Board provide oversight of the allowance for loan losses process and review and approve the allowance methodology on a quarterly basis.

Charge-off Methodology

When it becomes evident that a loan has a probable loss and is deemed uncollectable, regardless of delinquent status, the loan is charged-off. A partial charge-off will occur to the extent of the portion of the loan that is not well secured and is in the process of collection. Additionally, a partial charge-off will occur to the extent of the portion of the loan that is not guaranteed by a federal or state government agency and is in the process of collection. In circumstances where it is evident that a government guarantee will not be honored, the loan will be charged-off to the extent of the portion of the loan that is not well secured. Commercial overdrafts will be charged-off within the month the delinquent checking account becomes 90 days delinquent.

Troubled Debt Restructuring

Loans are reported as a troubled debt restructuring when the Company grants a concession to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date, or providing a lower interest rate than would be normally available for a transaction of similar risk. The Company will undertake a restructuring only when it occurs in ways which improve the likelihood that the credit will be repaid in full under the modified terms and in accordance with a reasonable repayment schedule.

Off-Balance Sheet Credit Exposure –A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with the Company’s commitment to lend funds under existing agreements such as letters or lines of credit. Management determines the adequacy of the reserve for unfunded commitments based upon reviews of individual credit facilities, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. These factors include: the quality of the current loan portfolio, the trend in the loan portfolio’s risk ratings, current economic conditions, loan concentrations, loan growth

 

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rates, past-due and nonperforming trends, evaluation of specific loss estimates for all significant problem loans, historical charge-off and recovery experience, and other pertinent information. The reserve is based on estimates and ultimate losses may vary from the current estimates. These estimates are evaluated on a regular basis and as adjustments become necessary, they are reported in earnings in the periods in which they become known. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the allowance. Provisions for unfunded commitment losses and recoveries on loans commitments previously charged-off are added to the reserve for unfunded commitments, which is included in the Accrued Interest and Other Payables section of the consolidated balance sheets. At December 31, 2016, the reserve for unfunded loan commitments totaled $548 compared to $360 at December 31, 2015.

Foreclosed Assets – Assets acquired through foreclosure, or deeds in lieu of foreclosure, are initially recorded at fair value less the estimated cost of disposal, at the date of foreclosure. Any excess of the loan’s balance over the fair value of the foreclosed collateral is charged to the allowance for loan losses.

Improvements to foreclosed assets are capitalized to the extent that the improvements increase the fair value of the assets. Expenditures for routine maintenance and repairs of foreclosed assets are charged to expense as incurred. Management performs periodic valuations of foreclosed assets and may adjust the values to the lower of carrying amount or fair value less the estimated costs to sell. Write downs to net realizable value, if any, and disposition gains or losses are included in noninterest income or expense.

Federal Home Loan Bank Stock – The investment in Federal Home Loan Bank (“FHLB”) stock is carried at par value, which approximates its fair value. As a member of the FHLB system, the Company is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets or FHLB advances.

FHLB stock is generally viewed as a long-term investment. Accordingly, when evaluating FHLB stock for impairment, its value is determined based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. As of December 31, 2016, the Bank determined there was no impairment. The determination of whether the decline affects the ultimate recoverability is influenced by criteria such as the following:

 

•

The significance of the decline in net assets of the FHLBs as compared to the capital stock amount for the FHLBs and the length of time this situation has persisted.

 

•

Commitments by the FHLBs to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLBs.

 

•

The impact of legislative and regulatory changes on the institution and, accordingly, on the customer base of the FHLBs.

 

•

The liquidity position of the FHLBs.

Property and Equipment – Property is stated at cost, net of accumulated depreciation and amortization. Additions, betterments and replacements of major units are capitalized. Expenditures for normal maintenance, repairs and replacements of minor units are charged to expense as incurred. Gains or losses realized from sales or retirements are reflected in operations currently.

Depreciation and amortization is computed by the straight-line method over the estimated useful lives of the assets. Estimated useful lives are 30 to 40 years for buildings, 3 to 10 years for furniture and equipment, and up to the lesser of the useful life or lease term for leasehold improvements.

Goodwill and Intangible Assets – Intangible assets are comprised of goodwill and other intangibles acquired in business combinations. Goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with definite useful lives are amortized to their estimated residual values over their respective estimated useful lives, and also reviewed for impairment. The Company performs a goodwill impairment analysis on an annual basis as of December 31, 2016. Additionally, the Company performs a goodwill impairment evaluation on an interim basis when events or circumstances indicate impairment potentially exists. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others, a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse action or assessment by a regulator; and unanticipated competition.

 

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Bank-owned Life Insurance – Bank-owned life insurance is recorded at the estimated cash-surrender value of the policies. Increases in the cash-surrender value are recorded as noninterest income.

Advertising – Advertising costs are charged to expense during the year in which they are incurred. Advertising expenses were $902, $718, and $745, for the years ended December 31, 2016, 2015, and 2014, respectively.

Income Taxes – Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are calculated using tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not that all or some of the potential deferred tax asset will not be realized.

The Company follows the provisions of the Financial Accounting Standards Boards’ (“FASB”) ASC 740, “Income Taxes,” relating to accounting for uncertain tax positions. Uncertain tax positions may arise when the Company takes or expects to take a tax position that is ultimately disallowed by the relevant taxing authority. The Company files income tax returns with the Internal Revenue Service and any states in which it has identified that it has nexus. Tax returns for the years subsequent to 2012 remain open to examination by the taxing jurisdictions. Management reviews the Company’s balance sheet, income statement, income tax provision and income tax returns as well as the permanent and temporary adjustments affecting current and deferred income taxes quarterly and assesses whether uncertain tax positions exist. At December 31, 2016, management does not believe that any uncertain tax positions exist, that are not more-likely-than-not, sustainable upon examination. The Company’s policy with respect to interest and penalties ensuing from income tax settlements is to recognize them as noninterest expense.

Earnings Per Share – Basic earnings per share are computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted earnings per share include the effect of common stock equivalents that would arise from the exercise of stock options discussed in Note 18. Weighted shares outstanding are adjusted retroactively for the effect of stock dividends.

 

		Weighted average shares outstanding as of December 31,
		2016				2015				2014
Basic			20,610,808				19,250,838				17,821,580
Common stock equivalents attributable to stock-based compensation plans			179,187				141,241				223,448
Diluted			20,789,995				19,392,079				18,045,028

Equity grants, including options and Stock Appreciation Rights, for 77,833, 320,864 and 323,933 weighted average shares of common stock were excluded from the diluted earnings per share calculation in 2016, 2015 and 2014, respectively, due to their anti-dilutive effect.

Share-Based Payment Plans – Financial accounting standards require companies to measure and recognize compensation expense for all share-based payments at the grant date based on the fair value of the award, as defined in FASB ASC 718, “Stock Compensation,” and include such costs as an expense in their income statements over the requisite service (vesting) period. The Company estimates the impact of forfeitures based on historical experience with previously granted share-based compensation awards, and considers the impact of the forfeitures when determining the amount of expense to record. The Company generally issues new shares of common stock to satisfy stock option exercises. The Company uses the Black-Scholes option pricing model to measure fair value. No options or Stock Appreciation Rights (“SARs”) were granted in 2016 or 2015. Incentive stock options, nonqualified stock options, restricted stock, restricted stock units, and stock-settled SARs are recognized as equity-based awards and compensation

 

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expense is recorded to the income statement over the requisite vesting period based on the grant-date fair value. SARs settled in cash are recognized on the balance sheet as liability-based awards. The grant-date fair value of liability-based awards vesting in the current period, along with the change in fair value of the awards during the period, are recognized as compensation expense and as an adjustment to the recorded liability.

Fair Value Measurements – Generally accepted accounting principles define 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.

Derivative Instruments—Derivative instruments are entered into primarily as a risk management tool of the Company to help manage its interest rate risk position. Financial derivatives are recorded at fair value as other assets and other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability are recognized currently in earnings. For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, are recorded in accumulated other comprehensive income and subsequently reclassified to earnings as the hedged transaction impacts net income. Any ineffective portion of a cash flow hedge is recognized currently in earnings.

Operating Segments –Public enterprises are required to report certain information about their operating segments in a complete set of financial statements to shareholders. They are also required to report certain enterprise-wide information about the Company’s products and services, its activities in different geographic areas and its reliance on major customers. The basis for determining the Company’s operating segments is the manner in which management operates the business. During 2016, 2015 and 2014, the Company operated under one segment.

Recently Issued Accounting Pronouncements –

In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis , which is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The ASU focuses on simplifying the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities by reducing the number of consolidation model from four to two, among other changes. The ASU will be effective for periods beginning after December 15, 2015, while early adoption is permitted. Adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. ASU No. 2016-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. ASU No. 2016-03 should be applied on a retrospective basis. The adoption of ASU No. 2016-03 did not have a material impact on the Company’s consolidated financial statements.

 

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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 did not 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 adoption of ASU No. 2016-01 is not expected to have a material impact 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, however estimates a new lease asset and related lease liability to be small due to the minimal lease locations currently occupied by the Bank.

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 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, 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

 

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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 but does not expect the ASU to have a material impact 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 but does not expect the ASU to have a material impact on the Company’s consolidated financial statements.

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,

 

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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 does not expect the ASU to have a material impact 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 and implementation could have the potential to materially affect the provision for loan losses in the 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.

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments-Equity Method and Joint Ventures (Topic 323). This ASU amends the Codification of SEC staff announcements made at recent Emerging Issues Task Force (EITF) meetings. The SEC guidance that specifically relates to our consolidated financial statements was from the September 2016 meeting, where the SEC staff expressed their expectations about the extent of disclosures registrants should make about the effects of the new FASB guidance as well as any amendments issued prior to adoption, on revenue (ASU 2014-09), leases (ASU2016-02) and credit losses on financial instruments (ASU 2016-13) in accordance with SAB topic 11.M. Registrants are required to disclose the effect that recently issued accounting standards will have on their financial statements when adopted in the future period. In cases where a registrant cannot reasonably estimate the impact of the adoption, then additional qualitative disclosures should be considered., The ASU incorporates these SEC staff views into ASC 250 and adds reference to that guidance in the transition paragraphs of each of the three new standards. The adoption of this ASU did not have a material effect on the Company’s consolidated financial statements.

Subsequent events – The Company has evaluated events and transactions subsequent to December 31, 2016, for potential recognition or disclosure.

Reclassifications – Certain amounts contained in the 2015 and 2014 consolidated financial statements have been reclassified where appropriate to conform to the financial statement presentation used in 2016. These reclassifications had no effect on previously reported net income.

 

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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, with small adjustments to the originally recorded fair values occurring in the fourth quarter related to other real estate owned properties final valuation. The application of the acquisition method resulted in the recognition of goodwill of $21,375 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			(2,979	)
Securities			1,673
Other			1,141
Goodwill		$	21,375

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 2,853,362 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. 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 $4,934 was recorded during 2016 and are included within the merger-related expense line item on the Consolidated Statements of Income.

 

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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			88,464
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			21,375
Core deposit intangible			5,762
Deferred tax asset			3,925
Other real estate owned			1,219
Bank-owned life insurance			11,574
Other asset			1,465
Total assets		$	450,046
LIABILITIES AND SHAREHOLDERS EQUITY
Deposits		$	396,509
Other liabilities			2,730
Junior subordinated debentures			3,013
Total liabilities			402,252
Common stock issued to Foundation Bancorp shareholders			47,794
Total liabilities and shareholders’ equity		$	450,046

 

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Acquired loans at the acquisition date and as of December 31, 2016, are presented below:

 

		September 6, 2016				December 31, 2016
Contractually required principal payments		$	281,790			$	243,552
Purchase adjustment for credit and interest rate			(11,257	)			(8,787	)
Balance of acquired loans		$	270,533			$	234,765

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.

NOTE 3—CASH AND CASH EQUIVALENTS:

The Company is required to maintain certain reserves with the Federal Reserve Bank. Such reserves totaling $33,561 and $11,015 were maintained within the Company’s cash balances at December 31, 2016, and 2015, respectively. The Company maintains cash held as collateral for interest rate swaps totaling $655 and $803 at December 31, 2016 and 2015, respectively.

NOTE 4—SECURITIES AVAILABLE-FOR-SALE:

The amortized cost and estimated fair values of securities available-for-sale at December 31, 2016, are as follows:

 

						Gross				Gross				Estimated				Percentage
		Amortized				Unrealized				Unrealized				Fair				of
		Cost				Gains				Losses				Value				Portfolio
Unrealized Loss Positions
Obligations of U.S. government agencies		$	3,995			$	—			$	(49	)		$	3,946				0.84	%
Obligations of states and political subdivisions			41,016				—				(1,279	)			39,737				8.44	%
Private-label mortgage-backed securities			241				—				(23	)			218				0.05	%
Mortgage-backed securities			221,835				—				(5,362	)			216,473				45.96	%
SBA variable rate pools			26,758				—				(493	)			26,265				5.57	%
		$	293,845			$	—			$	(7,206	)		$	286,639				60.86	%
Unrealized Gain Positions
Obligations of U.S. government agencies		$	21,290			$	384			$	—			$	21,674				4.60	%
Obligations of states and political subdivisions			69,148				1,854				—				71,002				15.07	%
Private-label mortgage-backed securities			1,566				153				—				1,719				0.36	%
Mortgage-backed securities			72,752				811				—				73,563				15.62	%
SBA variable rate pools			16,281				118				—				16,399				3.48	%
		$	181,037			$	3,320			$	—			$	184,357				39.14	%
		$	474,882			$	3,320			$	(7,206	)		$	470,996				100.00	%

At December 31, 2016, unrealized losses exist on certain securities classified as obligations of U.S. government agencies, obligations of states and political subdivisions, mortgage-backed securities, private-label mortgage-backed securities and SBA pools. 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 December 31, 2016.

 

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The following table presents a summary of securities in a continuous unrealized loss position at December 31, 2016:

 

		Securities in Continuous Unrealized Loss Positions for less than 12 Months				Gross Unrealized Loss on Securities in Loss Position for Less than 12 Months				Securities in Continuous Unrealized Loss Positions for 12 Months or Longer				Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
Obligations of U.S. government agencies		$	3,946			$	(49	)		$	—			$	—
Obligations of states and political subdivisions			39,737				(1,279	)			—				—
Private-label mortgage-backed securities			—				—				218				(23	)
Mortgage-backed securities			211,721				(5,266	)			4,752				(96	)
SBA variable rate pools			22,076				(458	)			4,189				(35	)
		$	277,480			$	(7,052	)		$	9,159			$	(154	)

On a monthly basis management reviewed all of its private-label mortgage-backed securities for the presence of OTTI and during 2016 recorded $21 on five securities. 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 amount of credit-related OTTI recognized in earnings during 2016, 2015 and 2014:

 

		December 31,
		2016				2015				2014
Balance, beginning of period:		$	249			$	227			$	227
Additions:
OTTI credit loss recorded			21				22				—
Less:
OTTI reduction from sale or maturity			—				—				—
Balance, end of period:		$	270			$	249			$	227

At December 31, 2016, 9 of the Company’s private-label mortgage-backed securities with an amortized cost of $1,338 were classified as substandard as their ratings were below investment grade. Securities with an amortized cost of $1,506 were classified as substandard at December 31, 2015.

At December 31, 2016 the projected average life of the securities portfolio was 4.9 years and its modified duration was 4.4 years.

 

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

 

						Gross				Gross				Estimated				Percentage
		Amortized				Unrealized				Unrealized				Fair				of
		Cost				Gains				Losses				Value				Portfolio
Unrealized Loss Positions
Obligations of U.S. government agencies		$	14,491			$	—			$	(119	)		$	14,372				3.93	%
Obligations of states and political subdivisions			13,438				—				(149	)			13,289				3.63	%
Private-label mortgage-backed securities			663				—				(33	)			630				0.17	%
Mortgage-backed securities			95,040				—				(856	)			94,184				25.75	%
SBA variable rate pools			17,225				—				(101	)			17,124				4.68	%
Corporate securities			899				—				(5	)			893				0.25	%
		$	140,857			$	—			$	(1,258	)		$	139,599				38.41	%
Unrealized Gain Positions
Obligations of U.S. government agencies		$	29,669			$	582			$	—			$	30,251				8.27	%
Obligations of states and political subdivisions			80,119				3,743				—				83,862				22.93	%
Private-label mortgage-backed securities			2,028				131				—				2,159				0.59	%
Mortgage-backed securities			90,126				1,060				—				91,186				24.93	%
SBA variable rate pools			18,560				88				—				18,648				5.10	%
			220,502				5,604				—				226,106				61.82	%
		$	361,359			$	5,604			$	(1,258	)		$	365,705				100.23	%

The following table presents a summary of securities in a continuous unrealized loss position at December 31, 2015:

 

		Securities in Continuous Unrealized Loss Positions for less than 12 Months				Gross Unrealized Loss on Securities in Loss Position for Less than 12 Months				Securities in Continuous Unrealized Loss Positions 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 variable rate pools			13,539				(78	)			3,585				(23	)
Corporate securities			893				(5	)			—				—
		$	129,701			$	(1,062	)		$	10,791			$	(201	)

 

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The amortized cost and estimated fair value of securities at December 31, 2016, and 2015, are shown below by maturity or projected average life, depending on the type of security. Obligations of U.S. government agencies and states and political subdivisions are shown by contractual maturity. Mortgage-backed securities are shown by projected average life.

 

		December 31,
		2016								2015
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
Due in one year or less		$	5,433			$	5,442			$	14,455			$	14,513
Due after one year through 5 years			258,557				259,777				235,926				238,637
Due after 5 years through 10 years			193,063				189,049				109,017				110,539
Due after 10 years			17,829				16,728				2,860				2,909
		$	474,882			$	470,996			$	362,258			$	366,598

During 2016, 58 investment securities were sold resulting in proceeds of $98,544. Of that total $54,450 related to securities acquired in the Foundation Bank acquisition, which were liquidated due to an alignment between the two portfolios. The total sales generated a gross gain of $552 and a gross loss of $179, totaling a net gain of $373. The specific identification method was used to determine the cost of the securities sold.

During 2015, 61 investment securities were sold resulting in proceeds of $52,371. The sales generated a gross gain of $922 and a gross loss of $250, totaling a net gain of $672. The specific identification method was used to determine the cost of the securities sold.

During 2014, 72 investment securities were sold resulting in proceeds of $25,570. The sales generated a gross gain of $318 and a gross loss of $352, totaling a net loss of $34. 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 and required by law:

 

		December 31,
		2016								2015
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
Pledged to secure public deposits		$	25,257			$	25,683			$	27,938			$	29,052
Pledged to secure repurchase agreements			3,579				3,573				3,985				4,111
		$	28,836			$	29,256			$	31,923			$	33,163

At December 31, 2016, and December 31, 2015, there was an outstanding balance for repurchase agreements of $1,966 and $71, respectively.

 

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NOTE 5 – 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 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 loans at December 31, 2016 and 2015 are as follows:

 

		December 31,				% of gross				December 31,				% of gross
		2016				loans				2015				loans
Real estate secured loans:
Multi-family residential		$	74,340				4.00	%		$	66,445				4.73	%
Residential 1-4 family			61,548				3.31	%			53,776				3.82	%
Owner-occupied commercial			461,557				24.82	%			364,742				25.94	%
Nonowner-occupied commercial			451,893				24.30	%			300,774				21.39	%
Total permanent real estate loans			1,049,338				56.43	%			785,737				55.88	%
Construction loans:
Multi-family residential			22,252				1.20	%			7,027				0.50	%
Residential 1-4 family			43,532				2.34	%			30,856				2.19	%
Commercial real estate			76,301				4.10	%			42,680				3.04	%
Commercial bare land and acquisition & development			15,081				0.81	%			20,537				1.46	%
Residential bare land and acquisition & development			10,645				0.57	%			7,268				0.52	%
Total construction real estate loans			167,811				9.02	%			108,368				7.71	%
Total real estate loans			1,217,149				65.45	%			894,105				63.59	%
Commercial loans			630,491				33.89	%			501,976				35.70	%
Consumer loans			2,922				0.16	%			3,351				0.24	%
Other loans			9,225				0.50	%			6,580				0.47	%
Gross loans			1,859,787				100.00	%			1,406,012				100.00	%
Deferred loan origination fees			(2,020	)							(1,530	)
			1,857,767								1,404,482
Allowance for loan losses			(22,454	)							(17,301	)
Total loans, net of allowance for loan losses and net deferred fees		$	1,835,313							$	1,387,181

At December 31, 2016, outstanding loans to dental professionals totaled $377,478 and represented 20.30% of total outstanding loans compared to dental professional loans of $340,162 or 24.19% of total loans at December 31, 2015. Additional information about the Company’s dental portfolio can be found in Note 6. There are no other industry concentrations in excess of 10.00% of the total loan portfolio. However, as of December 31, 2016, 65.45% 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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Acquired Loans

The following table represents the contractually required principal payments, net of any previous charge offs, and the carrying balance of loans acquired in the Century Bank, Capital Pacific Bank and Foundation Bank acquisitions, at December 31, 2016, 2015 and 2014, respectively.

 

		December 31,
		2016				2015				2014
Contractually required principal payments, net of charge offs		$	373,674			$	183,347			$	28,187
Purchase adjustment for credit and interest rate			(11,297	)			(3,958	)			(881	)
Balance of acquired loans		$	362,377			$	179,389			$	27,306

Purchased Credit Impaired Loans

On September 6, 2016, the Bank acquired purchased credit impaired loans with a fair value of $19,510, associated with the Foundation Bank Acquisition. The contractually required principal and interest payments at acquisition totaled $21,575, of which $919 were not expected to be collected.

The following table represents the contractually required principal balance of purchased credit impaired loans and the carrying balance at December 31, 2016, 2015 and 2014:

 

		December 31,
		2016				2015				2014
Contractually required principal payments for purchased credit impaired loans		$	22,941			$	11,528			$	2,753
Accretable yield			(1,453	)			(1,070	)			(151	)
Nonaccretable yield			(809	)			(378	)			(321	)
Balance of purchased credit impaired loans		$	20,679			$	10,080			$	2,281

The following tables summarize the changes in the accretable yield for purchased credit impaired loans for the year ended December 31, 2016 and 2015:

 

		Year ended
		December 31, 2016
		Century				Capital Pacific				Foundation				Total
Balance, beginning of period		$	40			$	1,030			$	—			$	1,070
Additions			—				—				908				908
Accretion to interest income			(40	)			(265	)			(220	)			(525	)
Balance, end of period		$	—			$	765			$	688			$	1,453

 

		Year ended
		December 31, 2015
		Century				Capital Pacific				Total
Balance, beginning of period		$	151			$	—			$	151
Additions			—				1,569				1,569
Accretion to interest income			(111	)			(539	)			(650	)
Balance, end of period		$	40			$	1,030			$	1,070

 

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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 provides 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 US political environment, including healthcare reform, federal tax structure, and immigration 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.

 

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The following tables present a summary of the activity in the allowance for loan losses by major loan classification for the periods ended December 31, 2016, 2015 and 2014:

 

		For the year ended December 31, 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			(716	)			—				—				(9	)			—				(725	)
Recoveries			207				55				163				3				—				428
Provision (reclassification)			2,774				2,520				360				1				(205	)			5,450
Ending balance		$	8,614			$	10,872			$	1,781			$	41			$	1,146			$	22,454
		For the year ended December 31, 2015
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Beginning balance		$	5,733			$	7,494			$	1,077			$	54			$	1,279			$	15,637
Charge-offs			(630	)			(61	)			—				(9	)			—				(700	)
Recoveries			562				76				16				15				—				669
Provision (reclassification)			684				788				165				(14	)			72				1,695
Ending balance		$	6,349			$	8,297			$	1,258			$	46			$	1,351			$	17,301
		For the year ended December 31, 2014
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Beginning balance		$	5,113			$	7,668			$	1,493			$	68			$	1,575			$	15,917
Charge-offs			(610	)			(58	)			(155	)			(12	)			—				(835	)
Recoveries			348				186				16				5				—				555
Provision (reclassification)			882				(302	)			(277	)			(7	)			(296	)			—
Ending balance		$	5,733			$	7,494			$	1,077			$	54			$	1,279			$	15,637

 

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

 

		December 31, 2016
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Ending allowance: collectively evaluated for impairment		$	7,881			$	10,869			$	1,781			$	41			$	1,146			$	21,718
Ending allowance: individually evaluated for impairment			733				3				—				—				—				736
Ending allowance: loans acquired with deteriorated credit quality			—				—				—				—				—				—
Total ending allowance		$	8,614			$	10,872			$	1,781			$	41			$	1,146			$	22,454
Ending loan balance: collectively evaluated for impairment		$	628,773			$	1,027,354			$	167,491			$	2,922			$	—			$	1,826,540
Ending loan balance: individually evaluated for impairment			4,396				7,852				320				—				—				12,568
Ending loan balance: loans acquired with deteriorated credit quality			6,547				14,132				—				—				—				20,679
Total ending loan balance		$	639,716			$	1,049,338			$	167,811			$	2,922			$	—			$	1,859,787
		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			$	771,915			$	107,605			$	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				8,040				372				—				—				10,080
Total ending loan balance		$	508,556			$	785,737			$	108,368			$	3,351			$	—			$	1,406,012

The 2016 ending allowance includes $736 in specific allowance for $12,568 of impaired loans ($10,567 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 December 31, 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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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.

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 our 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.

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.

Doubtful – An asset classified 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.

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

 

		Credit Quality Indicators
		As of December 31, 2016
		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Real estate loans
Multi-family residential		$	74,340			$	—			$	—			$	—			$	74,340
Residential 1-4 family			58,286				—				3,262				—				61,548
Owner-occupied commercial			443,737				—				17,820				—				461,557
Nonowner-occupied commercial			445,283				—				6,610				—				451,893
Total real estate loans			1,021,646				—				27,692				—				1,049,338
Construction
Multi-family residential			22,252				—				—				—				22,252
Residential 1-4 family			43,532				—				—				—				43,532
Commercial real estate			76,301				—				—				—				76,301
Commercial bare land and acquisition & development			15,081				—				—				—				15,081
Residential bare land and acquisition & development			9,852				—				793				—				10,645
Total construction loans			167,018				—				793				—				167,811
Commercial and other			621,165				—				16,890				1,661				639,716
Consumer			2,922				—				—				—				2,922
Totals		$	1,812,751			$	—			$	45,375			$	1,661			$	1,859,787
Percentage of total portfolio			97.47	%			0.00	%			2.44	%			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 total portfolio			97.32	%			0.00	%			2.68	%			0.00	%			100.00	%

 

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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 aged analysis of past due and nonaccrual loans at December 31, 2016, and 2015:

Aged Analysis of Loans Receivable

As of December 31, 2016

 

										Greater
		30-59 Days				60-89 Days				Than								Total Past
		Past Due				Past Due				90 Days								Due and				Total				Total Loans
		Still Accruing				Still Accruing				Still Accruing				Nonaccrual				Nonaccrual				Current				Receivable
Real estate loans
Multi-family residential		$	—			$	—			$	—			$	—			$	—			$	74,340			$	74,340
Residential 1-4 family			—				—				—				158				158				59,241				59,399
Owner-occupied commercial			—				—				—				—				—				452,748				452,748
Nonowner-occupied commercial			—				—				—				601				601				448,118				448,719
Total real estate loans			—				—				—				759				759				1,034,447				1,035,206
Construction
Multi-family residential			—				—				—				—				—				22,252				22,252
Residential 1-4 family			—				—				—				—				—				43,532				43,532
Commercial real estate			—				—				—				—				—				76,301				76,301
Commercial bare land and acquisition & development			—				—				—				—				—				15,081				15,081
Residential bare land and acquisition & development			—				—				—				—				—				10,645				10,645
Total construction loans			—				—				—				—				—				167,811				167,811
Commercial and other			363				366				—				2,794				3,523				629,646				633,169
Consumer			—				—				—				—				—				2,922				2,922
Total		$	363			$	366			$	—			$	3,553			$	4,282			$	1,834,826			$	1,839,108
Percentage of total portfolio			0.02	%			0.02	%			0.00	%			0.19	%			0.23	%			99.77	%			100.00	%

Aged Analysis of Loans Receivable

As of December 31, 2015

 

										Greater
		30-59 Days				60-89 Days				Than								Total Past
		Past Due				Past Due				90 Days								Due and				Total				Total Loans
		Still Accruing				Still Accruing				Still Accruing				Nonaccrual				Nonaccrual				Current				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				299,485				300,235
Total real estate loans			—				—				—				1,124				1,124				776,573				777,697
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				505,393				506,888
Consumer			1				3				—				—				4				3,347				3,351
Total		$	481			$	3			$	—			$	2,672			$	3,156			$	1,392,776			$	1,395,932
Percentage of total portfolio			0.03	%			0.00	%			0.00	%			0.19	%			0.23	%			99.77	%			100.00	%

 

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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 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.

 

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

Impaired Loan Analysis

As of December 31, 2016

 

		Recorded Investment With No Specific Allowance Valuation				Recorded Investment With Specific Allowance Valuation				Recorded Investment				Unpaid Principal Balance				Average Recorded Investment				Related Specific Allowance Valuation
Real estate
Multi-family residential		$	—			$	—			$	—			$	—			$	—			$	—
Residential 1-4 family			454				300				754				775				644				1
Owner-occupied commercial			4,106				865				4,971				4,971				1,804				2
Nonowner-occupied commercial			2,127				—				2,127				2,189				2,228				—
Total real estate loans			6,687				1,165				7,852				7,935				4,676				3
Construction
Multi-family residential			—				—				—				—				—				—
Residential 1-4 family			—				—				—				—				37				—
Commercial real estate			—				—				—				—				—				—
Commercial bare land and acquisition & development			—				—				—				—				—				—
Residential bare land and acquisition & development			320				—				320				320				1,556				—
Total construction loans			320				—				320				320				1,593				—
Commercial and other			2,255				2,141				4,396				4,767				3,518				733
Consumer			—				—				—				—				—				—
Total impaired loans		$	9,262			$	3,306			$	12,568			$	13,022			$	9,787			$	736
Impaired Loan Analysis As of December 31, 2015
		Recorded Investment With No Specific Allowance Valuation				Recorded Investment With Specific Allowance Valuation				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 $2,001 and $1,273 at December 31, 2016, and 2015, respectively. The recorded investment in impaired loans, net of government guarantees, totaled $10,567 and $7,527 at December 31, 2016, and 2015, respectively.

 

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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.

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

 

		Troubled Debt Restructurings as of
		December 31, 2016								December 31, 2015
		Number of Contracts				Outstanding Recorded Investment				Number of Contracts				Outstanding Recorded Investment
Real estate
Multifamily residential			—			$	—				—			$	—
Residential 1-4 family			4				754				6				682
Owner-occupied commercial			4				5,447				3				2,788
Non owner-occupied commercial			6				2,127				7				2,312
Total real estate loans			14				8,328				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			—				—				—				—
Total construction loans			—				—				—				—
Commercial and other			16				2,901				11				2,170
Consumer			—				—				—				—
			30			$	11,229				27			$	7,952

The recorded investment on TDRs in nonaccrual status totaled $2,250 and $1,807 at December 31, 2016, and December 31, 2015, respectively. The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appear relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

For the twelve months ended December 31, 2016, the Company restructured 10 loans into troubled debt restructurings for which impairment was previously measured under the Company’s general loan loss allowance methodology. The total recorded investment in such receivables was $5,870, and the associated allowance for loan losses was $11 at December 31, 2016.

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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The following tables present newly restructured loans that occurred during the twelve months ended December 31, 2016, and 2015, respectively:

 

		Troubled Debt Restructurings
		Restructured during the twelve months ended December 31, 2016
		Rate Modification				Term Modification				Interest Only Modification				Combination Modification
Real estate
Multifamily residential		$	—			$	—			$	—			$	—
Residential 1-4 family			—				—				—				296
Owner-occupied commercial			—				—				4,478				—
Non owner-occupied commercial			—				—				—				—
Total real estate loans			—				—				4,478				296
Construction
Multifamily 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			—				—				445				651
Consumer			—				—				—				—
		$	—			$	—			$	4,923			$	947
		Troubled Debt Restructurings
		Restructured during the twelve months ended December 31, 2015
		Rate Modification				Term Modification				Interest Only Modification				Combination Modification
Real estate
Multifamily residential		$	—			$	—			$	—			$	—
Residential 1-4 family			—				—				—				—
Owner-occupied commercial			—				1,780				—				—
Non owner-occupied commercial			—				—				—				—
Total real estate loans			—				1,780				—				—
Construction
Multifamily 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			297				—				—				—
Consumer			—				—				—				—
		$	297			$	1,780			$	—			$	—

 

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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 secure additional payments including the use of foreclosure proceedings. The following table presents loans receivable modified as troubled debt restructurings that subsequently defaulted within twelve months during the period:

 

		Troubled Debt Restructurings That Subsequently Defaulted within the 12 Months ended December 31,
		2016								2015
		Number of Contracts				Recorded Investment				Number of Contracts				Recorded Investment
Real estate
Multifamily residential			—			$	—				—			$	—
Residential 1-4 family			—				—				—				—
Owner-occupied commercial			1				475				—				—
Non owner-occupied commercial			—				—				—				—
Total real estate loans			1				475				—				—
Construction
Multifamily 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			—				—				—				—
			1			$	475				—			$	—

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

 

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NOTE 6 – DENTAL LOAN PORTFOLIO:

To assist in understanding the concentrations and risks associated with the Bank’s loan portfolio, the following Note has been included to provide additional information relating to the Bank’s dental lending portfolio. At December 31, 2016, and 2015, loans to dental professionals totaled $377,478 and $340,162, respectively, and represented 20.30% and 24.19% of outstanding loans. As of December 31, 2016, and 2015, dental loans supported by government guarantees totaled $5,641 and $9,027, respectively. This represented 1.49% and 2.65% of the outstanding dental loan balances, respectively as of such dates.

The Company defines a “dental loan” as 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 December 31, 2016, and 2015, are as follows:

 

		December 31,
		2016				2015
Real estate secured loans:
Owner-occupied commercial		$	63,793			$	56,145
Other dental real estate loans			806				2,198
Total permanent real estate loans			64,599				58,343
Dental construction loans			4,109				4,334
Total real estate loans			68,708				62,677
Commercial loans			308,770				277,485
Gross loans		$	377,478			$	340,162

Market Area

The Bank’s defined “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 Seattle. The Company also makes national dental loans throughout the United States, and currently has dental loans in 44 states, including Oregon and Washington. National loan relationships are maintained and serviced by Bank personnel primarily located in Portland.

The following table represents the dental lending by borrower location:

 

		December 31,
		2016				2015
Local		$	150,268			$	145,817
National			227,210				194,345
Total		$	377,478			$	340,162

 

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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.

 

		For the Years Ended December 31,
		2016				2015				2014
Balance, beginning of period		$	4,022			$	4,141			$	3,730
Provision (reclassification)			636				(71	)			918
Charge-offs			(9	)			(78	)			(631	)
Recoveries			64				30				124
Balance, end of period		$	4,713			$	4,022			$	4,141

Credit Quality

Please refer to Note 5 for additional information on the definitions of the credit quality indicators.

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

Dental Credit Quality Indicators

As of December 31, 2016

 

		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Local		$	148,805			$	—			$	1,463			$	—			$	150,268
National			224,493				—				1,056				1,661				227,210
Total		$	373,298			$	—			$	2,519			$	1,661			$	377,478

Dental Credit Quality Indicators

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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Past Due and Nonaccrual Loans

Please refer to Note 5 for additional information on the definitions of “past due.”

The following tables present an aged analysis of the dental loans by market, including nonaccrual loans, at December 31, 2016 and 2015:

Aged Analysis of Dental Loans Receivable

As of December 31, 2016

 

		30-59 Days Past Due Still Accruing				60-89 Days Past Due Still Accruing				Greater Than 90 Days Still Accruing				Nonaccrual				Total Past Due and Nonaccrual				Total Current				Total Loans Receivable
Local		$	—			$	—			$	—			$	407			$	407			$	149,861			$	150,268
National			263				366				—				1,660				2,289				224,921				227,210
Total		$	263			$	366			$	—			$	2,067			$	2,696			$	374,782			$	377,478
Aged Analysis of Dental 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 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

NOTE 7 – LOAN PARTICIPATIONS AND SERVICING:

In the normal course of business the Company may sell portions of loans to other institutions for cash in order to extend its lending capacity or to mitigate risk. These sales are commonly referred to as loan participations. Loan participations are performed without recourse and the participant’s interest is ratably concurrent with that retained by the Company. Cash flows are shared proportionately and neither the Company’s nor the participant’s interest is subordinated. The Company retains servicing rights and manages the client relationships for a reasonable servicing fee. The participated portion of these loans is not included in the accompanying consolidated balance sheets, and the servicing component of these transactions in the aggregate is material to the consolidated financial statements. The Company’s exposure to loss is limited to its retained interest in the loans.

The following table reflects the amounts of loans participated.

 

		December 31,
		2016				2015
Total principal amount outstanding		$	61,130			$	74,018
less: principal amount derecognized			(28,467	)			(37,211	)
Principal amount included in gross loans on the balance sheet		$	32,663			$	36,807

NOTE 8 – PROPERTY AND EQUIPMENT:

 

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The balance of property and equipment net of accumulated depreciation and amortization at December 31, 2016 and 2015, consists of the following:

 

		December 31,
		2016				2015
Land		$	3,831			$	3,831
Buildings and improvements			20,343				19,244
Furniture and equipment			16,794				14,310
			40,968				37,385
less: accumulated depreciation & amortization			(20,760	)			(19,371	)
Net property and equipment		$	20,208			$	18,014

Depreciation expense was $1,389, $1,531, and $1,491, for the years ended December 31, 2016, 2015, and 2014, respectively.

The Company leases certain facilities for office locations under non-cancelable operating lease agreements expiring through 2031. Rent expense related to these leases totaled $1,695, $1,542, and $1,324, in 2016, 2015, and 2014, respectively. The Company leases approximately 26.00% of its Gateway building (Springfield, Oregon) to others under non-cancelable operating lease agreements extending through 2021.

Future minimum payments required and anticipated lease revenues under these leases are:

 

		Lease Commitments				Property Leased to Others
2017		$	1,755			$	250
2018			1,650				254
2019			1,540				258
2020			1,127				228
2021			851				172
Thereafter			4,079				—
		$	11,002			$	1,162

 

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NOTE 9 – GOODWILL AND INTANGIBLE ASSETS:

The following table summarizes the changes in the Company’s goodwill and core deposit intangible asset for the three years ended December 31, 2016, 2015 and 2014:

 

		Goodwill				Core Deposit Intangible				Total
Balance, December 31, 2013		$	22,881			$	735			$	23,616
Amortization			—				(121	)			(121	)
Balance, December 31, 2014		$	22,881			$	614			$	23,495
Increase due to Capital Pacific acquisition			16,374				3,721				20,095
Amortization			—				(431	)			(431	)
Balance, December 31, 2015		$	39,255			$	3,904			$	43,159
Increase due to Capital Pacific acquisition			771				—				771
Increase due to Foundation acquisition			21,375				5,762				27,137
Amortization			—				(685	)			(685	)
Balance, December 31, 2016		$	61,401			$	8,981			$	70,382

At December 31, 2016, the Company had a recorded balance of $61,401 in goodwill from the November 30, 2005, acquisition of Northwest Business Financial Corporation (“NWBF”), the February 1, 2013, acquisition of Century Bank, the March 6, 2016, acquisition of Capital Pacific Bank, and the September 6, 2016, acquisition of Foundation Bank.

The Century Bank, Capital Pacific Bank, and Foundation Bank core deposit intangibles were determined to have an expected life of seven years, ten years and ten years, respectively, and each is being amortized over its respective period using the straight-line method. The Century Bank core deposit intangible will be fully amortized in January 2020, the Capital Pacific Bank core deposit intangible will be fully amortized in February 2025, and the Foundation Bank core deposit intangible will be fully amortized in August 2026.

The table below presents the forecasted amortization expense for intangible assets related to the acquisition of Century Bank, Capital Pacific Bank, and Foundation Bank.

 

Year		Expected Amortization
2017		$	1,069
2018			1,069
2019			1,069
2020			958
2021			948
Thereafter			3,868
		$	8,981

 

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NOTE 10 – DEPOSITS:

Scheduled maturities or repricing of time deposits at December 31, 2016, are as follows:

 

		December 31,
		2016
2017		$	87,701
2018			25,640
2019			28,049
2020			17,286
2021			7,842
Thereafter			12,365
		$	178,883

Time deposits with balances of $250 or greater were $63,370 at December 31, 2016.

NOTE 11 – SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE:

The Company sells certain securities under agreements to repurchase with its customers. The agreements transacted with its customers are utilized as an overnight investment product. The amounts received under these agreements represent short-term borrowings and are reflected as a liability in the consolidated balance sheets. The securities underlying these agreements are included in investment securities in the consolidated balance sheets. The Company has no control over the market value of the securities, which fluctuates due to market conditions. However, the Company is obligated to promptly transfer additional securities if the market value of the securities falls below the repurchase agreement price. The Company manages this risk by maintaining an unpledged securities portfolio that it believes is sufficient to cover a decline in the market value of the securities sold under agreements to repurchase. All securities sold under agreements to repurchase had a daily maturity date. See Note 4 in the Notes to Consolidated Financial Statements in this Form 10-K for additional information regarding the securities sold under agreement to repurchase.

The following table presents information regarding securities sold under agreements to repurchase at December 31, 2016 and 2015.

 

		December 31,
		2016				2015
Balance at end of period		$	1,966			$	71
Average Balance outstanding for the period			702				183
Maximum amount outstanding at any month end during the period			2,107				618
Weighted average interest rate for the period			0.06	%			0.00	%
weighted average interest rate at period end			0.08	%			0.00	%

NOTE 12 – FEDERAL FUNDS AND OVERNIGHT FUNDS PURCHASED:

The Company had unsecured federal funds borrowing lines with various correspondent banks totaling $154,000 at December 31, 2016 and $129,000 at December 31, 2015, with interest rates payable at the then stated rate. At December 31, 2016, and December 31, 2015, there were no outstanding borrowings on this line.

The Company also had a secured overnight borrowing line available from the Federal Reserve Bank that totaled $80,784 and $76,912 at December 31, 2016, and 2015, respectively. The Federal Reserve Bank borrowing line is secured through the pledging of approximately $143,679 of commercial loans under the Company’s Borrower-In-Custody program. At December 31, 2016, and 2015, there were no outstanding borrowings on this line.

 

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NOTE 13 – FEDERAL HOME LOAN BANK BORROWINGS:

The Company has a borrowing limit with the FHLB equal to 35.00% of total assets, subject to discounted collateral. The Company does have the ability to access the FHLB excess stock pool, thus borrowing is not limited by FHLB stock held. At December 31, 2016, the maximum borrowing line was $889,503; however, the FHLB borrowing line was limited by the discounted value of collateral pledged. The Company had pledged $867,596 in real estate loans to the FHLB that had a discounted value of $632,202. There was $65,000 borrowed on this line at December 31, 2016.

At December 31, 2015, the maximum FHLB borrowing line was $657,086, and the Company had pledged real estate loans and securities to the FHLB with a discounted value of $414,044. There was $77,500 borrowed on this line at December 31, 2015.

FHLB borrowings by year of maturity and applicable interest rate are summarized as follows as of December 31, 2016:

 

		Current				December 31,
		Rates				2016
Cash management advance			0.70	%		$	57,000
2017			2.28	%			3,000
2018			1.55	%			3,000
2019			—				—
2020			—				—
Thereafter			3.85	%			2,000
						$	65,000

NOTE 14 – 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 connection with the November 2005 acquisition of NWB Financial Corporation, the Company formed a wholly owned Delaware statutory business trust subsidiary, Pacific Continental Corporation Capital Trust (the “Trust”), which issued $8,248 of guaranteed undivided beneficial interests in the Company’s Junior Subordinated Deferrable Interest Debentures (“Trust Preferred Securities”). These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. All of the common securities of the Trust are owned by the Company. The proceeds from the issuance of the common securities and the Trust Preferred Securities were used by the Trust to purchase $8,248 of junior subordinated debentures of the Company. The debentures, which represent the sole asset of the Trust, accrued and paid distributions quarterly at a fixed rate of 6.265% per annum of the stated liquidation value of $1 per capital security. At January 7, 2012, the interest rate changed to a variable rate of three-month LIBOR plus 135 basis points. See Note 15 for additional information regarding the interest rate swap agreement executed on the debenture in 2013.

 

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The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of (1) accrued and unpaid distributions required to be paid on the Trust Preferred Securities, (2) the redemption price with respect to any Trust Preferred Securities called for redemption by the Trust, and (3) payments due upon a voluntary or involuntary dissolution, winding up, or liquidation of the Trust. The Trust Preferred Securities are mandatorily redeemable upon maturity of the debentures on January 7, 2036, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by the Trust in whole or in part, on or after, January 7, 2012. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued interest. For the years ended December 31, 2016, 2015, and 2014, the Company recognized net interest expense of $228, $226, and $225, respectively, related to the Trust Preferred Securities.

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 $6,186 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. For the year ended December 31, 2016, the Company recognized net interest expense of $50, related to the Foundation trust preferred securities.

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 15 – DERIVATIVE INSTRUMENTS:

During the second quarter 2013, the Company entered into an interest rate swap agreement with an $8,000 notional amount to convert its variable-rate Junior Subordinated Debenture debt into a fixed rate for a term of approximately 7 years at a rate of 2.73%. The derivative is designated as a cash flow hedge. The 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 December 31, 2016, was an unrealized gain of $91, which is recorded in the other asset section of the balance sheet, net of the tax effect.

The Company maintains written documentation for the hedge. This documentation identifies the hedging objective and strategy, the hedging instrument, the instrument being hedged, the reasoning behind the assertion that the hedge is highly effective and the methodology for measuring ongoing hedge effectiveness and ineffectiveness. The Company deposited cash collateral totaling $400 with a counterparty as of April 22, 2013, to satisfy collateral requirements associated with the interest rate swap contract.

Upon the acquisition of Capital Pacific Bank on March 6, 2015, the Bank acquired three interest rate swaps entered into by Capital Pacific Bank with commercial banking customers tied to loans on the 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 December 31, 2016, the Bank had interest rate swaps with an aggregate notional amount of approximately $8,540, 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 termination value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was approximately $14 as of December 31, 2016. 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 December 31, 2016.

The Bank has also entered into a swap with a third party to serve as a hedge to an equal amount of fixed rate loans. As of December 31, 2016, the Bank had one swap designated a hedging instrument with a notional amount of $1,492 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 allowance for loan losses and unearned fees.

 

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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. During the fourth quarter the company terminated the cash flow hedge which resulted in a onetime gain of $327 that was recognized in the other income section of the consolidated statements of operations.

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

 

		December 31, 2016								December 31, 2015
		Hedge- Designated				Not-Hedge- Designated				Hedge- Designated				Not-Hedge- Designated
Notional amount		$	1,492			$	8,540			$	1,525			$	8,774
Weighted average pay rate			5.71	%			4.85	%			5.71	%			4.85	%
Weighted average receive rate			3.54	%			3.63	%			3.20	%			3.28	%
Weighted average maturity in years			6.65				5.45				7.60				6.49

The following table presents the fair values of interest rate swaps and their locations in the Consolidated Balance Sheets as of December 31, 2016 and 2015:

 

						Asset Derivatives								Liability Derivatives
		Balance sheet				December 31,								December 31,
Derivative		location				2016				2015				2016				2015
Interest rate swap designated as a hedging instrument			Other assets or other liabilities			$	45			$	66			$	67			$	93
Interest rate swaps not designated as hedging instruments			Other assets or other liabilities			$	14			$	24			$	14			$	24

The following table presents the income statement impact of these interest rate swaps for the years ended December 31, 2016, 2015 and 2014:

 

Derivative		Consolidated Statements of Operations location				2016				2015				2014
Interest rate swaps not designated as a hedging instrument			Other noninterest income			$	6			$	(5	)		$	—
						$	6			$	(5	)		$	—

 

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NOTE 16 – INCOME TAXES:

The provision for income taxes for the years ended December 31, 2016, 2015 and 2014 consists of the following:

 

		December 31,
		2016				2015				2014
Current payable:
Federal		$	8,414			$	8,136			$	5,747
State			1,989				800				159
			10,403				8,936				5,906
Deferred:
Federal			(579	)			358				1,608
State			(115	)			795				1,158
			(694	)			1,153				2,766
Total income tax provision		$	9,709			$	10,089			$	8,672

The provision for income taxes results in effective tax rates which are different than the federal income tax statutory rate. The nature of the differences for the years ended December 31, 2016, 2015 and 2014 were as follows:

 

		2016								2015								2014
Expected federal income tax provision		$	10,320				35.00	%		$	10,094				35.00	%		$	8,650				35.00	%
State income tax, net of federal income tax effect			1,138				3.86	%			1,365				4.73	%			948				3.84	%
Municipal securities tax benefit			(1,429	)			-4.85	%			(1,049	)			-3.64	%			(747	)			-3.02	%
Equity-based compensation			—				0.00	%			—				0.00	%			5				0.02	%
(Expense) benefit of purchased tax credits			(1	)			0.00	%			1				0.00	%			25				0.10	%
Low-income housing tax credits			(393	)			-1.33	%			(234	)			-0.81	%			(199	)			-0.81	%
Bank Owned Life Insurance			(273	)			-0.93	%			(230	)			-0.80	%			(184	)			-0.74	%
Acquisition costs - Century Bank			—				0.00	%			—				0.00	%			150				0.61	%
Acquisition costs - Capital Pacific Bank			—				0.00	%			155				0.54	%			—				0.00	%
Acquisition costs - Foundation Bank			484				1.64	%			—				0.00	%			—				0.00	%
Deferred tax rate adjustments and other			(137	)			-0.46	%			(13	)			-0.05	%			24				0.10	%
Income tax provision		$	9,709				32.93	%		$	10,089				34.97	%		$	8,672				35.10	%

The excess tax benefit associated with stock option plans reduced taxes payable by $43, $9, and $14, at December 31, 2016, 2015, and 2014, respectively. Such benefit is credited to common stock.

 

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The components of deferred tax assets and liabilities for the periods ended December 31, 2016 and 2015 are as follows:

 

		December 31,
		2016				2015
Assets:
Allowance for loan losses		$	12,890			$	7,868
Basis adjustments on loans			1,307				1,677
Reserve for self-funded insurance			139				104
Nonqualified stock options			489				816
Accrued compensation			1,592				1,617
OTTI credit impairment			105				94
Nonaccrual loan interest			53				193
NOL carryforward			3,893				—
Net unrealized loss on securities			1,516				—
Other			137				91
Total deferred tax assets		$	22,121			$	12,460
Liabilities:
Federal Home Loan Bank stock dividends		$	599			$	589
Excess tax over book depreciation			1,502				1,134
Prepaid expenses			583				466
Acquisition adjustments relating to core deposit intangible, deferred loan origination costs, junior subordinated debenture and other			4,877				1,512
Loan origination fees			1,514				1,346
Net unrealized gains on swaps			35				32
Net unrealized gains on securities			—				1,694
Other			289				17
Total deferred tax liabilities			9,399				6,790
Deferred income tax asset			12,722				5,670
Valuation allowance			—				—
Net deferred tax asset		$	12,722			$	5,670

As a result of the Foundation Bancorp acquisition, the Company had a federal net operating loss carryforward of $10,943 and an AMT credit carryover of $40, at December 31, 2016. The amount of net operating loss carryforward that may be utilized annually is limited under Section 382 of the Internal Revenue Code of 1986 (Code) as a result of changes in control, with an annual limitation of $3,389. The federal net operating loss carryforward will begin to expire in 2030, however based on current income projections management anticipates the carryforwards to be utilized by 2020 and has therefore not established a valuation allowance. The AMT credits carryforward are available to reduce future federal regular income taxes, if any, over an indefinite period.

NOTE 17 – RETIREMENT PLAN:

The Company has a 401(k) profit sharing plan covering substantially all employees. The plan provides for employee and employer contributions. The total plan expenses, including employer contributions, were $1,038, $861, and $740 in 2016, 2015, and 2014, respectively.

 

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NOTE 18 – 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 subsidiaries. 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.

Prior to April 2006, incentive stock option (“ISO”) and non-qualified option awards were granted to employees and directors under the Company’s 1999 Employees’ Stock Option Plan and the Company’s 1999 Directors’ Stock Option Plan. The Company has stock options outstanding under both of these plans. Subsequent to the annual shareholders’ meeting in April 2006, all shares available under these plans were deregistered and are no longer available for future grants.

The following tables identify the compensation expenses recorded and tax benefits received by the Company in conjunction with its share-based compensation plans for the years ended December 31, 2016, 2015, and 2014:

 

		For the Year Ended December 31,
		2016								2015								2014
		Compensation Expense				Tax Benefit				Compensation Expense (Benefit)				Tax Benefit (Expense)				Compensation Expense				Tax Benefit
Equity-based awards:
Director restricted stock		$	269			$	94			$	248			$	87			$	200			$	70
Employee stock options			—				—				—				—				13				—
Employee stock SARs			—				—				—				—				26				9
Employee RSUs			1,584				554				1,452				508				1,215				425
Liability-based awards:
Employee cash SARs			150				53				(50	)			(18	)			75				26
		$	2,003			$	701			$	1,650			$	577			$	1,529			$	530

Prior to 2011, the Company granted stock options to selected employees and directors. The following table summarizes information about stock option activity under all plans for the years ended December 31, 2016, 2015, and 2014:

 

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		For the Years Ended December 31,
		2016								2015								2014
		Options Outstanding				Weighted Average Exercise Price				Options Outstanding				Weighted Average Exercise Price				Options Outstanding				Weighted Average Exercise Price
Balance, beginning of year			319,454			$	14.23				327,050			$	14.16				367,906			$	14.15
Exercised			(68,907	)			14.85				(7,596	)			11.44				(16,779	)			11.29
Forfeited or expired			(12,243	)			16.34				—				—				(24,077	)			16.00
Balance, end of year			238,304			$	13.94				319,454			$	14.23				327,050			$	14.16
Options exercisable, end of year			238,304			$	13.94				319,454			$	14.23				327,050			$	14.16

The total intrinsic value (which is the amount by which the stock price exceeds the exercise price) of options outstanding as of December 31, 2016, was $1,884. The weighted average remaining contractual term of options exercisable was 1.69 years as of December 31, 2016. All stock options were vested as of December 31, 2016. There was no unrecognized compensation expense related to stock options at December 31, 2016.

Prior to 2011, the Company granted SARs settled in stock to selected employees. The following table summarizes information about activity of SARs settled in stock for the years ended December 31, 2016, 2015, and 2014:

 

		For the Years Ended December 31,
		2016								2015								2014
		Stock-settled SARs Outstanding				Weighted Average Exercise Price				Stock-settled SARs Outstanding				Weighted Average Exercise Price				Stock-settled SARs Outstanding				Weighted Average Exercise Price
Balance, beginning of year			239,267			$	14.36				289,267			$	13.97				337,759			$	13.85
Exercised			(103,818	)			14.78				(49,600	)			12.12				(26,155	)			11.79
Forfeited or expired			(9,641	)			16.21				(400	)			11.30				(22,337	)			14.74
Balance, end of year			125,808			$	13.87				239,267			$	14.36				289,267			$	13.97
Stock-settled SARs exercisable, end of year			125,808			$	13.87				239,267			$	14.36				289,267			$	13.97

The total intrinsic value (which is the amount by which the stock price exceeds the exercise price) of stock-settled SARs as of December 31, 2016, was $1,004. The weighted average remaining contractual term of exercisable stock-settled SARs was 1.78 years as of December 31, 2016. As of December 31, 2016, there was no unrecognized compensation cost related to non-vested stock-settled SARs.

Prior to 2010, the Company granted SARs settled in cash to selected employees. The following table summarizes information about activity of SARs settled in cash for the years ended December 31, 2016, 2015, and 2014:

 

		For the Years Ended December 31,
		2016								2015								2014
		Cash-settled SARs Outstanding				Weighted Average Exercise Price				Cash-settled SARs Outstanding				Weighted Average Exercise Price				Cash-settled SARs Outstanding				Weighted Average Exercise Price
Balance, beginning of year			142,527			$	1,527.00				158,993			$	15.10				186,992			$	14.95
Exercised			(75,836	)			15.43				(12,087	)			12.95				(11,012	)			12.21
Forfeited or expired			(296	)			12.07				(4,379	)			15.77				(16,987	)			15.34
Balance, end of year			66,395			$	14.94				142,527			$	15.27				158,993			$	15.10
Cash-settled SARs exercisable, end of year			66,395			$	14.94				142,527			$	15.27				158,993			$	15.10

As of December 31, 2016, there was an intrinsic value of $409 on the Company’s outstanding cash-settled SARs. The weighted average remaining contractual term of exercisable cash-settled SARs was 1.19 years as of December 31, 2016.

 

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The following tables identify stock options, employee stock SARs, and employee cash SARs exercised during the periods ended December 31, 2016 and 2015:

 

		Twelve months ended December 31, 2016
		Number Exercised				Weighted Average Exercise				Intrinsic Value				Number of Shares Issued				Net Cash Payment to Employees
Stock options			68,907			$	14.85			$	117				48,665				NA
Employee stock SARs			103,818			$	12.28			$	40				9,131				NA
Employee cash SARs			75,836			$	11.81				NA				NA			$	178
		Twelve months ended December 31, 2015
		Number Exercised				Weighted Average Exercise				Intrinsic Value				Number of Shares Issued				Net Cash Payment to Employees
Stock options			7,596			$	11.44			$	29				7,596				NA
Employee stock SARs			49,600			$	12.12			$	94				6,250				NA
Employee cash SARs			12,087			$	12.95				NA				NA			$	27

During 2016, 16,144 restricted shares were granted and issued to directors with no restrictions imposed.

In 2016, the Company granted 130,151 RSUs to employees. Of the RSUs granted, 129,851 vest over four years, and 300 vested immediately. The Company’s RSUs do not accrue dividends and the grantees do not have voting rights.

The following table provides information regarding RSU activity during 2016, 2015 and 2014:

 

		For the Years Ended December 31,
		2016								2015								2014
		Restricted Stock Units Outstanding				Weighted Average Grant Date Fair Value				Restricted Stock Units Outstanding				Weighted Average Grant Date Fair Value				Restricted Stock Units Outstanding				Weighted Average Grant Date Fair Value
Balance, beginning of year			330,997			$	12.23				306,532			$	11.18				299,696			$	9.79
Granted			130,151				16.66				157,195				13.00				127,051				13.21
Vested shares issued			(80,051	)			11.50				(75,373	)			10.59				(58,518	)			9.65
Vested shares forfeited for taxes			(48,173	)			11.50				(46,105	)			10.59				(36,384	)			9.65
Forfeited or expired			(32,084	)			13.70				(11,252	)			12.33				(25,313	)			10.67
Balance, end of year			300,840			$	14.30				330,997			$	12.23				306,532			$	11.18

Under the terms of the 2006 SOEC Plan, shares of the Company common stock are to be issued as soon as is practicable upon vesting of RSUs.

 

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NOTE 19 – DEFERRED COMPENSATION PLAN:

During 2015, the Company established a nonqualified deferred compensation plan for certain eligible executives and eligible directors. Under the deferred compensation plan, eligible executives and eligible directors may elect to defer a portion of their base salary, bonuses, director fees, and/or long-term incentive compensation. The deferred compensation liability totaled $742 and $352 at December 31, 2016, and 2015, respectively, and is included within the other liabilities on the consolidated balance sheet.

NOTE 20 – ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table shows the changes in accumulated other comprehensive income (loss) by component for the years ended December 31, 2016, 2015 and 2014:

 

		Unrealized gains and losses on available-for-sale securities				Unrealized gains and losses on derivative instrument - cash flow hedge				Total
Year ended December 31, 2016
Beginning balance		$	2,649			$	50			$	2,699
Other comprehensive (loss) income before reclassifications			(4,804	)			191				(4,613	)
Amounts reclassified from accumulated other comprehensive income			(215	)			(186	)			(401	)
Net current-period other comprehensive (loss) income			(5,019	)			5				(5,014	)
Ending balance		$	(2,370	)		$	55			$	(2,315	)
Year ended December 31, 2015
Beginning balance		$	3,695			$	107			$	3,802
Other comprehensive (loss) before reclassifications			(649	)			(57	)			(706	)
Amounts reclassified from accumulated other comprehensive income			(397	)			—				(397	)
Net current-period other comprehensive (loss)			(1,046	)			(57	)			(1,103	)
Ending balance		$	2,649			$	50			$	2,699
Year ended December 31, 2014
Beginning balance		$	(148	)		$	247			$	99
Other comprehensive income (loss) before reclassifications			3,822				(140	)			3,682
Amounts reclassified from accumulated other comprehensive income			21				—				21
Net current-period other comprehensive income (loss)			3,843				(140	)			3,703
Ending balance		$	3,695			$	107			$	3,802

 

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NOTE 21 – TRANSACTIONS WITH RELATED PARTIES:

The Company has granted loans to officers and directors and to companies with which they are associated. Such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated parties. Activity with respect to these loans during the years ended December 31, 2016, 2015 and 2014, was as follows:

 

		For the Years Ended December 31,
		2016				2015				2014
Balance, beginning of year		$	25			$	100			$	100
Additions or renewals			25				35				—
Amounts collected			(50	)			(110	)			—
Balance, end of year		$	—			$	25			$	100

In addition, there were $106 in commitments to extend credit to directors and officers at December 31, 2016, which are included among loan commitments, disclosed in Note 22.

At December 31, 2016, 2015, and 2014, deposits to related parties totaled $6,439, $1,091, and $1,304, respectively.

NOTE 22 – COMMITMENTS AND CONTINGENCIES:

In the normal course of business under the provisions of the Company’s investment policy, additional investment securities may be purchased from time to time. Commitments to purchase securities are generally settled within a month and are not associated with repurchase agreements.

In order to meet the financing needs of its clients, the Company commits to extensions of credit and issues letters of credit. The Company uses the same credit policies in making commitments and conditional obligations as it does for other products. In the event of nonperformance by the client, the Company’s exposure to credit loss is represented by the contractual amount of the instruments. The Company’s collateral policies related to financial instruments with off-balance sheet risk conform to its general underwriting guidelines.

Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Letters of credit written are conditional commitments issued by the Company to guarantee the performance of a client to a third-party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients.

 

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Off-balance sheet instruments at December 31, 2016 and 2015 consist of the following:

 

		December 31,
		2016				2015
Commitments to extend credit (principally variable rate)		$	408,860			$	256,156
Letters of credit and financial guarantees written		$	2,425			$	1,184

The Company has entered into executive employment agreements with two key executive officers. The employment agreements provide for minimum aggregate annual base salaries of $840, plus performance adjustments, life insurance coverage, and other perquisites commonly found in such agreements. The two employment agreements expire in 2017 unless extended or terminated earlier.

Legal contingencies arise from time-to-time in the normal course of business. Based upon analysis of management and in consultation with the Company’s legal counsel there are no current legal matters which are expected to have a material effect on the Company’s consolidated financial position.

NOTE 23 – 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 December 31, 2016 and 2015, are as follows:

 

		December 31,
		2016								2015
		Carrying Amount				Fair Value				Carrying Amount				Fair Value
Financial assets:
Cash and cash equivalents		$	67,113			$	67,113			$	36,675			$	36,675
Securities available-for-sale			470,996				470,996				366,598				366,598
Loans			1,857,767				1,837,673				1,404,482				1,389,562
Accrued interest receivable			7,017				7,017				5,721				5,721
Federal Home Loan Bank stock			5,423				5,423				5,208				5,208
Bank-owned life insurance			35,165				35,165				22,884				22,884
Interest rate swaps			150				150				171				171
Financial liabilities:
Deposits		$	2,148,103			$	2,147,056			$	1,597,093			$	1,597,280
Federal Home Loan Bank borrowings			65,000				65,043				77,500				77,651
Subordinated debentures			34,096				32,140				—				—
Junior subordinated debentures			11,311				6,972				8,248				2,741
Accrued interest payable			176				176				138				138
Interest rate swaps			81				81				116				116

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.

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

 

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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.

Federal Home Loan Bank stock – The carrying amount approximates fair value.

Bank-owned life insurance – The carrying amount approximates fair value.

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

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.

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

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

Accrued Interest payable – The carrying amounts of accrued interest payable approximate their fair value

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 at fair value as of December 31, 2016, and 2015:

 

		Carrying Amount				Fair Value at December 31, 2016
						Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	67,113			$	67,113			$	—			$	—
Loans			1,857,767				—				—				1,837,673
Accrued interest receivable			7,017				7,017				—				—
Federal Home Loan Bank stock			5,423				5,423				—				—
Bank-owned life insurance			35,165				35,165				—				—
Interest rate swaps			150				150				—				—
Financial liabilities:
Deposits		$	2,148,103			$	1,969,220			$	177,836			$	—
Federal Home Loan Bank borrowings			65,000				—				65,043				—
Subordinated debentures			34,096				—				32,140
Junior subordinated debentures			11,311				—				6,972				—
Accrued interest payable			176				176				—				—
Interest rate swaps			81				81				—				—
		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
Accrued interest receivable			5,721				5,721				—				—
Federal Home Loan Bank stock			5,208				5,208				—				—
Bank-owned life insurance			22,884				22,884				—				—
Swap derivative			171				171				—				—
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			116				116				—				—

 

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

 

		Carrying Value				Fair Value Measurements Using
December 31, 2016						Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available-for-sale securities
Obligations of U.S government agencies		$	25,620			$	—			$	25,620			$	—
Obligation of states and political subdivisions			110,739				—				110,739				—
Agency mortgage-backed securities			290,036				—				290,036				—
Private-label mortgage-backed securities			1,937				—				569				1,368
SBA variable vate pools			42,664				—				42,664				—
Interest rate swaps			69				69				—				—
Total assets measured on a recurring basis		$	471,065			$	69			$	469,628			$	1,368
		Carrying Value				Fair Value Measurements Using
December 31, 2015						Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available-for-sale securities
Obligations of U.S government agencies		$	44,623			$	—			$	44,623			$	—
Obligation 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 variable rate pools			35,771				—				35,771				—
Corporate securities			893				—				893
Interest rate swaps			55				55				—				—
Total assets measured on a recurring basis		$	366,653			$	55			$	365,012			$	1,586

No transfers to or from level 1 and 2 occurred on assets measured at fair value on a recurring basis during the twelve months ended December 31, 2016.

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

 

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The following table provides a reconciliation of assets measured at fair value on a recurring basis using unobservable inputs (Level 3) for the periods ended December 31, 2016, 2015 and 2014:

 

		For the Years Ended December 31,
		2016				2015				2014
Beginning balance		$	1,586			$	1,568			$	1,786
Transfers into Level 3			70				300				—
Transfers out of Level 3			—				—				—
Total gains or losses
Included in earnings			(21	)			—				—
Included in other comprehensive income			43				66				(106	)
Paydowns			(310	)			(348	)			(112	)
Purchases, issuances, sales, and settlements
Purchases			—				—				—
Issuances			—				—				—
Sales			—				—				—
Settlements			—				—				—
Ending balance		$	1,368			$	1,586			$	1,568

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.

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.

 

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•

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 December 31, 2016, and 2015:

 

						Fair Value Measurements Using
December 31, 2016		Carrying Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Other real estate owned		$	10,936			$	—			$	—			$	10,936
		$	10,936			$	—			$	—			$	10,936
						Fair Value Measurements Using
December 31, 2015		Carrying Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Loans measured for impairment (net of guarantees and specific reserve)		$	53			$	—			$	—			$	53
Other real estate owned			10,147				—				—				10,147
		$	10,200			$	—			$	—			$	10,200

During second quarter 2016, there was one security that transferred from level 2 to level 3 as the Bank recorded OTTI on a security. For additional information, see Note 4.

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.

 

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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.

NOTE 24 – 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, Tier 1 capital, and common equity Tier 1 to risk-weighted assets and of Tier 1 capital to leverage assets. Management believes that, as of December 31, 2016, the Company and the Bank met all capital adequacy requirements to which they were subject.

As of December 31, 2016, according to FDIC guidelines, the Bank is considered to be well-capitalized. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table.

 

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The Company’s and the Bank’s actual capital amounts and ratios are presented in the table below:

 

		Actual								For Capital Adequacy Purposes								To Be Well Capitalized Under Prompt Corrective Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of December 31, 2016:
Total capital (to risk weighted assets)
Bank:		$	267,416				12.19	%		$	175,555				8.00	%		$	219,444				10.00	%
Company:		$	278,444				12.69	%			NA								NA
Tier 1 capital (to risk weighted assets)
Bank:		$	244,414				11.14	%		$	131,666				6.00	%		$	175,555				8.00	%
Company:		$	221,346				10.08	%			NA								NA
Common Equity Tier 1 (to risk weighted assets)
Bank:		$	244,414				11.14	%		$	98,750				4.50	%		$	142,638				6.50	%
Company:		$	208,873				9.52	%			NA								NA
Tier 1 capital (to leverage assets)
Bank:		$	244,414				9.96	%		$	98,181				4.00	%		$	122,726				5.00	%
Company:		$	221,346				9.01	%			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	%		$	73,938				4.00	%		$	92,422				5.00	%
Company:		$	183,600				9.93	%			NA								NA

On July 2, 2013, the federal banking regulators approved the final proposed rules that revised the regulatory capital rules to conform the U.S. regulatory capital framework for U.S. banking organizations to the Basel Committee’s Base III capital framework (“Basel III”). The phase-in period for the final rules began for the Company on January 1, 2016, with full compliance with the final rules entire requirement to be phased in by January 1, 2019.

The final rules, among other things, included a new common equity Tier 1 capital (“CET1”) to risk-weighted assets ratio, including a capital conservation buffer composed of CET1, which will gradually increase from 4.50% on January 1, 2016 to 7.00% on January 1, 2019. The final rules also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4.00% to 6.00%, as well as require a minimum total capital ratio of 8.00% and a minimum leverage ratio of 4.00%.

Also, under the final rules, trust preferred security debt issuances will be phased out of Tier 1 capital into Tier 2 capital over a 10-year period, except for bank holding companies with less than $15 billion assets as of December 31, 2009 which will be allowed to continue to include these issuances in Tier 1 capital, subject to certain restrictions. As the Company had less than $15 billion in assets at December 31, 2009, the Company will be able to continue to include its existing trust preferred securities, less the common stock of the Trusts, in the Company’s Tier 1 capital.

 

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NOTE 25 – PARENT COMPANY FINANCIAL INFORMATION:

Financial information for the Company is presented below:

BALANCE SHEET

 

		December 31,
		2016				2015
Assets:
Cash deposited with the Bank		$	7,558			$	678
Cash and due from banks			403				400
Goodwill			4,464				—
Prepaid expenses			9				4
Equity in Trust			434				248
Swap unrealized gain			91				82
Investment in the Bank			306,304				225,416
		$	319,263			$	226,828
Liabilities and shareholders’ equity:
Liabilities		$	66			$	57
Deferred tax liability			35				32
Subordinated debentures			34,096				—
Junior subordinated debentures			11,311				8,248
Shareholders’ equity			273,755				218,491
		$	319,263			$	226,828

 

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STATEMENTS OF OPERATIONS

 

		For the Years Ended December 31,
		2016				2015				2014
Income:
Cash dividends from the Bank		$	4,400			$	6,550			$	16,211
Income from Trust Preferred			8				4				4
			4,408				6,554				16,215
Expenses:
Interest expense			1,422				226				225
Investor relations			103				132				84
Legal, registration expense, and other			230				98				132
Personnel costs paid to Bank			189				167				183
			1,944				623				624
Income before income tax expense and equity in undistributed earnings from the Bank			2,464				5,931				15,591
Income tax benefit			200				139				140
Equity in undistributed earnings of the Bank			17,112				12,681				311
Net income		$	19,776			$	18,751			$	16,042

STATEMENTS OF CASH FLOWS

 

		For the Years Ended December 31,
		2016				2015				2014
Cash flows from operating activities:
Net income		$	19,776			$	18,751			$	16,042
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed earnings from the Bank			(17,112	)			(12,681	)			(311	)
Excess tax benefit of stock options exercised			(43	)			(9	)			(14	)
Other, net			(665	)			652				525
Net cash provided by operating activities			1,956				6,713				16,242
Cash flows from investing activities:
Capital Investment in the Bank			(20,000	)			—				—
Net cash used by investing activities			(20,000	)			—				—
Cash flows from financing activities:
Proceeds from stock options exercised			691				86				189
Excess tax benefit of stock options exercised			43				9				14
Repurchase of common stock			—				—				(3,600	)
Dividends paid			(8,983	)			(8,042	)			(12,308	)
Vested SARS and RSUs surrendered by employees to cover tax consequences			(896	)			(649	)			(517	)
Proceeds from subordinated debt issuance			34,072				—				—
Net cash provided by (used in) financing activities			24,927				(8,596	)			(16,222	)
Net change in cash			6,883				(1,883	)			20
Cash, beginning of period			1,078				2,961				2,941
Cash, end of period		$	7,961			$	1,078			$	2,961

 

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NOTE 26 – SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

Quarterly financial information for the years ended December 31, 2016 and 2015 is summarized as follows:

 

		First Quarter				Second Quarter				Third Quarter				Fourth Quarter				Year Ended December 31,
2016
Total interest income		$	19,953			$	20,284			$	22,662			$	27,044			$	89,943
Total interest expense			1,144				1,137				1,891				2,060				6,232
Net interset income			18,809				19,147				20,771				24,984				83,711
Provision for loan losses			245				1,950				1,380				1,875				5,450
Noninterest Income			1,807				1,747				1,919				2,344				7,817
Noninterest Expense			12,007				14,932				13,825				15,829				56,593
Income before income taxes			8,364				4,012				7,485				9,624				29,485
Provision for income taxes			2,905				1,406				2,634				2,764				9,709
Net income		$	5,459			$	2,606			$	4,851			$	6,860			$	19,776
Per common share
Earnings (basic) (1)		$	0.28			$	0.13			$	0.24			$	0.30			$	0.96
Earnings (diluted) (1)		$	0.28			$	0.13			$	0.23			$	0.30			$	0.95
		First Quarter				Second Quarter				Third Quarter				Fourth Quarter				Year Ended December 31,
2015
Total interest income		$	16,069			$	18,840			$	19,450			$	19,877			$	74,236
Total interest expense			1,095				1,144				1,142				1,055				4,436
Net interset income			14,974				17,696				18,308				18,822				69,800
Provision for loan losses			—				550				625				520				1,695
Noninterest Income			1,276				1,627				1,714				2,008				6,625
Noninterest Expense			11,972				11,030				11,182				11,706				45,890
Income before income taxes			4,278				7,743				8,215				8,604				28,840
Provision for income taxes			1,475				2,648				2,890				3,076				10,089
Net income		$	2,803			$	5,095			$	5,325			$	5,528			$	18,751
Per common share
Earnings (basic) (1)		$	0.15			$	0.26			$	0.27			$	0.28			$	0.97
Earnings (diluted) (1)		$	0.15			$	0.26			$	0.27			$	0.28			$	0.97

 

(1)	Due to average share calculations, quarterly earnings per share may not total the amount reported for the full year

NOTE 27 – SUBSEQUENT EVENTS

On January 9, 2017, Pacific Continental entered into a definitive agreement to merge with Columbia Banking System, Inc., headquartered in Tacoma, Washington. Upon completion of the merger, the combined company will operate under the Columbia Bank name and brand. The agreement was approved by the Board of Directors of each company. Closing of the transaction, which is expected to occur in mid-2017, is contingent on shareholder approval and receipt of necessary regulatory approvals, along with satisfaction of other customary closing conditions.

 

ITEM 9

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None

 

ITEM 9A

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, the CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and timely reported as provided in the SEC rules and forms. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the twelve months ended December 31, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Management’s Report on Internal Control Over Financial Reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system has been designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of the Company’s published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

The management of the Company has assessed the effectiveness of its internal control over financial reporting at December 31, 2016. To make this assessment, the Company used the criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, at December 31, 2016, management has determined that internal controls over financial reporting were effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles.

 

ITEM 9B

Other Information

None

PART III

 

ITEM 10

Directors, Executive Officers and Corporate Governance

This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment to this Report on Form 10-K.

 

ITEM 11

Executive Compensation

This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment to this Report on Form 10-K.

 

ITEM 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment to this Report on Form 10-K.

 

ITEM 13

Certain Relationships and Related Transactions and Director Independence

This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment to this Report on Form 10-K.

 

ITEM 14

Principal Accountant Fees and Services

This Item is incorporated by reference to our definitive proxy statement on Schedule 14A, which will be filed within 120 days after the close of the fiscal year covered by this report on Form 10-K, or if our proxy statement is not filed by that date, will be included in an amendment to this Report on Form 10-K.

 

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PART IV

 

ITEM 15

Exhibits and Financial Statement Schedules

(a)(1)(2) See Index to Consolidated Financial Statements filed under Item 8 of this Form 10-K.

All other schedules to the financial statements required by Regulation S-X are omitted because they are not applicable, not material, or because the information is included in the financial statements or related notes.

(a)(3) Exhibit Index

 

Exhibit
3.1		Second Amended and Restated Articles of Incorporation (1)
3.2		Amended and Restated Bylaws (2)
4.1		Form of Indenture relating to the issuance of debentures, notes, bonds or other evidences of indebtedness (3)
10.1*		1999 Employee Stock Option Plan (4)
10.2*		1999 Director’s Stock Option Plan (4)
10.3*		Amended 2006 Stock Option and Equity Compensation Plan (5)
10.4*		Form of Restricted Stock Award Agreement (6)
10.5*		Form of Stock Option Award Agreement (6)
10.6*		Form of Restricted Stock Unit Agreement (6)
10.7*		Form of Stock Appreciation Rights Agreement (6)
10.8*		Form of Executive Restricted Stock Unit Award Agreement (6)
10.9*		Form of Change in Control Agreement with executive officers (7)
10.10*		Amended and Restated Employment Agreement for Roger Busse dated July 19, 2016 (8)
10.11*		Amended and Restated Employment Agreement for Casey Hogan dated July 19, 2016 (8)
10.12*		NWB Financial Corporation Employee Stock Option Plan (9)
10.13*		NWB Financial Corporation Director Stock Option Plan (9)
10.14*		Director Fee Schedule, Effective January 1, 2013 (10)
10.15*		Director Stock Trading Plan (11)
10.15*		Deferred Compensation Plan (12)
14.1		Code of Ethics for Senior Financial Officers and Principal Executive Officer (10)
23.1+		Consent of Moss Adams LLP
24.1+		Power of Attorney (included on signature page to this Form 10-K)
31.1+		302 Certification, Roger S. Busse, Chief Executive Officer
31.2+		302 Certification, Richard R. Sawyer, Executive Vice President and Chief Financial Officer
32+		Certifications Pursuant to 18 U.S.C. Section 1350
101+		The following financial information from Pacific Continental Corporation’s Annual Report on Form 10-K for the year ended December 31, 2016, is formatted in XBRL; (i) the Audited Consolidated Balance Sheets, (ii) the Audited Consolidated Statements of Operations, (iii) the Audited Consolidated Statements of Comprehensive Income , (iv) the Audited Consolidated Statements of Changes in Shareholders’ Equity, (v) the Audited Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements.

 

(1)	Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the Quarter ended March 31, 2010.

 

(2)	Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the Quarter ended September 30, 2008.

 

(3)	Incorporated by reference to Exhibit 4.1 of the Company’s Form S-3 Registration Statement, filed March 29, 2013.

 

(4)	Incorporated by reference to Exhibits 99.1 and 99.2 of the Company’s S-8 Registration Statement (File No. 333-109501) filed October 6, 2003.

 

(5)	Incorporated by reference to Exhibit 10.3 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

 

(6)	Incorporated by reference to Exhibits 99.1 to 99.5 of the Company’s Form S-8 Registration Statement (File No. 333-181826) filed on June 1, 2012.

 

(7)	Incorporated by reference to Exhibits 10.1, 10.2 and 10.3 of the Company’s Current Report on Form 8-K filed February 2, 2013

 

(8)	Incorporated by reference to Exhibits 10.1 and 10.2 of the Quarterly Report on Form 10-Q for the quarter ended September 30, 2016.

 

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(9)	Incorporated by reference to Exhibits 99.1 and 99.2 of the Company’s Form S-8 Registration Statement (File No. 333-130886) filed January 1, 2006.

 

(10)	Incorporated by reference to Exhibit 10.15 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

 

(11)	Incorporated by reference to Exhibits 10.14 and 14 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

 

(12)	Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed June 30, 2015.

 

*	Executive Contract, Compensatory Plan or Arrangement

+	Filed Herewith

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

Power of Attorney

Know all persons by these presents, that each person whose signature appears below constitutes and appoints Roger S. Busse and Richard R. Sawyer, and each of them, as such person’s true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for such person and in such person’s name, place and stead, in any and all capacities, to sign any and all amendments to the Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in connection therewith, as fully to all intents and purposes as such person might or could do in person, hereby, ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or such person’s substitute or substitutes, may lawfully do or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 13th day of March 2017.

Principal Executive Officer

 

By		/s/ Roger S. Busse						Chief Executive Officer
		Roger S. Busse						and Director

Principal Financial and Accounting Officer

 

By		/s/ Richard R. Sawyer						Executive Vice President and
		Richard R. Sawyer						Chief Financial Officer

Directors

 

By

/s/ Robert A. Ballin

Chairman

By

/s/ Michael E. Heijer

Director

Robert A. Ballin

Michael E. Heijer

 

By

/s/ Donald G. Montgomery

Vice Chairman

By

/s/ Michael D. Holzgang

Director

Donald G. Montgomery

Michael D. Holzgang

 

By

/s/ John H. Rickman

Director

By

/s/ Donald L. Krahmer, Jr.

Director

John H. Rickman

Donald L. Krahmer, Jr.

 

By

/s/ Jeffrey D. Pineo

Director

By

/s/ Judith Ann Johansen

Director

Jeffrey D. Pineo

Judith Ann Johansen

 

By

/s/ Eric Forrest

Director

By

/s/ Karen L. Whitman

Director

Eric S. Forrest

Karen L. Whitman

 

By

/s/ Duane Woods

Director

By

/s/ Tom Ellison

Director

Duane Woods

Tom Ellison

 

By

/s/ Roger S. Busse

Director

Roger S. Busse

 

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