PACIFIC CONTINENTAL CORP - FORM 10-Q

Attached files

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EX-32 - EXHIBIT 32 - PACIFIC CONTINENTAL CORP	d479554dex32.htm
EX-31.2 - EXHIBIT 31.2 - PACIFIC CONTINENTAL CORP	d479554dex312.htm
EX-31.1 - EXHIBIT 31.1 - PACIFIC CONTINENTAL CORP	d479554dex311.htm

UNITED STATES

SECURITIES & EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

☒	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2017.

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

COMMISSION FILE NUMBER: 0-30106

PACIFIC CONTINENTAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)


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

111 West 7th Avenue Eugene, Oregon		97401
(Address of principal executive offices)		(Zip Code)

(541) 686-8685

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ 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 whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Act. (Check one)


Large accelerated filer	☐	Accelerated filer	☒	Non-accelerated filer	☐

Smaller Reporting company	☐	Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has selected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act ☐

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

The number of shares of common stock outstanding as of October 31, 2017 was 22,772,483.

PACIFIC CONTINENTAL CORPORATION

FORM 10-Q

QUARTERLY REPORT

TABLE OF CONTENTS


PART I	FINANCIAL INFORMATION	3

ITEM 1	Financial Statements	3

	Consolidated Balance Sheets	3

	Consolidated Statements of Income	4

	Consolidated Statements of Comprehensive Income	5

	Consolidated Statements of Changes in Shareholders’ Equity	6

	Consolidated Statements of Cash Flows	7

	Notes to Consolidated Financial Statements	8

ITEM 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	43

ITEM 3	Quantitative and Qualitative Disclosures about Market Risk	65

ITEM 4	Controls and Procedures	65

PART II	OTHER INFORMATION	66

ITEM 1	Legal Proceedings	66

ITEM 1A	Risk Factors	66

ITEM 2	Unregistered Sales of Equity Securities and Use of Proceeds	67

ITEM 3	Defaults upon Senior Securities	67

ITEM 4	Mine Safety Disclosures	67

ITEM 5	Other Information	67

ITEM 6	Exhibits	67

PART I FINANCIAL INFORMATION

ITEM 1 Financial Statements

Pacific Continental Corporation and Subsidiary

Consolidated Balance Sheets

(In thousands, except share amounts)

(Unaudited)


	September 30, 2017			December 31, 2016
ASSETS
Cash and due from banks	$	27,748		$	30,154
Interest-bearing deposits with banks		42,530			36,959

Total cash and cash equivalents		70,278			67,113

Securities available-for-sale		453,660			470,996
Loans, net of deferred fees		1,882,842			1,857,767
Allowance for loan losses		(23,363	)		(22,454	)

Net loans		1,859,479			1,835,313
Interest receivable		6,502			7,107
Federal Home Loan Bank stock		7,084			5,423
Property and equipment, net of accumulated depreciation		19,302			20,208
Goodwill and intangible assets		68,969			70,382
Deferred tax asset		11,281			12,722
Other real estate owned		9,900			12,068
Bank-owned life insurance		35,840			35,165
Other assets		4,328			4,940


Total assets	$	2,546,623		$	2,541,437


LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing demand	$	906,015		$	858,996
Savings and interest-bearing checking		1,055,648			1,110,224
Core time deposits		54,625			65,847

Total core deposits		2,016,288			2,035,067

Other deposits		81,869			113,036

Total deposits		2,098,157			2,148,103
Securities sold under agreements to repurchase		2,031			1,966
Federal Home Loan Bank borrowings		101,000			65,000
Subordinated debentures		34,167			34,096
Junior subordinated debentures		11,428			11,311
Accrued interest and other payables		9,262			7,206

Total liabilities		2,256,045			2,267,682

Shareholders’ equity
Common stock, no par value, shares authorized: 50,000,000; shares issued and outstanding: 22,772,400 at September 30, 2017, and 22,611,535 at December 31, 2016		205,961			205,584
Retained earnings		85,286			70,486
Accumulated other comprehensive loss		(669	)		(2,315	)

		290,578			273,755

Total liabilities and shareholders’ equity	$	2,546,623		$	2,541,437

See accompanying notes.

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Income

(In thousands, except share and per share amounts)

(Unaudited)


	Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016
Interest and dividend income
Loans	$	23,916		$	20,145		$	71,282		$	55,810
Taxable securities		2,247			1,995			6,819			5,551
Tax-exempt securities		498			482			1,510			1,435
Interest-bearing deposits with banks		149			40			335			104

		26,810			22,662			79,946			62,900


Interest expense
Deposits		1,216			984			3,597			2,678
Federal Home Loan Bank borrowings		398			286			1,205			758
Subordinated debentures		590			553			1,735			553
Junior subordinated debentures		105			66			293			179
Federal funds purchased		—			2			1			6

		2,309			1,891			6,831			4,174

Net interest income		24,501			20,771			73,115			58,726

Provision for loan losses		350			1,380			3,725			3,575

Net interest income after provision for loan losses		24,151			19,391			69,390			55,151


Noninterest income
Service charges on deposit accounts		686			717			2,119			2,099
Bankcard income		338			314			968			899
Bank-owned life insurance income		226			172			675			463
Net gain on sale of investment securities		—			—			—			309
Impairment losses on investment securities (OTTI)		(7	)		(2	)		(9	)		(19	)
Other noninterest income		645			718			2,797			1,726

		1,888			1,919			6,550			5,477


Noninterest expense
Salaries and employee benefits		7,554			7,520			25,830			23,084
Property and equipment		1,323			1,202			3,929			3,404
Data processing		1,062			924			3,137			2,682
Legal and professional services		576			569			1,789			2,321
Business development		319			460			1,299			1,492
FDIC insurance assessment		297			273			989			848
Other real estate expense (income)		48			71			20			(32	)
Merger related expense		176			1,767			1,429			3,745
Other noninterest expense		1,453			1,039			3,846			3,222

		12,808			13,825			42,268			40,766


Income before provision for income taxes		13,231			7,485			33,672			19,862
Provision for income taxes		4,606			2,634			11,370			6,946

Net income	$	8,625		$	4,851		$	22,302		$	12,916


Earnings per share
Basic	$	0.38		$	0.24		$	0.98		$	0.65

Diluted	$	0.38		$	0.23		$	0.97		$	0.64

Weighted average shares outstanding
Basic		22,772,393			20,511,392			22,719,181			19,940,709
Common stock equivalents attributable to stock-based awards		167,018			165,572			162,032			154,813

Diluted		22,939,411			20,676,964			22,881,213			20,095,522

See accompanying notes.

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)


	Three months ended						Nine months ended
	September 30,						September 30,
	2017			2016			2017			2016
Net income	$	8,625		$	4,851		$	22,302		$	12,916

Other comprehensive income:
Available-for-sale securities:
Unrealized gain (loss) arising during the period		17			(1,929	)		2,781			5,397
Reclassification adjustment for gains realized in net income		—			—			—			(309	)
Other than temporary impairment		7			2			9			19
Income tax effects		(9	)		751			(1,088	)		(1,991	)
Derivative agreements—cash flow hedge								—
Unrealized gain (loss) arising during the period		—			160			(14	)		(944	)
Reclassification adjustment for gains realized in net income		—			—			35			—
Income tax effects		—			(62	)		(77	)		368

Total other comprehensive income (loss), net of tax		15			(1,078	)		1,646			2,540

Total comprehensive income	$	8,640		$	3,773		$	23,948		$	15,456

See accompanying notes.

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

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

(Unaudited)


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

Net income							22,302						22,302
Other comprehensive income, net of tax										1,646			1,646

Comprehensive income													23,948

Stock issuance		160,865		861									861
Share-based compensation expense				1,042									1,042
Vested employee RSUs and SARs surrendered to cover tax consequences				(1,526	)								(1,526	)
Cash dividends ($.33 per share)							(7,502	)					(7,502	)

Balance, September 30, 2017		22,772,400	$	205,961		$	85,286		$	(669	)		290,578

See accompanying notes.

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Nine months ended
	September 30,
	2017			2016
Cash flows from operating activities:
Net income	$	22,302		$	12,916
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net of accretion		5,947			4,919
Deferred income taxes		(1	)		3
Bank-owned life insurance income		(675	)		(469	)
Share-based compensation		1,192			1,427
Provision for loan losses		3,725			3,575
Gain on sale of investment securities		—			(309	)
Valuation adjustment on foreclosed assets		—			162
Gain on sale of foreclosed assets		(91	)		(302	)
Other than temporary impairment on investment securities		9			19
Change in:
Interest receivable		605			698
Deferred loan fees		(169	)		381
Accrued interest payable and other liabilities		2,094			(1,991	)
Other assets		1,520			(1,073	)

Net cash provided by operating activities		36,458			19,956

Cash flows from investing activities:
Proceeds from maturities and sales of available-for-sale investment securities		41,529			135,319
Purchase of available-for-sale investment securities		(25,308	)		(160,943	)
Net loan principal originations		(27,905	)		(133,405	)
Proceeds from sale of foreclosed assets		2,442			1,371
Net purchase of property and equipment		(342	)		(2,196	)
(Purchase) Redemption of Federal Home Loan Bank stock		(1,661	)		1,097
Cash consideration received, net of cash acquired in merger		—			43,855

Net cash used by investing activities		(11,245	)		(114,902	)

Cash flows from financing activities:
Change in deposits		(49,946	)		169,032
Change in repurchase agreements		65			1,036
Change in Federal Home Loan Bank short-term borrowings		36,000			(19,500	)
FHLB term advances paid off		—			(12,500	)
Proceeds from stock options exercised		861			620
Excess tax benefit from stock options exercised		—			41
Proceeds from subordinated debenture issuance		—			34,072
Dividends paid		(7,502	)		(6,497	)
Vested employee RSUs and SARs surrendered to cover tax consequences		(1,526	)		(861	)

Net cash (used)/provided by financing activities		(22,048	)		165,443

Net change in cash and cash equivalents		3,165			70,497
Cash and cash equivalents, beginning of period		67,113			36,675

Cash and cash equivalents, end of period	$	70,278		$	107,172

Supplemental information:
Noncash investing and financing activities:
Transfer of loans to other real estate owned	$	183		$	958
Change in fair value of securities, net of deferred income taxes	$	(1,187	)	$	3,116
Change in fair value of cash flow hedge, net of deferred income taxes	$	—		$	(576	)

Cash paid during the period for:
Income taxes	$	9,098		$	7,667
Interest	$	6,336		$	3,653

See accompanying notes.

Pacific Continental Corporation and Subsidiary

Notes to Consolidated Financial Statements

(Unaudited)

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

On January 9, 2017, Pacific Continental Corporation entered into a definitive agreement to merge with Columbia Banking System, Inc., headquartered in Tacoma, Washington (“Columbia”). 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 occurred on November 1, 2017 was contingent on satisfaction of customary closing conditions.

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

NOTE 1—BASIS OF PRESENTATION

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

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

The balance sheet data as of December 31, 2016, was derived from audited consolidated financial statements, but does not include all disclosures contained in the Company’s 2016 Form 10-K. The interim consolidated financial statements should be read in conjunction with the December 31, 2016, consolidated financial statements, including the notes thereto, included in the Company’s 2016 Form 10-K.

NOTE 2 – SECURITIES AVAILABLE-FOR-SALE

The amortized cost and estimated fair values of securities available-for-sale at September 30, 2017, were as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Percentage of Portfolio
Unrealized Loss Positions
Obligations of U.S. government agencies	$	2,000	$	—	$	(25	)	$	1,975		0.44	%
Obligations of states and political subdivisions		27,060		—		(513	)		26,547		5.85	%
Private-label mortgage-backed securities		10		—		—			10		0.00	%
Mortgage-backed securities		233,868		—		(4,113	)		229,755		50.64	%
SBA pools		19,649		—		(298	)		19,351		4.27	%

	$	282,587	$	—	$	(4,949	)	$	277,638		61.20	%

Unrealized Gain Positions
Obligations of U.S. government agencies	$	23,270	$	425	$	—		$	23,695		5.22	%
Obligations of states and political subdivisions		81,446		2,481		—			83,927		18.50	%
Private-label mortgage-backed securities		1,309		199		—			1,508		0.33	%
Mortgage-backed securities		48,558		552		—			49,110		10.83	%
SBA pools		17,586		196		—			17,782		3.92	%

	$	172,169	$	3,853	$	—		$	176,022		38.80	%

	$	454,756	$	3,853	$	(4,949	)	$	453,660		100.00	%

At September 30, 2017, the Bank held 469 investment securities, of which 167 were in unrealized loss positions. Unrealized losses existed on certain securities classified as obligations of U.S. government agencies, private-label mortgage-backed securities, mortgage-backed securities, SBA pools and obligations of states and political subdivisions. The unrealized losses on all securities are deemed to be temporary, as these securities retain strong credit ratings, continue to perform adequately, and are backed by various government sponsored enterprises. These decreases in fair value are associated with the changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities has resulted from changes in interest rates relative to where these investments fall within the yield curve and their individual characteristics. Because the Company does not currently intend to sell these securities nor does the Company consider it more likely than not that it will be required to sell these securities before the recovery of amortized cost basis, which may be upon maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2017.

The following table presents a summary of securities in a continuous unrealized loss position at September 30, 2017:


	Securities in Continuous Unrealized Loss Position for Less Than 12 Months		Gross Unrealized Loss on Securities in Loss Position for Less Than 12 Months			Securities in Continuous Unrealized Loss Position for 12 Months or Longer		Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
Obligations of U.S. government agencies	$	1,975	$	(25	)	$	—	$	—
Obligations of states and political subdivisions		12,204		(152	)		14,343		(361	)
Private-label mortgage-backed securities		10		—			—		—
Mortgage-backed securities		171,984		(2,580	)		57,771		(1,533	)
SBA pools		7,949		(102	)		11,402		(196	)

	$	194,122	$	(2,859	)	$	83,516	$	(2,090	)

On a monthly basis, management reviews all private-label mortgage-backed securities for the presence of other than temporary impairment (“OTTI”). The Bank recorded $9 and $19 of OTTI during the nine months ended September 30, 2017 and 2016, respectively, with $7 and $2 of additional OTTI booked during the three months ended September 30, 2017 and 2016, respectively. Management’s evaluation included the use of independently-generated third-party credit surveillance reports that analyze the loans underlying each security. These reports include estimates of default rates and severities, life collateral loss rates and static voluntary prepayment assumptions to generate estimated cash flows at the individual security level. Additionally, management considered factors such as downgraded credit ratings, severity and duration of the impairments, the stability of the issuers and any discounts paid when the securities were purchased. Management has considered all available information related to the collectability of the impaired investment securities and believes that the estimated credit loss is appropriate.

Following is a tabular roll-forward of the aggregate amount of credit-related OTTI at the beginning and end of the periods presented along with the amounts recognized in earnings during the three months and nine months ended September 30, 2017 and 2016:


	Three months ended September 30,				Nine months ended September 30,
	2017		2016		2017		2016
Balance, beginning of period:	$	272	$	266	$	270	$	249
Additions:
Initial OTTI credit loss		7		2		9		19

Balance, end of period:	$	279	$	268	$	279	$	268

At September 30, 2017, nine of the Company’s private-label mortgage-backed securities, with an aggregate amortized cost of $1,055, were classified as substandard as their underlying credit was considered impaired. At December 31, 2016, nine securities with an aggregate amortized cost of $1,338 were classified as substandard.

At September 30, 2017 and December 31, 2016, the projected average life of the securities portfolio was 4.51 years and 4.94 years, respectively.

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


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Percentage of Portfolio
Unrealized Loss Positions
Obligations of U.S. government agencies	$	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 pools		26,758		—		(493	)		26,265		5.58	%

	$	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 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, the Bank held 485 investment securities, of which 179 were in unrealized loss positions. The following table presents a summary of securities in a continuous unrealized loss position at December 31, 2016:


	Securities in Continuous Unrealized Loss Position for Less Than 12 Months		Gross Unrealized Loss on Securities in Loss Position for Less Than 12 Months			Securities in Continuous Unrealized Loss Position for 12 Months or Longer		Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
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 pools		22,076		(458	)		4,189		(35	)

	$	277,480	$	(7,052	)	$	9,159	$	(154	)

The amortized cost and estimated fair value of securities at September 30, 2017, by maturity, are shown below. Obligations of U.S. government agencies, states and political subdivisions and corporate securities are shown by contractual maturity. Mortgage-backed securities and SBA variable pools are shown by projected average life.


	September 30, 2017
	Amortized Cost		Estimated Fair Value
Due in one year or less	$	24,349	$	24,340
Due after one year through 5 years		237,873		237,754
Due after 5 years through 10 years		156,651		155,892
Due after 10 years		35,883		35,674

	$	454,756	$	453,660

During the quarter ended September 30, 2017, there were no investment securities sold.

During the quarter ended September 30, 2016, 30 investment securities were sold resulting in proceeds of $54,426. The sales generated a gross gain of $552 and a gross loss of $243, totaling a net gain of $309.

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


	September 30, 2017				December 31, 2016
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Pledged to secure public deposits	$	23,025	$	23,630	$	25,257	$	25,683
Pledged to secure repurchase agreements		4,973		4,944		3,579		3,573

	$	27,998	$	28,574	$	28,836	$	29,256

At September 30, 2017 and December 31, 2016, there was an outstanding balance for repurchase agreements of $2,031 and $1,966, respectively.

NOTE 3 - LOANS, ALLOWANCE FOR LOAN LOSSES, AND CREDIT QUALITY INDICATORS

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

Major classifications of period-end loans are as follows:


	September 30, 2017			% of Gross Loans			December 31, 2016			% of Gross Loans
Real estate loans
Multi-family residential	$	85,732			4.55	%	$	74,340			4.00	%
Residential 1-4 family		61,379			3.26	%		61,548			3.31	%
Owner-occupied commercial		465,536			24.70	%		461,557			24.82	%
Nonowner-occupied commercial		453,895			24.08	%		451,893			24.30	%

Total permanent real estate loans		1,066,542			56.59	%		1,049,338			56.43	%
Construction loans
Multi-family residential		19,711			1.05	%		22,252			1.20	%
Residential 1-4 family		48,274			2.56	%		43,532			2.34	%
Commercial real estate		96,426			5.12	%		76,301			4.10	%
Commercial bare land and acquisition & development		8,635			0.46	%		15,081			0.81	%
Residential bare land and acquisition & development		8,836			0.47	%		10,645			0.57	%

Total construction real estate loans		181,882			9.66	%		167,811			9.02	%

Total real estate loans		1,248,424			66.25	%		1,217,149			65.45	%
Commercial loans		619,266			32.85	%		630,491			33.89	%
Consumer loans		2,855			0.15	%		2,922			0.16	%
Other loans		14,148			0.75	%		9,225			0.50	%

Gross loans		1,884,693			100.00	%		1,859,787			100.00	%
Deferred loan origination fees		(1,851	)					(2,020	)

		1,882,842						1,857,767
Allowance for loan losses		(23,363	)					(22,454	)

Total loans, net of allowance for loan losses and net deferred fees	$	1,859,479					$	1,835,313

At September 30, 2017, outstanding loans to dental professionals totaled $390,333 and represented 20.71% of total outstanding loan principal balances compared to dental professional loans of $377,478, or 20.30% of total outstanding loan principal balance, at December 31, 2016. Additional information about the Company’s dental portfolio can be found in Note 4 to these consolidated financial statements. As of September 30, 2017, there were no other industry concentrations in excess of 10% of the total loan portfolio. However, as of September 30, 2017, 66.25% of the Company’s loan portfolio was collateralized by real estate and is, therefore, susceptible to change based on 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.

Purchased Credit Impaired Loans

The following table represents the contractually required principal balance of purchased credit impaired loans and the carrying balance at September 30, 2017 and December 31, 2016:


	September 30, 2017			December 31, 2016
Contractually required principal payments for purchased credit impaired loans	$	18,883		$	22,941
Accretable yield		(1,173	)		(1,453	)
Nonaccretable yield		(582	)		(809	)

Balance of purchased credit impaired loans	$	17,128		$	20,679

The following tables summarize the changes in the accretable yield for purchased credit impaired loans for the three and nine months ended September 30, 2017 and 2016:


	Three months ended September 30,
	2017									2016
	Capital Pacific			Foundation			Total			Century			Capital Pacific			Foundation			Total
Balance, beginning of period	$	682		$	1,324		$	2,006		$	—		$	860		$	—		$	860
Additions		—			—			—			—			—			908			908
Accretion to interest income		(45	)		(46	)		(91	)		—			(50	)		(22	)		(72	)

Balance, end of period	$	637		$	1,278		$	1,915		$	—		$	810		$	886		$	1,696


	Nine months ended September 30,
	2017									2016
	Capital Pacific			Foundation			Total			Century			Capital Pacific			Foundation			Total
Balance, beginning of period	$	765		$	688		$	1,453		$	39		$	1,030		$	—		$	1,069
Additions		—			742			742			—			—			908			908
Accretion to interest income		(128	)		(152	)		(280	)		(39	)		(220	)		(22	)		(281	)

Balance, end of period	$	637		$	1,278		$	1,915		$	—		$	810		$	886		$	1,696

Allowance for Loan Losses

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

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

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

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

•

The quality of the current loan portfolio,

•

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

•

The velocity of migration of losses and potential losses,

•

Current economic conditions,

•

Loan concentrations,

•

Loan growth rates,

•

Past-due and nonperforming trends,

•

Evaluation of specific loss estimates for all significant problem loans,

•

Recovery experience, and

•

Peer comparison loss rates.

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


	For the three months ended September 30, 2017
	Commercial and Other			Real Estate			Construction			Consumer			Unallocated			Total
Beginning balance	$	8,693		$	11,699		$	2,142		$	41		$	876		$	23,451
Charge-offs		(516	)		—			—			(7	)		—			(523	)
Recoveries		30			54			1			—			—			85
Provision (reclassification)		481			60			(134	)		4			(61	)		350

Ending balance	$	8,688		$	11,813		$	2,009		$	38		$	815		$	23,363


	For the nine months ended September 30, 2017
	Commercial and Other			Real Estate			Construction			Consumer			Unallocated			Total
Beginning balance	$	8,614		$	10,872		$	1,781		$	41		$	1,146		$	22,454
Charge-offs		(2,844	)		(150	)		—			(12	)		—			(3,006	)
Recoveries		90			97			2			1			—			190
Provision (reclassification)		2,828			994			226			8			(331	)		3,725

Ending balance	$	8,688		$	11,813		$	2,009		$	38		$	815		$	23,363

At September 30, 2017, the allowance for loan losses on dental loans was $5,373, compared to $4,713 at December 31, 2016. See Note 4 for additional information on the dental loan portfolio.

The following table presents the allowance and recorded investment in loans by major loan classification at September 30, 2017 and December 31, 2016:


	Balances as of September 30, 2017
	Commercial and Other		Real Estate		Construction		Consumer		Unallocated		Total
Ending allowance: collectively evaluated for impairment	$	8,679	$	11,813	$	2,009	$	38	$	815	$	23,354
Ending allowance: individually evaluated for impairment		9		—		—		—		—		9
Ending allowance: loans acquired with deteriorated credit quality		—		—		—		—		—		—

Total ending allowance	$	8,688	$	11,813	$	2,009	$	38	$	815	$	23,363

Ending loan balance: collectively evaluated for impairment	$	626,451	$	1,046,756	$	181,882	$	2,855	$	—	$	1,857,944
Ending loan balance: individually evaluated for impairment		2,105		7,516		—		—		—		9,621
Ending loan balance: loans acquired with deteriorated credit quality		4,858		12,270		—		—		—		17,128

Total ending loan balance	$	633,414	$	1,066,542	$	181,882	$	2,855	$	—	$	1,884,693


					Balances as of 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

The September 30, 2017, ending allowance includes $9 in specific allowance for $9,621 of impaired loans ($7,260 net of government guarantees). At December 31, 2016, the Company had $12,568 of impaired loans ($10,567 net of government guarantees) with a specific allowance of $736.

Management believes that the allowance for loan losses was adequate as of September 30, 2017. 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.

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

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

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

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

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

The following tables present the Company’s loan portfolio information by loan type and credit grade at September 30, 2017 and December 31, 2016:

Credit Quality Indicators

As of September 30, 2017


	Loan Grade
	Pass			Special Mention			Substandard			Doubtful			Totals
Real estate loans
Multi-family residential	$	85,732		$	—		$	—		$	—		$	85,732
Residential 1-4 family		60,094			—			1,285			—			61,379
Owner-occupied commercial		446,902			—			18,634			—			465,536
Nonowner-occupied commercial		449,306			—			4,589			—			453,895

Total real estate loans		1,042,034			—			24,508			—			1,066,542

Construction
Multi-family residential		19,711			—			—			—			19,711
Residential 1-4 family		48,274			—			—			—			48,274
Commercial real estate		96,426			—			—			—			96,426
Commercial bare land and acquisition & development		8,635			—			—			—			8,635
Residential bare land and acquisition & development		8,286			—			550			—			8,836

Total construction loans		181,332			—			550			—			181,882

Commercial and other		618,016			—			15,398			—			633,414

Consumer		2,855			—			—			—			2,855

Totals	$	1,844,237		$	—		$	40,456		$	—		$	1,884,693

Percentage of portfolio		97.85	%		0.00	%		2.15	%		0.00	%		100.00	%

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 portfolio		97.47	%		0.00	%		2.44	%		0.09	%		100.00	%

At September 30, 2017 and December 31, 2016, the Company had $941 and $1,026, respectively, in unfunded commitments on its classified loans, which amounts are included in the calculation of our classified asset ratio.

Past Due and Nonaccrual Loans

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

The following tables present an aging analysis of past due and nonaccrual loans at September 30, 2017 and December 31, 2016:

Age Analysis of Loans Receivable

As of September 30, 2017


	30-59 Days Past Due Still Accruing		60-89 Days Past Due Still Accruing		Greater Than 90 days Past Due Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Total Current		Total Loans Receivable
Real estate loans
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	85,732	$	85,732
Residential 1-4 family		—		—		—		185		185		60,478		60,663
Owner-occupied commercial		837		—		—		519		1,356		455,671		457,027
Nonowner-occupied commercial		—		—		1,428		531		1,959		448,893		450,852

Total real estate loans		837		—		1,428		1,235		3,500		1,050,774		1,054,274

Construction
Multi-family residential		—		—		—		—		—		19,711		19,711
Residential 1-4 family		—		—		—		—		—		48,274		48,274
Commercial real estate		—		—		—		—		—		96,426		96,426
Commercial bare land and acquisition & development		199		—		—		—		199		8,437		8,636
Residential bare land and acquisition & development		—		—		—		—		—		8,835		8,835

Total construction loans		199		—		—		—		199		181,683		181,882

Commercial and other		696		—		—		1,479		2,175		626,379		628,554

Consumer		9		2		—		—		11		2,844		2,855

Total	$	1,741	$	2	$	1,428	$	2,714	$	5,885	$	1,861,680	$	1,867,565


Age Analysis of 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 Past Due Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Total Current		Total Loans 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

Impaired Loans

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

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

The following tables display an analysis of the Company’s impaired loans at September 30, 2017, and December 31, 2016:

Impaired Loan Analysis

As of September 30, 2017


	Recorded Investment With No Specific Allowance Valuation		Recorded Investment With Specific Allowance Valuation		Total Recorded Investment		Unpaid Principal Balance		Average Recorded Investment		Related Specific Allowance Valuation
Real estate
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	—
Residential 1-4 family		100		—		100		100		101		—
Owner-occupied commercial		5,456		—		5,456		5,456		5,467		—
Nonowner-occupied commercial		1,960		—		1,960		1,959		1,999		—

Total real estate loans		7,516		—		7,516		7,515		7,567		—

Construction
Multi-family residential		—		—		—		—		—		—
Residential 1-4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—		—		—
Residential bare land and acquisition & development		—		—		—		—		—		—

Total construction loans		—		—		—		—		—		—

Commercial and other		1,627		478		2,105		3,986		2,596		9

Consumer		—		—		—		—		—		—

Total impaired loans	$	9,143	$	478	$	9,621	$	11,501	$	10,163	$	9


Impaired Loan Analysis As of December 31, 2016

	Recorded Investment With No Specific Allowance Valuation		Recorded Investment With Specific Allowance Valuation		Total Recorded Investment		Unpaid Principal Balance		Average Recorded Investment		Related Specific Allowance Valuation
Real estate
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	—
Residential 1-4 family		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

The impaired balances reported above are not adjusted for government guarantees of $2,361 and $2,001 at September 30, 2017 and December 31, 2016, respectively. The recorded investment in impaired loans, net of government guarantees, totaled $7,260 and $10,567 at September 30, 2017, and December 31, 2016, respectively.

Troubled Debt Restructurings

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

The following table displays the Company’s TDRs by class at September 30, 2017 and December 31, 2016:


	Troubled Debt Restructurings as of
	September 30, 2017				December 31, 2016
	Number of Contracts		Post-Modification Outstanding Recorded Investment		Number of Contracts		Post-Modification Outstanding Recorded Investment
Real estate
Multifamily residential		—	$	—		—	$	—
Residential 1-4 family		1		100		4		754
Owner-occupied commercial		4		5,215		4		5,447
Non owner-occupied commercial		5		1,959		6		2,127

Total real estate loans		10		7,274		14		8,328

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		15		2,142		16		2,901

Consumer		—		—		—		—

Total		25	$	9,416		30	$	11,229

The recorded investment in TDRs on nonaccrual status totaled $1,630 and $2,250 at September 30, 2017 and December 31, 2016, respectively. The Company’s policy is that loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Company’s policy generally refers to a minimum of six months of payment performance as sufficient to warrant a return to accrual status.

For the nine months ended September 30, 2017, the Company restructured one loan into a TDR for which impairment was previously measured under the Company’s general loan loss allowance methodology.

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

•

Rate Modification - A modification in which the interest rate is modified.

•

Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.

•

Interest-only Modification - A modification in which the loan is converted to interest-only payments for a period of time.

•

Combination Modification - Any other type of modification, including the use of multiple types of modifications.

Below is a table of the newly restructured loans identified in the nine months ended September 30, 2017.


	Troubled Debt Restructurings Identified During the nine months ended September 30, 2017
	Rate Modification		Term Modification		Interest-only Modification		Combination Modification

Real estate
Multi-family residential	$	—	$	—	$	—	$	—
Residential 1-4 family		—		—		—		50
Owner-occupied commercial		—		—		—		—
Nonowner-occupied commercial		—		—		—		—

Total real estate loans		—		—		—		50

Construction
Multi-family residential		—		—		—		—
Residential 1-4 family		—		—		—		—
Commercial real estate		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—
Residential bare land and acquisition & development		—		—		—		—

Total construction loans		—		—		—		—

Commercial and other		—		—		—		—

Consumer		—		—		—		—

Total	$	—	$	—	$	—	$	50

There were no TDRs identified in the three months ended September 30, 2017.

Subsequent to a loan being classified as a TDR, a borrower may become unwilling or unable to abide by the terms of the modified agreement. In such cases of default, the Company takes appropriate action to recover principal and interest payments including the use of foreclosure proceedings.

The following table represents loans receivable modified as TDRs that subsequently defaulted within the first twelve months of restructure during the period.


	Troubled Debt Restructurings that Subsequently Defaulted During the nine months ended September 30,
	2017				2016
	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment

Real estate
Multi-family residential		—	$	—		—	$	—
Residential 1-4 family		—		—		—		—
Owner-occupied commercial		—		—		1		444
Nonowner-occupied commercial		—		—		—		—

Total real estate loans		—		—		1		444
Construction
Multi-family residential		—		—		—		—
Residential 1-4 family		—		—		—		—
Commercial real estate		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—
Residential bare land and acquisition & development		—		—		—		—

Total construction loans		—		—		—		—

Commercial and other		—		—		—		—

Consumer		—		—		—		—

Total		—	$	—		1	$	444

At September 30, 2017 and December 31, 2016, the Company had no commitments to lend additional funds on loans restructured as TDRs.

NOTE 4 – DENTAL LOAN PORTFOLIO

Dental lending is not operated as a business segment, and dental loans are made in the normal course of commercial lending activities throughout the Company. However, to assist in understanding the concentrations and risks associated with the Company’s loan portfolio, the following Note has been included to provide additional information relating to the Company’s dental loan portfolio. At September 30, 2017 and December 31, 2016, loans to dental professionals totaled $390,333 and $377,478, respectively, and represented 20.71% and 20.30% in principal amount of total outstanding loans, respectively. As of September 30, 2017 and December 31, 2016, dental loans were supported by government guarantees totaling $4,658 and $5,641, respectively. These guarantees represented 1.19% and 1.49% in principal amount of the outstanding dental loan balances as of such respective dates. The Company defines a “dental loan” as a loan to dental professionals for the purpose of practice expansion, acquisition or other purpose supported by the cash flows of a dental practice.

Loan Classification

Major classifications of dental loans at September 30, 2017 and December 31, 2016, were as follows:


	September 30, 2017		December 31, 2016
Real estate secured loans:
Owner-occupied commercial	$	62,376	$	63,793
Other dental real estate loans		358		806

Total permanent real estate loans		62,734		64,599

Dental construction loans		10,130		4,109

Total real estate loans		72,864		68,708

Commercial loans		317,469		308,770

Gross loans	$	390,333	$	377,478

Market Area

The Bank’s principal “market area” is within the States of Oregon and Washington west of the Cascade Mountain Range. This area is serviced by branch locations in Eugene, Portland and the Puget Sound. The Company also makes national dental loans throughout the United States, and currently has dental loans in 45 states. National loan relationships are maintained and serviced by Bank personnel primarily located in Portland.

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


	September 30, 2017		December 31, 2016
Local	$	154,061	$	150,268
National		236,272		227,210

Total	$	390,333	$	377,478

Allowance

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


	Three months ended						Nine months ended
	September 30,						September 30,
	2017			2016			2017			2016
Balance, beginning of period	$	5,257		$	4,151		$	4,713		$	4,022
Provision		120			601			2,924			704
Charge-offs		(50	)		(9	)		(2,325	)		(9	)
Recoveries		46			55			61			81

Balance, end of period	$	5,373		$	4,798		$	5,373		$	4,798

Credit Quality

Please refer to Note 3 for additional information on the definitions of the credit quality indicators.

The following tables present the Company’s dental loan portfolio by market and credit grade at September 30, 2017 and December 31, 2016:


As of September 30, 2017
	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Local	$	151,696	$	—	$	2,365	$	—	$	154,061
National		235,090		—		1,182		—		236,272

Total	$	386,786	$	—	$	3,547	$	—	$	390,333

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

Past Due and Nonaccrual Loans

Please refer to Note 3 for additional information on the definitions of “past due.”

The following tables present an aged analysis of the dental loan portfolio by market, including nonaccrual loans, as of September 30, 2017 and December 31, 2016:


As of September 30, 2017
	30-59 Days Past Due Still Accruing		60-89 Days Past Due Still Accruing		Greater Than 90 Days Past Due Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Total Current		Total Loans Receivable
Local	$	74	$	—	$	—	$	358	$	432	$	153,629	$	154,061
National		—		—		—		767		767		235,505		236,272

Total	$	74	$	—	$	—	$	1,125	$	1,199	$	389,134	$	390,333


As of December 31, 2016
	30-59 Days Past Due Still Accruing		60-89 Days Past Due Still Accruing		Greater Than 90 Days Past Due Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Total Current		Total Loans Receivable
Local	$	—	$	—	$	—	$	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

NOTE 5 – 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 2 in the Notes to Consolidated Financial Statements included in this Form 10-Q for additional information regarding the securities pledged under agreements to repurchase.

The following table presents information regarding securities sold under agreements to repurchase at September 30, 2017 and December 31, 2016:


	September 30, 2017			December 31, 2016

Balance at end of period	$	2,031		$	1,966
Average balance outstanding for the period		2,134			702
Maximum amount outstanding at any month end during the period		3,100			2,017
Weighted average interest rate for the period		0.08	%		0.06	%
Weighted average interest rate at period end		0.07	%		0.08	%

NOTE 6 – FEDERAL FUNDS AND OVERNIGHT FUNDS PURCHASED

The Company had unsecured federal funds borrowing lines with various correspondent banks totaling $154,000 at September 30, 2017 and $154,000 at December 31, 2016. The terms of the lines are subject to change with interest payable at the then stated rate. At September 30, 2017 and December 31, 2016, there were no borrowings outstanding on these lines.

The Company also had a secured overnight borrowing line available from the Federal Reserve Bank that totaled $87,965 and $80,784 at September 30, 2017 and December 31, 2016, respectively. The Federal Reserve Bank borrowing line is secured through the pledging of $142,321 and $143,679 at September 30, 2017 and December 31, 2016, respectively, of commercial loans under the Company’s Borrower-In-Custody program. At September 30, 2017 and December 31, 2016, there were no outstanding borrowings on this line. The terms of the lines are subject to change with interest payable at the then stated rate.

NOTE 7 – FEDERAL HOME LOAN BANK BORROWINGS

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

At September 30, 2017, the maximum borrowing line was $891,318; however, the FHLB borrowing line was limited by the discounted value of collateral pledged. At September 30, 2017, the Company had pledged $896,580 in real estate loans to the FHLB that had a discounted collateral value of $632,226. There was $101,000 borrowed on this line at September 30, 2017.

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. At December 31, 2016, the Company had pledged $867,596 in real estate loans to the FHLB that had a discounted collateral value of $632,202. There was $65,000 borrowed on this line at December 31, 2016.

Below is a summary of outstanding FHLB borrowings by maturity.


	Current Rates		September 30, 2017
Cash management advance		NA	$	96,000
2017		0		—
2018		1.55		3,000
2019		0		—
2020		0		—
2021		0		—
Thereafter		3.85		2,000

			$	101,000

NOTE 8 – BORROWED FUNDS

Subordinated Debentures

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

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

Junior Subordinated Debentures

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

On September 6, 2016, the Company completed the acquisition of Foundation Bancorp, 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 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”) issued to the trust in exchange for ownership of all of the common securities of the trust and the proceeds of the preferred securities sold by the trust. In accordance with current accounting guidance, the trust is not consolidated in the Company’s financial statements, but rather the Foundation Debentures are shown as a liability, and acquired at an acquisition date fair value of $3,013.

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

NOTE 9 – SHARE-BASED COMPENSATION

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

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

The following table identifies the compensation expense recorded and tax benefits received by the Company on its share-based compensation plans for the three and nine months ended September 30, 2017 and 2016:


	Three months ended
	September 30,
	2017				2016
	Compensation Expense		Tax Benefit		Compensation Expense		Tax Benefit
Equity-based awards:
Employee RSUs	$	315	$	120	$	397	$	151
Liability-based awards:
Employee cash SARs		—		—		—		—

	$	315	$	120	$	397	$	151


	Nine months ended
	September 30,
	2017				2016
	Compensation Expense		Tax Benefit		Compensation Expense		Tax Benefit
Equity-based awards:
Director restricted stock	$	—	$	—	$	240	$	91
Employee RSUs		1,042		396		1,187		451
Liability-based awards:
Employee cash SARs		150		—		—		—

	$	1,192	$	396	$	1,427	$	542

The following table identifies stock options, employee stock settled SARs, and employee cash settled SARs exercised during the three and nine months ended September 30, 2017 and 2016:


	Three months ended September 30, 2017
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		—		—		—		—		NA
Employee stock SARs		77	$	11.30		—		24		NA
Employee cash SARs		—		—		NA		NA		—

		77				—		24		—


	Nine months ended September 30, 2017
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		137,307	$	14.90	$	1,396		79,601		NA
Employee stock SARs		46,798	$	15.84		116		10,614		NA
Employee cash SARs		28,150	$	16.47		NA		NA	$	169

		212,255			$	1,512		90,215	$	169


	Three months ended September 30, 2016
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		30,074	$	16.54	$	9		9,832		NA
Employee stock SARs		41,237	$	15.83		5		1,768		NA
Employee cash SARs		27,521	$	15.95		NA		NA	$	45

		98,832			$	14		11,600	$	45


	Nine months ended September 30, 2016
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		65,034	$	13.86	$	117		44,792		NA
Employee stock SARs		79,806	$	14.54		26		6,634		NA
Employee cash SARs		47,644	$	15.11		NA		NA	$	73

		192,484				143		51,426		73

At September 30, 2017, the Company had estimated unrecognized compensation expense of approximately $2,019 for unvested RSUs. This amount is based on a historical forfeiture rate of 13.00% for all RSUs granted to employees. The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested RSUs was approximately 2.26 years as of September 30, 2017.

NOTE 10 – DERIVATIVE INSTRUMENTS

The Bank maintains two interest rate swaps with commercial banking customers tied to loans on the consolidated balance sheet. Those interest rate swaps are simultaneously hedged by offsetting the interest rate swaps that the Bank executes with a third party, such that the Bank minimizes its net rate risk exposure. As of September 30, 2017 and December 31, 2016, the Bank had non-hedge designated interest rate swaps with an aggregate notional amount of approximately $8,357 and $8,540, respectively, related to this program. The Bank does not require separately pledged collateral to secure its interest rate swaps with customers. However, it does make a practice of cross-collateralizing the interest rate swaps with collateral on the underlying loan. The Bank has minimum collateral posting thresholds with certain of its derivative counterparties, and has posted collateral totaling $250 consisting of cash held on deposit for the benefit of the counterparty against its obligations under these agreements as of September 30, 2017 and December 31, 2016.

Previously, the Bank entered into a swap with a third party to serve as a hedge to a fixed rate loan. This swap was designated a hedging instrument, hedging a 10-year fixed rate note bearing interest at 5.71% and maturing August 2023. As of September 30, 2017 the swap was terminated, resulting in a one-time termination fee of $71 paid by the Company to the third party.

The following tables present quantitative information pertaining to the commercial loan related interest rate swaps as of September 30, 2017 and December 31, 2016:


	September 30, 2017			December 31, 2016
	Not-Hedge- Designated			Hedge- Designated			Not-Hedge- Designated
Notional amount	$	8,357		$	1,492		$	8,540
Weighted average pay rate		4.58	%		5.71	%		4.85	%
Weighted average receive rate		4.32	%		3.54	%		3.63	%
Weighted average maturity in years		4.70			6.65			5.45

The following table presents the fair values of derivative instruments and their locations in the consolidated balance sheets as of September 30, 2017 and December 31, 2016:


		Asset Derivatives				Liability Derivatives
Derivative	Balance sheet location	September 30, 2017		December 31, 2016		September 30, 2017		December 31, 2016
Cash flow hedge - trust preferred	Other assets or other payables	$	—	$	91	$	—	$	—
Interest rate swap designated as hedging instrument	Other assets or other payables		—		45		—		67
Interest rate swap not designated as hedging instrument	Other assets or other payables		17		14		17		14

		$	17	$	150	$	17	$	81

The following table presents the income statement impact of the derivative instruments for the three and nine months ended September 30, 2017 and 2016:


Derivative	Income statement location	Three months ended September 30,					Nine months ended September 30,
Derivative	Income statement location	2017		2016			2017		2016
Interest rate swap designated as hedging instrument	Other noninterest income	$	—	$	(2	)	$	4	$	(6	)

		$	—	$	(2	)	$	4	$	(6	)

NOTE 11 – FAIR VALUE

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

The following table presents the estimated fair values of the financial instruments at September 30, 2017 and December 31, 2016:


	September 30, 2017				December 31, 2016
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	70,278	$	70,278	$	67,113	$	67,113
Securities available-for-sale		453,660		453,660		470,996		470,996
Loans, net of deferred fees		1,882,842		1,855,447		1,857,767		1,837,673
Accrued interest receivable		6,502		6,502		7,017		7,017
Federal Home Loan Bank stock		7,084		7,084		5,423		5,423
Bank-owned life insurance		35,840		35,840		35,165		35,165
Interest rate swaps		17		17		150		150

Financial liabilities:
Deposits	$	2,098,157		2,097,073	$	2,148,103	$	2,147,056
Federal Home Loan Bank borrowings		101,000		101,005		65,000		65,043
Subordinated debenture		34,167		34,167		34,096		32,140
Junior subordinated debentures		11,428		7,610		11,311		6,972
Accrued interest payable		672		672		176		176
Interest rate swaps		17		17		81		81

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

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

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

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

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

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

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

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

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

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

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

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

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

•

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

•

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

•

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

The following table presents information about the level in the fair value hierarchy for the Company’s assets and liabilities not measured and carried at fair value as of September 30, 2017 and December 31, 2016:


	Carrying Amount		Fair Value at September 30, 2017
	Carrying Amount		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	70,278	$	70,278	$	—	$	—
Loans, net of deferred fees		1,882,842		—		—		1,855,447
Accrued interest receivable		6,502		6,502		—		—
Federal Home Loan Bank stock		7,084		7,084		—		—

Financial liabilities:
Deposits	$	2,098,157	$	1,961,663	$	135,410	$	—
Federal Home Loan Bank borrowings		101,000		—		101,005		—
Subordinated debentures		34,167		—		34,167		—
Junior subordinated debentures		11,428		—		7,610		—
Accrued interest payable		672		672		—		—

	Carrying Amount		Fair Value at December 31, 2016
	Carrying Amount		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		—		—

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		—		—

The tables below show assets and liabilities measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016:


	Carrying		Fair Value at September 30, 2017
	Value		Level 1		Level 2		Level 3

Financial Assets
Available-for-sale securities
Obligations of U.S. government agencies	$	25,670	$	—	$	25,670	$	—
Obligations of states and political subdivisions		110,474		—		110,474		—
Agency mortgage-backed securities		278,865		—		278,865		—
Private-label mortgage-backed securities		1,518		—		315		1,203
SBA variable rate pools		37,133		—		37,133		—
Interest rate swaps		17		17		—		—

Total assets measured on a recurring basis	$	453,677	$	17	$	452,457	$	1,203

Financial Liabilities

Interest rate swap liabilities measured on a recurring basis	$	17	$	17	$	—	$	—


	Carrying		Fair Value at December 31, 2016
	Value		Level 1		Level 2		Level 3

Available-for-sale securities
Obligations of U.S. government agencies	$	25,620	$	—	$	25,620	$	—
Obligations 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 rate pools		42,664		—		42,664		—
Interest rate swaps		150		150		—		—

Total assets measured on a recurring basis	$	471,146	$	150	$	469,628	$	1,368

Financial Liabilities

Interest rate swap liabilities measured on a recurring basis	$	81	$	81	$	—	$	—

No transfers to or from Levels 1 and 2 occurred on assets and liabilities measured at fair value on a recurring basis during the three or nine months ended September 30, 2017 or during the year ended December 31, 2016.

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

The following table provides a reconciliation of private-label mortgage-backed securities measured at fair value on a recurring basis using unobservable inputs (Level 3) for the three and nine months ended September 30, 2017 and 2016:


	Three months ended						Nine months ended
	September 30,						September 30,
	2017			2016			2017			2016
Beginning balance	$	1,267		$	1,399		$	1,368		$	1,586
Transfers into level 3		—			70			—			70
Transfers out of Level 3		—			—			—			—
Total gains or losses
Included in earnings		(7	)		(2	)		(9	)		(19	)
Included in other comprehensive income		13			64			70			45
Paydowns		(70	)		(77	)		(226	)		(228	)
Purchases, issuances, sales and settlements
Purchases		—			—			—			—
Issuances		—			—			—			—
Sales		—			—			—			—
Settlements		—			—			—			—

Ending balance	$	1,203		$	1,454		$	1,203		$	1,454

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.

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.

•

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.

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. Due to the pending merger with Columbia and the anticipated timing of the closing, the independent analysis that would have normally been conducted as of June 30, 2017 was not completed.

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

The tables below show assets measured at fair value on a nonrecurring basis as of September 30, 2017 and December 31, 2016:


	Carrying		Fair Value
September 30, 2017	Value		Level 1		Level 2		Level 3

Loans measured for impairment (net of government guarantees and specific reserve)	$	458	$	—	$	—	$	458

	Carrying		Fair Value
December 31, 2016	Value		Level 1		Level 2		Level 3

Other real estate owned	$	10,936	$	—	$	—	$	10,936

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

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

collectible government guarantees, is less than the recorded investment in the loan, impairment is recognized as a charge-off through the allowance for loan losses. The carrying value of the loan is adjusted to the estimated fair value. The carrying value of loans fully charged off is zero.

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

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

NOTE 12 – REGULATORY MATTERS

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total capital, Tier 1 capital, common equity Tier 1 to risk-weighted assets and Tier 1 capital to leverage assets. Management believes that, as of September 30, 2017, the Company and the Bank met all capital adequacy requirements to which they were subject.

As of September 30, 2017, and according to Federal Reserve and FDIC guidelines, the Bank was considered to be well-capitalized. To be categorized as well-capitalized, the Bank must maintain minimum Total capital, Tier 1 capital, common equity Tier 1 to risk-weighted assets and Tier 1 capital to leverage assets ratios as set forth in the following table.


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

As of September 30, 2017:
Total capital (to risk weighted assets)
Bank:	$	291,800		13.41	%	$	174,002		8.00	%	$	217,502		10.00	%
Company:	$	295,048		13.56	%		NA					NA
Tier 1 capital (to risk weighted assets)
Bank:	$	267,989		12.32	%	$	130,501		6.00	%	$	174,002		8.00	%
Company:	$	237,069		10.90	%		NA					NA
Common Equity Tier 1 (to risk weighted assets)
Bank:	$	267,989		12.32	%	$	97,876		4.50	%	$	141,376		6.50	%
Company:	$	223,696		10.28	%		NA					NA
Tier 1 capital (to leverage assets)
Bank:	$	267,989		10.72	%	$	100,002		4.00	%	$	108,751		5.00	%
Company:	$	237,069		9.48	%		NA					NA

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

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

The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition than can be obtained from reading the Consolidated Financial Statements alone. The discussion should be read in conjunction with the consolidated financial statements and the notes included in this report. Please refer also to our Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in the Company’s 2016 Form 10-K. All dollar amounts, except share and per share data, are expressed in thousands of dollars.

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

•

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

•

The local housing or real estate market could decline.

•

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

•

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

•

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

•

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

•

Competition among financial institutions could increase significantly.

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

The pending acquisition of the Company by Columbia may not achieve the anticipated benefits and cost savings, or the anticipated benefits of the merger may not be realized fully or at all, or may take longer to realize than expected.

•

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

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Part I, Item 1A “Risk Factors” in the Company’s 2016 Form 10-K and Part II, Item 1A, “Risk Factors” in this report and elsewhere in this report or in our other reports with the SEC, and include risks and uncertainties described or referred to in Part I, Item 1 “Business” under the captions “Competition” and “Supervision and Regulation” in the Company’s 2016 Form 10-K and Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. Please take into account that forward-looking statements speak only as of the date of this report. The Company does not undertake any obligation to publicly correct or update any forward-looking statement whether as a result of new information, future events or otherwise.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

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

The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2016 Form 10-K. Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements in the Company’s 2016 Form 10-K should be considered critical under the SEC definition:

Nonaccrual Loans

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

Allowance for Loan Losses and Reserve for Unfunded Commitments

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

Troubled Debt Restructurings

Goodwill and Intangible Assets

At September 30, 2017, the Company had $68,969 in goodwill and other intangible assets. In accordance with financial accounting standards, assets with indefinite lives are periodically tested for impairment. Management performs an impairment analysis of its goodwill and intangible assets with indefinite lives at least annually and has determined that there was no impairment as of December 31, 2016, the date the most recent analysis was performed.

Share-based Compensation

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

Fair Value Measurements

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

Recent Accounting Pronouncements

In 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 this ASU 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 issued 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, the Company estimates a new lease asset and related lease liability to be immaterial due to the minimal lease locations currently occupied by the Bank.

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 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 was effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The adoption of this ASU did not have a material impact 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 was effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The adoption of this ASU did not have a material impact 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 was effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The adoption of this ASU did not 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, 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 Company’s financial condition and results of operations.

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 that the Update will not have a material impact on the Company’s consolidated financial statements.

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 (ASU 2016-02) 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.

Financial Highlights


	For the three months ended September 30,									For the nine months ended September 30,
	2017			2016			$ Change			2017			2016			$ Change
Net interest income	$	24,501		$	20,771		$	3,730		$	73,115		$	58,726		$	14,389
Noninteret income		1,888			1,919			(31	)		6,550			5,477			1,073

Operating revenue ⁽¹⁾		26,389			22,690			3,699			79,665			64,203			15,462
Provision for loan losses		350			1,380			(1,030	)		3,725			3,575			150
Noninterest expense		12,632			12,058			574			40,839			37,021			3,818
Merger related expenses		176			1,767			(1,591	)		1,429			3,745			(2,316	)
Provision for income taxes		4,606			2,634			1,972			11,370			6,946			4,424

Net income	$	8,625		$	4,851		$	3,774		$	22,302		$	12,916		$	9,386


Earnings per share
Basic	$	0.38		$	0.24		$	0.14		$	0.98		$	0.65		$	0.33
Diluted	$	0.38		$	0.23		$	0.15		$	0.97		$	0.64		$	0.33

Assets, period-end	$	2,546,623		$	2,539,060		$	7,563
Gross loans, period-end	$	1,884,693		$	1,808,646		$	76,047
Core deposits, period end ⁽²⁾	$	2,016,288		$	2,049,352		$	(33,064	)
Deposits, period-end	$	2,098,157		$	2,162,633		$	(64,476	)

Return on average assets ⁽³⁾		1.33	%		0.89	%					1.16	%		0.85	%
Return on average equity ⁽³⁾		11.91	%		8.05	%					10.59	%		7.55	%
Return on average tangible equity ⁽³⁾⁽⁴⁾		15.68	%		10.14	%					14.08	%		9.43	%

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

⁽²⁾	Defined by the Company as demand, interest checking, money market, savings, and local nonpublic time deposits, including local nonpublic time deposits in excess of $250.

⁽³⁾	Amounts annualized.

⁽⁴⁾	Tangible equity excludes goodwill and core deposit intangibles related to acquisitions, see “Reconciliation of Non-GAAP Financial Information” below.

During the third quarter 2017, the Company earned $8,625, or $0.38 per diluted share, compared to $4,851, or $0.23 per diluted share, in third quarter 2016. The increase in net income was attributable to an increase in operating revenues, primarily net interest income, and a reduction in merger related expenses.

Third quarter 2017 results included the impact of acquisition expenses for Columbia’s acquisition of the Company, which closed on November 1, 2017. Third quarter 2016 contained $1,767 in expense related to the Company’s acquisition of Foundation Bancorp, Inc. of Bellevue, Washington (“Foundation”), which closed on September 6, 2017. The Company’s acquisition of Foundation, combined with organic loan growth, were the primary drivers of increased operating revenues and noninterest expense in third quarter 2017 when compared to third quarter 2016. The decrease in the provision for loan losses in third quarter 2017 over third quarter 2016 was primarily due to the decline in outstanding loan balance in the quarter being offset by minimal credit downgrades experienced during the quarter.

Outstanding gross loans at September 30, 2017, were $1,884,693, down $38,599 from June 30, 2017. During third quarter 2017, the Company experienced a reduction in outstanding loan totals compared to the prior quarter; however, this was expected given the market disruption caused by the pending merger with Columbia. Outstanding core deposits at September 30, 2017, were $2,016,288, which represented an increase of $9,720, from June 30, 2017. The moderate increase was due to normal seasonal fluctuations in the deposit base. Deposits generally stay flat or decline during the first half of the year, and growth is typically experienced in the second half of the year.

Reconciliation of Non-GAAP Financial Information

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

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


	September 30,			June 30,			September 30,
	2017			2017			2016
Total shareholders’ equity	$	290,578		$	273,755		$	276,471
Subtract:
Goodwill		(60,790	)		(61,401	)		(61,436	)
Core deposit intangible assets		(8,179	)		(8,447	)		(9,248	)

Tangible shareholders’ equity (non-GAAP)	$	221,609		$	203,907		$	205,787


Book value per share	$	12.76		$	12.48		$	12.23
Tangible book value per share (non-GAAP)	$	9.73		$	9.41		$	9.10

Year-to-date return on average equity		10.59	%		9.90	%		7.55	%
Year-to-date return on average tangible equity (non-GAAP)		14.08	%		13.23	%		9.43	%

Reconciliation of Adjusted Net Interest Income to Net Interest Income


	Three months ended
	September 30,			September 30,
	2017			2016
Tax equivalent net interest income ⁽¹⁾	$	25,223		$	21,354
Subtract
Century Bank accretion		68			68
Capital Pacific Bank accretion		231			300
Foundation Bank accretion		725			509
Prepayment penalties on loans		38			276

Total adjustments		1,062			1,153

Adjusted net interest income (non-GAAP)	$	24,161		$	20,201


Average earnings assets	$	2,382,828		$	2,014,889

Net interest margin		4.20	%		4.22	%
Core net interest margin (non-GAAP)		4.02	%		3.99	%

⁽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 $722 and $582 for the three months ended September 30, 2017 and September 30, 2016, respectively.

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

RESULTS OF OPERATIONS

Net Interest Income

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

Net interest margin as a percentage of average earning assets for third quarter 2017 was 4.20%, a decrease of 2 basis points from the third quarter 2016. The decrease in the net interest margin was primarily due to an increase in the costs of interest bearing liabilities, which increased to 0.67% in third quarter 2017, compared to 0.61% in third quarter 2016. The increase was primarily due to the increase in the FHLB borrowing costs, which increased to 1.39% in third quarter 2017 from 0.97% in third quarter 2016. The increase in FHLB costs was related to the increase in short-term rates over the past twelve months tied to the increase in the fed funds rates.

The Company experienced a slight decrease in yield on earnings assets of 1 basis points, primarily tied to a reduction in the yield on loans. Included in the yield on loans was the credit and interest rate accretion on purchased loans and other nonrecurring items, which totaled $1,062 and added 18 basis points to the net interest margin in the third quarter 2017, compared to loan fair value accretion and other nonrecurring items of $1,153 in third quarter 2016 that added 23 basis points to the net interest margin in that prior period. The impact of the credit and interest fair value accretion generally lessens over time as loans mature and are paid off. In total, the yield on earning assets actually increased in third quarter 2017 when compared to third quarter 2016 when the impact of the fair value accretion is removed. This is evidenced with the core margin of 4.02% in third quarter 2017 compared to 3.99% in third quarter 2016.

The following table presents condensed balance sheet information, together with interest income and yields on average interest earning assets, and interest expense and rates on interest-bearing liabilities, for the quarter ended September 30, 2017, compared to the quarter ended September 30, 2016:

Table I

Average Balance Analysis of Net Interest Income

(dollars in thousands)


	Three months ended September 30, 2017								Three months ended September 30, 2016
	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	$	44,060	$	149			1.34	%	$	28,811	$	40			0.55	%
Federal Home Loan Bank stock		7,545		72			3.79	%		6,975		46			2.62	%
Securities available-for-sale:
Taxable		386,624		2,175			2.23	%		346,658		1,949			2.24	%
Tax-exempt⁽¹⁾		77,718		766			3.91	%		74,427		742			3.97	%
Loans, net of deferred fees and allowance⁽²⁾
Taxable		1,776,544		23,072			5.15	%		1,502,108		19,545			5.18	%
Tax-exempt⁽³⁾		90,337		1,298			5.70	%		55,910		923			6.57	%

Total interest-earning assets		2,382,828		27,532			4.58	%		2,014,889		23,245			4.59	%

Non earning assets
Cash and due from banks		29,079								28,300
Property and equipment		19,550								19,380
Goodwill and intangible assets		68,948								49,517
Interest receivable and other assets		64,935								51,901

Total nonearning assets		182,512								149,098

Total assets	$	2,565,340							$	2,163,987


Interest-bearing liabilities
Money market and NOW accounts	$	967,746	$	(674	)		-0.28	%	$	825,800	$	(553	)		-0.27	%
Savings deposits		78,274		(155	)		-0.79	%		75,344		(23	)		-0.12	%
Time deposits—core⁽⁴⁾		56,773		(55	)		-0.38	%		59,830		(59	)		-0.39	%

Total interest-bearing core deposits		1,102,793		(884	)		-0.32	%		960,974		(635	)		-0.26	%
Time deposits—noncore		96,574		(332	)		-1.36	%		107,753		(349	)		-1.29	%
Interest-bearing repurchase agreements		1,840		—			0.00	%		780		—			0.00	%
Federal funds purchased				—			0.00	%		909		(2	)		-0.88	%
FHLB borrowings		113,253		(398	)		-1.39	%		117,277		(286	)		-0.97	%
Subordinated debenture		34,154		(590	)		-6.85	%		34,079		(553	)		-6.46	%
Junior subordinated debenture		11,407		(105	)		-3.65	%		9,034		(66	)		-2.91	%

Total interest-bearing wholesale funding		257,228		(1,425	)		-2.20	%		269,832		(1,256	)		-1.85	%

Total interest-bearing liabilities		1,360,021		(2,309	)		-0.67	%		1,230,806		(1,891	)		-0.61	%

Noninterest-bearing liabilities
Demand deposits		909,994								687,803
Interest payable and other		8,106								5,594

Total noninterest liabilities		918,100								693,397

Total liabilities		2,278,121								1,924,203
Shareholders’ equity		287,219								239,784

Total liabilities and shareholders’ equity	$	2,565,340							$	2,163,987

Net interest income			$	25,223							$	21,354

Net interest margin⁽¹⁾				4.20	%							4.22	%

⁽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 $268 and $260 for the three months ended September 30, 2017, and September 30, 2016, respectively. Net interest margin was positively impacted by 4 and 5 basis points for the three months ended September 30, 2017, and September 30, 2016, respectively.

⁽²⁾	Interest income includes recognized loan origination fees of $322 and $340 for the three months ended September 30, 2017, and September 30, 2016, 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 $454 and $323 for the three months ended September 30, 2017, and September 30, 2016, respectively. Net interest margin was positively impacted by 8 and 6 basis points for the three months ended September 30, 2017, and September 30, 2016, respectively.

⁽⁴⁾	Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $250.

Table I shows that earning asset yields in third quarter 2017 were 4.58%, down 1 basis point from the 4.59% recorded in third quarter 2016. The Company experienced a decrease in yield on the taxable loan portfolio of 3 basis points when compared to the prior period, which is primarily tied to a reduction in accretion of the fair value discounts associated with the acquired loan portfolios. The yield on securities was relatively flat due to no purchases or sales of securities during the third quarter 2017.

The cost of interest-bearing liabilities increased by 6 basis points from 0.61% in third quarter 2016 compared to 0.67% in third quarter 2017. The increase in the cost of interest-bearing liabilities was due to the increase in of FHLB borrowings due to the rise in the fed funds rate. The rates paid on interest-bearing core deposits increased by 6 basis points, primarily due to the higher cost of the acquired Foundation deposits, which were only included in the third quarter 2016 figures from September 6, 2016 through September 30, 2016.

The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the three months ended September 30, 2017, compared to the three months ended September 30, 2016.

Table II

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)


	Three months ended September 30, 2017 compared to September 30, 2016 Increase (decrease) due to
	Volume			Rate			Net
Interest earned on:
Federal funds sold and interest-bearing deposits	$	22		$	87		$	109
Federal Home Loan Bank stock		4			22			26
Securities available-for-sale:
Taxable		231			(5	)		226
Tax-exempt⁽¹⁾		35			(11	)		24
Loans, net of deferred fees and allowance
Taxable		3,634			(107	)		3,527
Tax-exempt⁽²⁾		571			(197	)		374

Total interest-earning assets		4,497			(211	)		4,286

Interest paid on:
Money market and NOW accounts		97			24			121
Savings deposits		1			131			132
Time deposits—core ⁽³⁾		(3	)		(1	)		(4	)

Total interest-bearing core deposits		95			154			249
Time deposits—noncore		(35	)		18			(17	)
Federal funds purchased		(2	)		—			(2	)
FHLB and FRB borrowings		(9	)		121			112
Subordinated debenture		3			34			37
Junior subordinated debenture		18			21			39

Total interest-bearing wholesale funding		(25	)		194			169

Total interest-bearing liabilities		70			348			418

Net interest income⁽¹⁾	$	4,427		$	(559	)	$	3,868

⁽¹⁾

⁽²⁾

⁽³⁾	Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $250.

The third quarter 2017 rate/volume analysis shows that net interest income increased by $3,868 over third quarter 2016. Interest income increased $4,286, while interest expense increased $418 in the third quarter 2017. The increase in interest income was primarily due to higher volumes, which generated an additional $4,497 in interest income. The increase in interest expense in third quarter 2017, when compared to third quarter 2016, was primarily due to an increase in the rates of non-core deposits, primarily FHLB borrowings.

Table I

Average Balance Analysis of Net Interest Income

(dollars in thousands)


	Nine months ended September 30, 2017								Nine months ended September 30, 2016
	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	$	42,489	$	335			1.05	%	$	26,539	$	104			0.52	%
Federal Home Loan Bank stock		8,417		149			2.37	%		6,016		94			2.09	%
Securities available-for-sale:
Taxable		391,581		6,670			2.28	%		322,679		5,456			2.26	%
Tax-exempt⁽¹⁾		77,568		2,323			4.00	%		72,703		2,208			4.06	%
Loans, net of deferred fees and allowance⁽²⁾
Taxable		1,786,210		68,887			5.16	%		1,418,191		54,244			5.11	%
Tax-exempt⁽³⁾		87,024		3,685			5.66	%		50,831		2,411			6.34	%

Total interest earning assets		2,393,289		82,049			4.58	%		1,896,959		64,517			4.54	%

Non earning assets
Cash and due from banks		29,146								25,809
Property and equipment		19,815								18,970
Goodwill and intangible assets		69,726								45,641
Interest receivable and other assets		66,631								49,548

Total non earning assets		185,318								139,968

Total assets	$	2,578,607							$	2,036,927

Interest-bearing liabilities
Money market and NOW accounts	$	979,020	$	(2,009	)		-0.27	%	$	820,173	$	(1,615	)		-0.26	%
Savings deposits		74,323		(376	)		-0.68	%		70,843		(65	)		-0.12	%
Time deposits—core⁽⁴⁾		61,314		(166	)		-0.36	%		66,022		(182	)		-0.37	%

Total interest-bearing core deposits		1,114,657		(2,551	)		-0.31	%		957,038		(1,862	)		-0.26	%
Time deposits—non-core		104,701		(1,045	)		-1.33	%		80,092		(816	)		-1.36	%
Interest-bearing repurchase agreements		2,134		(1	)		-0.06	%		493		—			0.00	%
Federal funds purchased		121		(1	)		-1.10	%		872		(6	)		-0.92	%
FHLB borrowings		136,358		(1,205	)		-1.18	%		95,356		(758	)		-1.06	%
Subordinated debenture		34,131		(1,735	)		-6.80	%		11,940		(553	)		-6.19	%
Junior subordinated debenture		11,369		(293	)		-3.45	%		8,512		(179	)		-2.81	%

Total interest-bearing wholesale funding		288,814		(4,280	)		-1.98	%		197,265		(2,312	)		-1.57	%

Total interest-bearing liabilities		1,403,471		(6,831	)		-0.65	%		1,154,303		(4,174	)		-0.48	%

Noninterest-bearing liabilities
Demand deposits		886,017								647,967
Interest payable and other		7,568								6,065

Total noninterest liabilities		893,585								654,032

Total liabilities		2,297,056								1,808,335
Shareholders’ equity		281,551								228,592

Total liabilities and shareholders’ equity	$	2,578,607							$	2,036,927

Net interest income			$	75,218							$	60,343

Net interest margin⁽¹⁾				4.20	%							4.25	%

⁽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 $813 and $773 for the nine months ended September 30, 2017, and September 30, 2016, respectively. Net interest margin was positively impacted by 5 and 5 basis points for the nine months ended September 30, 2017, and September 30, 2016, respectively.

⁽²⁾	Interest income includes recognized loan origination fees of $989 and $776 for the nine months ended September 30, 2017, and September 30, 2016, 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 $1,290 and $844 for the nine months ended September 30, 2017, and September 30, 2016, respectively. Net interest margin was positively impacted by 12 and 11 basis points for the nine months ended September 30, 2017, and September 30, 2016, respectively.

⁽⁴⁾	Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $250.

Table II

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)


	Nine months ended September 30, 2017 Compared to nine months ended September 30, 2016 Increase (decrease) due to
	Volume			Rate			Days			Net
Interest earned on:
Federal funds sold and interest-bearing deposits	$	62		$	169		$	—		$	231
Federal Home Loan Bank stock		37			18			—			55
Securities available-for-sale:
Taxable		1,164			55			(5	)		1,214
Tax-exempt⁽¹⁾		148			(31	)		(2	)		115
Loans, net of deferred fees and allowance
Taxable		14,063			630			(50	)		14,643
Tax-exempt⁽²⁾		1,715			(439	)		(2	)		1,274

Total interest earning assets		17,189			402			(59	)		17,532

Interest paid on:
Money market and NOW accounts		312			83			(1	)		394
Savings deposits		3			308			—			311
Time deposits—core ⁽³⁾		(13	)		(3	)		—			(16	)

Total interest-bearing core deposits		302			388			(1	)		689

Time deposits—noncore		250			(21	)		1			230
Federal funds purchased		(5	)		—			—			(5	)
FHLB borrowings		326			122			(1	)		447
Subordinated debenture		1,027			156			(1	)		1,182
Junior subordinated debenture		60			54			—			114

Total interest-bearing wholesale funding		1,658			311			(1	)		1,968

Total interest-bearing liabilities		1,960			699			(2	)		2,657

Net interest income⁽¹⁾	$	15,229		$	(297	)	$	(57	)	$	14,875

⁽¹⁾

⁽²⁾

⁽³⁾	Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $250.

Loan Loss Provision and Allowance

Below is a summary of the Company’s allowance for loan losses for the three and nine months ended September 30, 2017 and 2016:


	Three months ended						Nine months ended
	September 30,						September 30,
	2017			2016			2017			2016
Balance, beginning of period	$	23,451		$	19,127		$	22,454		$	17,301
Provision charged to income		350			1,380			3,725			3,575
Loans charged against allowance		(523	)		(44	)		(3,006	)		(712	)
Recoveries credited to allowance		85			68			190			367

Balance, end of period	$	23,363		$	20,531		$	23,363		$	20,531

The Company recorded $350 in provision for loan losses during the third quarter 2017, while experiencing a reduction in outstanding loan balances in the quarter$38,599. This provision is reflective of a small downward migration in a few portfolio credits which more than offset the contraction in the outstanding loan balances. The Company’s classified assets at September 30, 2017 were 18.59% of Tier 1 capital, compared to 23.51% of regulatory capital at December 31, 2016.

For the nine months ended September 30, 2017, the Company recorded net loan charge offs of $2,816 compared to $345 for the same period in 2016. The net charge offs primarily related to two charge-offs, one of which totaled approximately $1,600 from the dental loan portfolio.

The allowance for loan losses for outstanding loans at September 30, 2017 was $23,363, or 1.24% of outstanding loans, compared to 1.21% and 1.14% of outstanding loans at December 31, 2016 and September 30, 2016, respectively. The allowance as a percentage of outstanding loans also included loans acquired through merger transactions, which were booked net of their credit related fair value adjustment and were only included in the allowance for loan losses to the extent their credit impairment exceeded the remaining credit related fair value discount. At September 30, 2017, the Company had a total of $5,397 of credit related fair value adjustment assigned to acquired loans. The balance of these acquired loans totaled $273,584, before the credit and interest rate fair value adjustments. When acquired loans with an assigned credit fair value mark were excluded from outstanding loans, the allowance for loan losses of $23,363 as a percentage of organic loans outstanding was 1.45% as of September 30, 2017. The allowance as a percentage of nonperforming loans, net of government guarantees, was 273.09% at September 30, 2017, compared to 236.88% and 210.232% at December 31, 2016, and September 30, 2016, respectively.

At September 30, 2017, $7,260 of loans (net of government guarantees) were classified as impaired. A specific allowance of $9 (included in the ending allowance at September 30, 2017) was assigned to these loans. That compares to impaired loans of $10,567 and a specific allowance assigned of $736 at December 31, 2016.

Total nonperforming assets, net of government guarantees, were $18,455, or 0.72% of total assets, at September 30, 2017, down $3,092 from December 31, 2016, as the Company continued to resolve problem loans and negotiated the sale of an easement on an OREO property during the third quarter 2017. At September 30, 2017, nonperforming assets consisted of $8,555 in nonaccrual loans (net of government guarantees), there was one loan in the amount of $1,428 90 days past due and still accruing interest, and there was $9,900 of OREO.

The following table shows a summary of nonaccrual loans, loans past due 90 days or more, including purchased credit impaired loans that are on nonaccrual status or past due 90 days or more, and other real estate owned for the periods covered in this report:

Nonperforming Assets and Asset Quality Ratios


	September 30,			December 31,			September 30,
	2017			2016			2016
NONPERFORMING ASSETS
Nonaccrual loans
Real estate loans
Multi-family residential	$	—		$	—		$	—
Residential 1-4 family		282			1,294			1,465
Owner-occupied commercial		1,842			1,605			1,634
Nonowner-occupied commercial		3,160			3,374			3,475

Total permanent real estate loans		5,284			6,273			6,574
Construction loans
Multi-family residential		—			—			—
Residential 1-4 family		—			—			—
Commercial real estate		—			—			—
Commercial bare land and acquisition & development		—			—			—
Residential bare land and acquisition & development		—			—			—

Total construction real estate loans		—			—			—

Total real estate loans		5,284			6,273			6,574
Commercial loans		4,204			5,560			5,619

Total nonaccrual loans		9,488			11,833			12,193
90-days past due and accruing interest		1,428			—			—
Total nonperforming loans		10,916			11,833			12,193
Nonperforming loans guaranteed by government		(2,361	)		(2,354	)		(2,427	)

Net nonperforming loans		8,555			9,479			9,766
Other real estate owned		9,900			12,068			13,066

Total nonperforming assets, net of guaranteed loans	$	18,455		$	21,547		$	22,832


ASSET QUALITY RATIOS
Allowance for loan losses as a percentage of total loans outstanding		1.24	%		1.21	%		1.14	%
Allowance for loan losses as a percentage of total nonperforming loans, net of government guarantees		273.09	%		236.88	%		210.23	%
Net loan charge offs (recovery) as a percentage of average loans, annualized		0.32	%		-0.01	%		0.03	%
Net nonperforming loans as a percentage of total loans		0.45	%		0.51	%		0.54	%
Nonperforming assets as a percentage of total assets		0.72	%		0.85	%		0.90	%
Consolidated classified asset ratio⁽¹⁾		18.59	%		23.51	%		23.80	%

⁽¹⁾

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

Other real estate owned at September 30, 2017, consisted of four properties. One of the properties, a commercial land development project valued at $9,663, comprised 97.61% of the total other real estate owned category. The Company has actively marketed this property; however, the location and nature of the commercial land development property make it susceptible to possible future valuation write-downs as it is appraised on an annual basis, or as facts or circumstances change.

Noninterest Income


	Noninterest Income Summary
	Three months ended									Nine months ended
	September 30,			September 30,			Change			September 30,			September 30,			Change
	2017			2016			$			2017			2016			$
Service charges on deposit accounts	$	686		$	717		$	(31	)	$	2,119		$	2,099		$	20
Bankcard income		338			314			24			968			899			69
Bank-owned life insurance income		226			172			54			675			463			212
Net gain on sale of investment securities		—			—			—			—			309			(309	)
Impairment losses on investment securities (OTTI)		(7	)		(2	)		(5	)		(9	)		(19	)		10
Other noninterest income		645			718			(73	)		2,797			1,726			1,071

	$	1,888		$	1,919		$	(31	)	$	6,550		$	5,477		$	1,073

For the three months ended September 30, 2017, noninterest income was $1,888, down $31 or 1.62% from the same period last year. The decrease in noninterest income in third quarter 2017, when compared to the same period last year, was primarily attributable to a reduction in recoveries on acquired loans, which was partially offset by an increase in earnings on bank owned life insurance income.

Noninterest Expense


	Noninterest Expense Summary
	Three months ended							Nine months ended
	September 30,		September 30,		Change			September 30,		September 30,			Change
	2017		2016		$			2017		2016			$
Salaries and employee benefits	$	7,554	$	7,520	$	34		$	25,830	$	23,084		$	2,746
Property and equipment		1,323		1,202		121			3,929		3,404			525
Data processing		1,062		924		138			3,137		2,682			455
Legal and professional services		576		569		7			1,789		2,321			(532	)
Business development		319		460		(141	)		1,299		1,492			(193	)
FDIC insurance assessment		297		273		24			989		848			141
Other real estate income (expense), net		48		71		(23	)		20		(32	)		52
Merger related expense		176		1,767		(1,591	)		1,429		3,745			(2,316	)
Other noninterest expense		1,453		1,039		414			3,846		3,222			624

	$	12,808	$	13,825	$	(1,017	)	$	42,268	$	40,766		$	1,502

For the three months ended September 30, 2017, noninterest expense was $12,808, a decrease of $1,017 or 7.36% over the prior period. A decrease in merger related expense of $1,591 largely contributed to the reduction. Merger expenses in 2016 related to the Company’s acquisition of Foundation, which closed in third quarter 2016. Merger related expenses in 2017 relate to Columbia’s acquisition of Pacific Continental Bank. The merger related expense decrease was partially offset by an increase in other noninterest expense of $414 or 39.85%. The increase in other noninterest expense primarily relates to local taxes, including Washington business and occupancy tax and Bellevue city tax, reflecting the full quarter of Foundation taxable income.

BALANCE SHEET

Loans

A summary of outstanding loans by market at September 30, 2017, June 30, 2017, December 31, 2016, and September 30, 2016, follows:


	Period Ended
	September 30,		June 30,		December 31,		September 30,
	2017		2017		2016		2016
Eugene market gross loans, period-end	$	471,805	$	465,789	$	442,556	$	404,858
Portland market gross loans, period-end		765,781		780,597		747,037		728,749
Puget Sound market gross loans, period-end		359,637		394,068		405,843		423,581
National healthcare gross loans, period-end		287,470		282,838		264,351		251,458

Total gross loans, period-end	$	1,884,693	$	1,923,292	$	1,859,787	$	1,808,646

During third quarter 2017, the Company experienced a contraction in gross loans; however this was expected given the market disruption caused by the pending merger with Columbia. While quarter over quarter loan growth is down, outstanding gross loans at September 30, 2017 were up $24,906 over December 31, 2016 outstanding loans. Annualized loan growth through the first nine months of 2017 was 1.78%.

Outstanding loans to dental professionals, which are comprised of both local and national loans, at September 30, 2017 totaled $390,333, or 20.71% of the loan portfolio, compared to $377,478, or 20.30% of the loan portfolio, at December 31, 2016. The Company’s national dental loans increased by $9,062 from December 31, 2016 and were represented in 45 states by the end of the third quarter 2017. In addition to national growth, the Company saw growth in the local dental market, with the portfolio growing $3,793 from year-end 2016, which was primarily due to a slowdown of prepayments and an increase in production in the Company’s Portland Market local lending. At September 30, 2017, $4,658, or 1.19% 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 only to acquisition of a seasoned practice by experienced dental professionals, practice refinances and owner-occupied real estate loans. Additional data on the Company’s dental loan portfolio and the credit quality of this portfolio can be found in Note 4 of the Notes to Consolidated Financial Statements in this report.

In addition to loan growth in the dental industry, growth was also experienced in the non-dental healthcare field, which includes loans to physicians, veterinarians, optometrists, and medical specialists. This portfolio grew by $22,509 over year-end 2016, to $164,515 as of September 30, 2017. The Company saw expansion in veterinary practice acquisition financing and nursing/residential care facility owner-occupied real estate financing.

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

Detailed credit quality data on the entire loan portfolio can be found in Note 3 of the Notes to Consolidated Financial Statements in this report.

Securities

At September 30, 2017, the balance of securities available-for-sale was $453,660, down $17,336 from December 31, 2016. At September 30, 2017, the portfolio had an unrealized pre-tax loss of $1,096, compared to an unrealized pre-tax loss of $3,886 at December 31, 2016. The average life and duration of the portfolio at September 30, 2017 and December 31, 2016, was 4.51 years and 4.94 years, respectively. At September 30, 2017, $28,574 of the securities portfolio was 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 neutral rate-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. Given the pending merger with Columbia and the resulting slowdown in loan growth in third quarter 2017, management’s third quarter strategy was to cease purchases of securities, rather than replace cash flow.

At September 30, 2017, $1,518, or 0.33% of the total securities portfolio, was composed of private-label mortgage-backed securities. Management booked OTTI on this portion of the portfolio totaling $279 on a cumulative basis, which included an additional $7 in OTTI booked during third quarter 2017. Management reviews monthly all available information, including current and projected default rates and current and projected loss severities, related to the collectability of its potentially impaired investment securities to determine if an additional OTTI is required. Recognition of additional OTTI on the private-label mortgage-backed portion of the portfolio is possible in future quarters depending upon economic conditions, default rates on home mortgages, loss severities on foreclosed homes, unemployment levels, and home values.

In management’s opinion, the remaining securities in the portfolio in an unrealized loss position were considered only temporarily impaired at quarter-end. At September 30, 2017, the Company had no intent, nor was it more likely than not that it would be required, to sell its impaired securities before their recovery. The impairment was due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal was expected at September 30, 2017.

Goodwill and Intangible Assets

At September 30, 2017, the Company had the following goodwill and core deposit intangibles (“CDI”) associated with prior bank acquisitions:


	September 30, 2017
	Foundation Bank		Capital Pacific Bank		Century Bank		Northwest Business Bank		Total
Goodwill	$	20,763	$	17,145	$	851	$	22,031	$	60,790
CDI		5,137		2,760		282		—		8,179

	$	25,900	$	19,905	$	1,133	$	22,031	$	68,969

The Company periodically tests goodwill for impairment. Management performs an impairment analysis of the intangible assets with indefinite lives at least annually, but more frequently if an impairment triggering event is deemed to have occurred. The last impairment test was performed at December 31, 2016, at which time no impairment was determined to exist.

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

Deposits

Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and nonpublic local time deposits, including nonpublic local time deposits in excess of $250, were $2,016,288 and represented 96.10% of total deposits at September 30, 2017. On a linked quarter basis, core deposits increased $9,720. The increase was partially attributable to normal seasonal fluctuations in both our large depositor and small depositor portfolios. A key component of core deposits is noninterest-bearing demand deposits, which totaled $906,015 and represented 44.93% of core deposits at September 30, 2017. The weighted average cost of core deposits, when factoring in non-interest bearing core deposits, for the third quarter 2017 was 0.17%.

A summary of outstanding core deposits and average core deposits by market and wholesale funding classified as non-core deposits at September 30, 2017, June 30, 2016, and March 31, 2016, and December 31, 2016 follows:


	Period Ended
	September 30, 2017		June 30, 2017		March 31, 2017		December 31, 2016
Eugene market core deposits, period-end⁽¹⁾	$	738,308	$	745,050	$	770,468	$	815,674
Portland market core deposits, period-end⁽¹⁾		705,140		678,193		625,676		630,806
Puget Sound market core deposits, period-end⁽¹⁾		572,840		583,325		571,122		588,587

Total core deposits, period-end ⁽¹⁾		2,016,288		2,006,568		1,967,266		2,035,067
Non-core deposits, period-end		81,869		98,733		113,000		113,036

Total deposits, period-end	$	2,098,157	$	2,105,301	$	2,080,266	$	2,148,103


	Three Months Ended
	September 30, 2017		June 30, 2017		March 31, 2017		December 31, 2016
Eugene market core deposits, average⁽¹⁾	$	739,135	$	742,021	$	806,369	$	770,123
Portland market core deposits, average ⁽¹⁾		693,636		651,525		630,962		644,037
Puget Sound market core deposits, average⁽¹⁾		580,016		579,135		579,268		590,865

Total core deposits, average⁽¹⁾		2,012,787		1,972,681		2,016,599		2,005,025
Non-core deposits, average		96,571		104,705		113,007		114,091

Total deposits, average	$	2,109,358	$	2,077,386	$	2,129,606	$	2,119,116

⁽¹⁾	Core deposits include all demand, savings, money market, interest checking accounts, plus all nonpublic local time deposits including local time deposits in excess of $250.

Other Deposits

The Company uses public and brokered deposits to provide short-term and long-term funding sources. The Company defines short-term as having a contractual maturity of less than one year. The Company uses brokered deposits to help mitigate interest rate risk in a rising rate environment. During the third quarter 2017, the Company elected to not renew a $15,000 public time deposit with the State of Oregon pool due to the decrease in loan demand during the quarter. This primarily contributed to the reduction the non-core deposit totals.

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

Non-Core Deposit Summary


	September 30, 2017							September 30, 2016
	Balance		Weighted average rate			Weighted average maturity		Balance		Weighted average rate			Weighted average maturity
	(dollars in thousands)							(dollars in thousands)
<3 Months	$	1,876		0.78	%		51 Days	$	30,375		0.79	%		57 Days
3-6 Months		1,500		0.90	%		129 Days		—		—			—
6-12 Months		11,409		0.98	%		261 Days		1,744		0.87	%		335 Days
>12 Months		67,084		1.32	%		2.86 Years		81,162		1.27	%		3.42 Years

	$	81,869						$	113,281

Borrowings

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

At September 30, 2017, the Company held $7,084 of stock in the FHLB of Des Moines. The FHLB stock is broken into two classes: membership and activity. The membership class is based on asset size and the Company is required to be a member of the FHLB. The amount of membership stock held at September 30, 2017 was $3,044 and is updated in the first quarter of each year. The activity stock outstanding at September 30, 2017 totaled $5,684; however, it is subject to fluctuation on a daily basis based on outstanding borrowings. At September 30, 2017, membership stock paid dividends at 1.00% annually and activity stock paid dividends at 3.50% annually. Both classes of FHLB stock are included in the asset section of the Company’s balance sheet.

Subordinated Debentures

Junior Subordinated Debentures

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

The Company had an additional $8,248 in junior subordinated debentures, which were issued in conjunction with the 2005 acquisition of Northwest Business Bank. These debentures had an interest rate of 6.265% that was fixed until January 2011, after which the rate changed to a floating rate of three-month LIBOR plus 135 basis points. On April 22, 2013, the Company entered into a cash flow hedge on $8,000 of the trust preferred securities, swapping the variable interest rate for a fixed rate of 2.73% for approximately seven years. In January 2017, the Company terminated the cash flow hedge associated with the swap and recognized a gain of $77. The $8,000 of the Northwest Business Bank junior subordinated debentures qualifies as Tier 1 capital under regulatory capital guidelines.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances, such as the Foundation Debenture and the Debenture, as Tier 1 capital. Under final rules adopted by the Federal Reserve and the other U.S. Federal banking agencies, our trust preferred securities will remain as Tier 1 capital since total assets of the Company are less than $15 billion. Additional information regarding these final capital rules is included in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” of this report, Part I, Item 1, “Business-Supervision and Regulation – Capital Adequacy” of our 2016 Form 10-K, and in Part II, Item 1A “Risk Factors” of our 2016 Form 10-K under the heading “We operate in a highly regulated environment and the effects of recent and pending federal legislation or of changes in, or supervisory enforcement of, banking or other laws and regulations could adversely affect us.”

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

Capital Resources

Capital is the shareholders’ investment in the Company. Capital grows through the retention of earnings and the issuance of new stock or other equity securities whether through stock offerings or through the exercise of equity awards. Capital formation allows the Company to grow assets and provides flexibility in times of adversity. Shareholders’ equity at September 30, 2017 was $290,578, up $16,823 from December 31, 2016. The increase in shareholders’ equity was primarily due to a reduction in the unrealized loss on the investment portion combined with retention of a portion of income earned during third quarter 2017.

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

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 10.28%, 10.90%, 13.56% and 9.48%, respectively, at September 30, 2017, with all capital ratios for the Company above the minimum regulatory designations and the Company’s internal capital policy thresholds. For additional information regarding the Company’s regulatory capital levels, see Note 12 in Notes to Consolidated Financial Statements in Part I, Item I of this report.

The Company has regularly paid cash dividends on a quarterly basis, typically in February, May, August and November of each year. The Board of Directors considers the dividend amount quarterly and takes a broad perspective in its dividend deliberations, including a review of recent operating performance, capital levels, 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.

On July 17, 2017, the Board of Directors approved a regular quarterly cash dividend of $0.11 per share payable to shareholders on August 7, 2017. Subsequent to the end of the third quarter 2017, on October 13, 2017, the Board of Directors approved a regular quarterly cash dividend of $0.11 per share payable to shareholders on October 30, 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 September 30, 2017, the Company had $370,222 in commitments to extend credit, up from $352,361 at December 31, 2016.

Letters of credit written are conditional commitments issued by the Company to guarantee performance of a customer to a third party. The credit risk involved is essentially the same as that involved in extending loan facilities to customers. At September 30, 2017, the Company had $2,254 in letters of credit and financial guarantees outstanding.

LIQUIDITY AND CASH FLOWS

Liquidity is the term used to define the Company’s ability to meet its financial commitments. The Company maintains sufficient liquidity to ensure funds are available for both lending needs and the withdrawal of deposit funds. The Company derives liquidity through core deposit growth, maturity of investment securities, and loan payments. Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $250. 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.

Total deposits at September 30, 2017, were $2,098,157, representing a reduction of $49,946 from December 31, 2016. Outstanding loans were up $25,075 from December 31, 2016. The combination of those shifts lead to an increase in FHLB borrowing, which was partially offset by a reduction in the securities portfolio of $17,336. The securities portfolio represented 17.81% of total assets at September 30, 2017. At September 30, 2017, $28,574 of the securities portfolio was pledged to support public deposits and repurchase agreements, leaving $425,086 of the securities portfolio unencumbered and available-for-sale. In addition, at September 30, 2017, the Company had $25,010 of government guaranteed loans that could be sold in the secondary market to support the Company’s liquidity position. Due to its strategic focus to market to specific segments, the Company has been successful in developing deposit relationships with several large clients, which are generally defined as deposit relationships of $2,000 or more, which are closely monitored by management. The loss of any such deposit relationship or other large deposit

relationships could cause an adverse effect on short-term liquidity. The Company uses a 10-point risk-rating system to evaluate each of its large depositors in order to assist management in its daily monitoring of the volatility of this portion of its core deposit base. The risk-rating system attempts to determine the stability of the deposits of each large depositor, evaluating, among other things, the length of time the depositor has been with the Company and the likelihood of loss of individual large depositor relationships. Risk ratings on large depositors are reviewed at least quarterly and adjusted if necessary. Company management maintain close relationships and hold regular meetings with its large depositors to assist in management of these relationships. Management has placed more emphasis in review of the large depositor relationships given the pending acquisition by Columbia, with external competition likely pursuing the Company’s clients given the potential market disruption and the client’s perception that their relationship service or pricing may change due to the acquisition. At this point, management has not identified any significant deposit totals at risk due to the merger, but will continue to evaluate the relationships once the merger occurs.

At September 30, 2017, the Company had secured borrowing lines with the FHLB and the FRB, along with unsecured borrowing lines with various correspondent banks, totaling $874,191. The Company’s secured lines with the FHLB and FRB were limited by the amount of collateral pledged. At September 30, 2017, the Company had pledged $632,226 in discounted collateral value in commercial real estate loans, first and second lien single-family residential loans, multi-family loans, and securities to the FHLB. Additionally, certain commercial and commercial real estate loans with a discounted value of $87,965 were pledged to the FRB under the Company’s Borrower-In-Custody program. The Company’s unsecured correspondent bank lines totaled $154,000. At September 30, 2017, the Company had $101,000 in borrowings outstanding from the FHLB, no borrowings outstanding with the FRB, and no borrowings on its overnight correspondent bank lines, leaving a total of $773,191 available on its secured and unsecured borrowing lines as of such date.

Net cash provided by operating activities was $36,458 during the first three quarters of 2017. During the same period, cash of $11,245 was used in investing activities, consisting principally of a net loan principal increase of $27,905 and net purchases of securities of $16,221. Cash used by financing activities during the first nine months of 2017 was $22,048. Additional information on the Company’s cash flows can be reviewed in the Consolidated Statement of Cash Flows in Part I, Item I of this report.

ITEM 3 Quantitative and Qualitative Disclosures about Market Risk

There has been no material change in the Company’s exposure to market risk. Readers are referred to the Company’s 2016 Form 10-K, for additional information.

ITEM 4 Controls and Procedures

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

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

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the quarter ended September 30, 2017, that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1 Legal Proceedings

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, the aggregate, to have a material adverse effect on our financial condition.

ITEM 1A

Risk Factors

For a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our 2016 Form 10-K, which is incorporated by reference herein, in addition to the following information:

Industry Factors

Fluctuating interest rates could adversely affect our profitability.

As is the case with many banks, our profitability is dependent to a large extent upon our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect, and has in past years, impacted, our net interest margin, and, in turn, our profitability. This impact could result in a decrease in our interest income relative to interest expense. Increases in interest rates may also adversely impact the value of our securities investment portfolio. At September 30, 2017, our balance sheet was liability sensitive, and an increase in interest rates could cause our net interest margin and our net interest income to decline. Since the financial crisis of 2008, the banking industry has operated in an extremely low interest rate environment relative to historical averages, and the Federal Reserve has pursued highly accommodative monetary policies (including a very low Federal funds rate and substantial purchases of long-term U.S. Treasury and agency securities) in an effort to facilitate growth in the U.S. economy and a reduction in levels of unemployment. Among the instruments of monetary policy available to the Federal Reserve are (a) conducting open market operations in U.S. Government securities, (b) changing the discount rates on borrowings by depository institutions and the federal funds rate, and (c) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits, and have placed downward pressure on the net interest margins of banks. In September 2017, the Federal Reserve announced that, starting in October 2017, it would begin the process of reducing its $4.5 trillion balance sheet by ceasing the reinvestment of principal on the maturing bonds that it holds. The impact of the Federal Reserve’s unwinding of quantitative easing on the U.S. economy and financial markets cannot be predicted with certainty at this time; however, this change in the Federal Reserve’s monetary policy could result in increased interest rates and volatility in the financial markets. The policies of the Federal Reserve can be expected to have a material effect on our business, prospects, results of operations and financial condition.

Company Factors

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

Bank regulatory authorities and investors generally view significant loan concentrations within any particular industry as carrying higher inherent risk than a loan portfolio without any significant concentration in one industry. We have a significant concentration of loans to dental professionals which represented 20.71% in principal amount of our total loan portfolio at September 30, 2017 (see Note 4 in the Notes to Consolidated Financial Statements included in this report). 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.

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

At September 30, 2017, our nonperforming loans (which include all nonaccrual loans, net of government guarantees) were 0.43% of the loan portfolio. At September 30, 2017, our nonperforming assets (which include foreclosed real estate) were 0.71% 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.

ITEM 2

Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

ITEM 3

Defaults upon Senior Securities

None

ITEM 4

Mine Safety Disclosures

Not applicable

ITEM 5

Other Information

None

ITEM 6

Exhibits



31.1		Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer of the Registrant

31.2		Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of the Registrant

32*		Furnished statements of the Chief Executive Officer and Chief Financial Officer under 18 U.S.C Section 1350

101		The following financial information from Pacific Continental Corporation’s 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.

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

SIGNATURES

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


		PACIFIC CONTINENTAL CORPORATION
		(Registrant)

Dated	October 31, 2017	/s/ Roger Busse

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

Dated	October 31, 2017	/s/ Richard R. Sawyer

		Richard R. Sawyer
		Executive Vice President and Chief Financial Officer (Duly Authorized Officer; Principal Financial and Accounting Officer)

PACIFIC CONTINENTAL CORP - FORM 10-Q - November 1, 2017

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