10-K 1 pcbkform10k123108.htm PCBK FORM 10K 123108 pcbkform10k123108.htm

 SECURITIES & EXCHANGE COMMISSION
Washington D.C. 20549

FORM 10-K

[ X ]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008

COMMISSION FILE NUMBER 0-30106

PACIFIC CONTINENTAL CORPORATION
(Exact name of registrant as specified in its charter)

OREGON                                                             93-1269184
(State of Incorporation)                                                 (IRS Employer Identification No)

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

(541) 686-8685
(Registrant’s telephone number)

Securities registered pursuant to section 12(b) of the Act:
Title of Each Class                                                                           Name of Each Exchange on Which Registered

Common Stock, No par value per share                                                                                                           Nasdaq Global Select Market

Securities registered pursuant to 12(g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act                    Yes   __No  X

Indicate by check mark if the registrant is not required to file report pursuant to Section 13 or Section 15(d) of the Act                    Yes   __No  X

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

Check if there is no disclosure of delinquent filers in response to item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K.    (  )

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
Large accelerated filer   __                                                                          Accelerated filer   X    Non-accelerated filer   __    Smaller Reporting Company  __

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

The aggregate market value of the voting stock held by non-affiliates of the registrant at June 30, 2008 (the last business day of the most recent second quarter) was $154,698,279 based on the closing price as quoted on the NASDAQ Global Market on that date.

The number of shares outstanding of each of the registrant’s classes of common stock, as of March 6, 2009, was 12,862,691 shares of no par value Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates by reference information from the registrant’s definitive proxy statement for the 2009 annual meeting of shareholders.

 
 
 


PACIFIC CONTINENTAL CORPORATION
FORM 10-K
ANNUAL REPORT
TABLE OF CONTENTS


PART 1
  
Page
     
     
     
     
     
     
PART II
    
     
   
     
     
   
     
     
     
   
     
     
     
PART III
(Items 10 through 14 are incorporated by reference from
  
 
Pacific Continental Corporation’s definitive proxy statement for the
  
 
annual meeting of shareholders scheduled for April 20, 2009)
  
     
     
     
   
     
     
     
PART IV
    
     
     
 
     
 
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PART I

General

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

The Company’s principal business activities are conducted through its full-service commercial bank subsidiary, Pacific Continental Bank (the “Bank”), an Oregon state-chartered bank with deposits insured by the Federal Deposit Insurance Corporation (“FDIC”).   The Bank has two subsidiaries, PCB Service Corporation (presently inactive), which holds and manages Bank property, and PCB Loan Services (presently inactive), which manages certain other real estate owned.

The Bank operates in three primary markets: Portland, Oregon / Southwest Washington; Seattle, Washington; and Eugene, Oregon.  At December 31, 2008, the Bank operated fourteen full-service offices in six Oregon and three Washington cities.

Results

For the year ended December 31, 2008, the consolidated net income of the Company was $12.9 million or $1.08 per diluted share.  At December 31, 2008, the consolidated equity of the Company was $116.2 million with 12.1 million shares outstanding and a book value of $9.62 per share.  Total assets were $1,090.8 million.  Loans, including loans held for sale, net of allowance for loan losses and unearned fees, were $945.8 million at December 31, 2008 and represented 87% of total assets.  Deposits totaled $722.4 million at year-end 2008 with core deposits representing 85% or $615.8 of total deposits.  At December 31, 2008, the Company had a total risk-based capital ratio of 11.11% and was rated as “well-capitalized” under FDIC guidelines.  Subsequent to the end of the year, the company raised approximately $9.7 million in additional capital through a private equity placement that is expected to increase the total risk-based capital ratio to more than 12%.  In addition, in December 2008, the Company received preliminary approval to receive up to $30 million in capital in the form of preferred stock through the Federal Government’s Troubled Asset Relief Program.  In January 2009, the Company announced that it had determined not to participate in this program.  For more information regarding the Company’s financial condition and results of operations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Financial Statements and Supplementary Data” in sections 7 and 8 of this Form 10-K.

THE BANK

General

The Bank commenced operations on August 15, 1972.  At December 31, 2008, the Bank operated fourteen banking offices in Oregon and Washington.  The primary business strategy of the Bank is to provide comprehensive banking and related services tailored to community-based business, not-for-profits, professional service providers and private banking services for business owners and executives.  The Bank emphasizes the diversity of its product lines, high levels of personal service, and through technology, offers convenient access typically associated with larger financial institutions, while maintaining local decision-making authority and market knowledge, typical of a local community bank.  More information on the Bank and its banking services can be found on its Website.  The Bank operates under the banking laws of the State of Oregon, State of Washington and the rules and regulations of the FDIC and the Federal Reserve Bank of San Francisco.

Primary Market Area

The Bank’s primary markets consist of metropolitan Portland, which includes Southwest Washington, and metropolitan Eugene in the State of Oregon and metropolitan Seattle in the State of Washington.  The Bank has five full-service banking offices in the metropolitan Portland and Southwest Washington area, seven full-service banking offices in the metropolitan Eugene area, and two full-service offices in the metropolitan Seattle area.  The Bank has its headquarters and administrative office in Eugene, Oregon.

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Competition

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

In addition to larger institutions, numerous “community” banks and credit unions have been formed, expanded or moved into the Bank’s three primary areas and have developed a similar focus to the Bank.  These institutions have further increased competition in all three of the Bank’s primary markets.  This growing number of similar financial institutions and an increased focus by larger institutions in the Bank’s primary markets has led to intensified competition in all aspects of the Bank’s business, particularly in the area of loan and deposit pricing.

The adoption of the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) has led to further intensification of competition in the financial services industry.  The GLB Act has eliminated many of the barriers to affiliation among providers of various types of financial services and has permitted business combinations among financial service providers such as banks, insurance companies, securities or brokerage firms, and other financial service providers.  Additionally, the rapid adoption of financial services through the Internet has reduced or even eliminated many barriers to entry by financial services providers physically located outside our market area. For example, remote deposit services allow depository companies physically located in other geographical markets to service local businesses with minimal cost of entry.  Although the Bank has been able to compete effectively in the financial services business in its markets to date, there can be no assurance that it will be able to continue to do so in the future.

The financial services industry has experienced widespread consolidation over the last decade.  The Company anticipates that consolidation among financial institutions in its market area will continue.  In particular, the current economic conditions suggest a number of bank failures are possible in the Company’s market areas that will lead to additional consolidation in the industry.  The Company seeks acquisition opportunities, including FDIC assisted takeovers, from time to time, in its existing markets and in new markets of strategic importance.  However, other financial institutions aggressively compete against the Bank in the acquisition market.   Some of these institutions may have greater access to capital markets, larger cash reserves, and stock for use in acquisitions that is more liquid and more highly valued by the market.

Services Provided

Lending Activities

The Bank emphasizes specific areas of lending within its primary market areas: loans to community-based businesses, professional service providers, not-for-profit organizations and private banking services for business owners and executives.

Commercial loans, secured and unsecured, are made primarily to professionals, community-based businesses, and not-for-profit organizations.  These loans are available for general operating purposes, acquisition of fixed assets, purchases of equipment and machinery, financing of inventory and accounts receivable, and other business purposes.  The Bank also originates Small Business Administration (“SBA”) loans and enjoys a national preferred lender status with the SBA.

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Within its primary markets, the Bank also concentrates on permanent and construction loan financing for commercial facilities and for pre-sold, custom, and speculative home construction.  The major thrust of residential construction lending is smaller in-fill construction projects consisting of single-family residences.  However, in fourth quarter 2007, due to the rapid deterioration in the national and regional housing market, the Bank severely restricted lending on speculative home construction and significantly reduced its exposure to residential construction lending.  The Bank also finances requests for multi-family residences.

Fixed-rate and variable rate residential mortgage loans are offered through the Bank’s mortgage loan department.  Most residential mortgage loans originated are sold in the secondary market along with the mortgage loan servicing rights.

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

The Bank offers credit card services to its business customers and uses an outside vendor for credit card processing.  In addition, the Bank provides merchant bankcard processing services through an outside processor, for its client base, including businesses, not-for-profits, and professional service providers.

The Board of Directors has approved specific lending policies and procedures for the Bank and management is responsible for implementation of the policies.  The lending policies and procedures include guidelines for loan term, loan-to-value ratios, collateral appraisals, and cash flow coverage.  The loan policies also vest varying levels of loan authority in management, the Bank’s Loan Committee, and the Board of Directors.  Bank management monitors lending activities through management meetings, loan committee meetings, monthly reporting, and periodic review of loans by third-party contractors.

Deposit Services

The Bank offers a full range of deposit services that are typically available in most banks and other financial institutions, including checking, savings, money market accounts, and time deposits.  The transaction accounts and time deposits are tailored to the Bank’s primary markets and market segments at rates competitive with those offered in the area.  Additional deposits are generated through national networks for institutional deposits and the State of Oregon and State of Washington for public time deposits.  All deposit accounts are insured by the FDIC to the maximum amount permitted by law.

Subsequent to the end of the year, as a result of a financial institution failure in the State of Washington, the Bank was assessed $9 thousand for uninsured public deposits at the failed institution.  The assessment was based upon the Bank’s pro rata share of public deposits as of December 31, 2008, which amounted to less than one-tenth of one percent.  However, due to the increased risk of future bank failures in Washington, the Bank chose to exit the public deposit pool in order to minimize its exposure to possible assessments for uninsured deposits.  The Bank will continue to have a potential liability for uninsured deposits for a period of one year following its exit from the state public deposit pool.

The Bank has invested continuously in image technology since 1994 for the processing of checks.  The Bank was the first financial institution in Lane, Multnomah, Clackamas, and Washington Counties to offer this service.  Due to this investment in image technology, commencing in July 2007, the Bank has been able to accelerate its funds availability by presenting all items for clearing to its correspondent banks via an imaged file. In addition, the Bank provides on-line cash management, remote deposit capture, and banking services to businesses and consumers. The Bank also allows 24-hour customer access to deposit and loan information via telephone and on-line cash management products.

Merchant Card Services

The Bank provides merchant card services to its clients, which includes processing of credit card transactions and issuance of business credit cards.  This service is an integral part of the Bank’s strategy to focus on marketing to community-based business, not-for-profits, and service providers.  During 2008, the Company processed approximately $190 million in credit card transactions for its merchant clients.

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Other Services

The Bank provides other traditional commercial and consumer banking services, including cash management products for businesses, on-line banking, safe deposit services, debit and ATM cards, ACH transactions, savings bonds, cashier’s checks, travelers’ checks, notary services and others.  The Bank is a member of numerous ATM networks and utilizes an outside processor for the processing of these automated transactions.

Employees

At December 31, 2008, the Bank employed 255 full-time equivalent  (FTE) employees with 29 FTE’s in the Seattle market, 49 FTE’s in the Portland market, 83 FTE’s in the Eugene market, and 94 FTE’s in administrative functions located in Eugene, Oregon.  None of these employees are represented by labor unions, and management believes that the Company’s relationship with employees is good.  The Company emphasizes a positive work environment for its employees, which is validated by recognition from independent third parties.  In December 2008, the Bank was recognized for the second consecutive year as one of Oregon’s ten most admired companies in the Portland Business Journal’s Most Admired Companies survey.  During 2008, the Bank was also recognized for the seventh consecutive year by Oregon Business Magazine as one of Oregon’s Best 100 Companies for which to work, and was the highest rated financial institution in the state.  In addition, in 2004, the Bank was named as the number one small company (employees under 250) to work for in the State of Oregon by Oregon Business Magazine.  The Bank and its employees have also been recognized for their involvement in the community.  Management continually strives to retain and attract top talent as well as provide career development opportunities to enhance skill levels.  A number of benefit programs are available to eligible employees, including group medical plans, paid sick leave, paid vacation, group life insurance, 401(k) plans, and equity compensation plans.

Supervision and Regulation

General

The following discussion describes elements of the extensive regulatory framework applicable to the Company and the Bank. This regulatory framework is primarily designed for the protection of depositors, federal deposit insurance funds and the banking system as a whole, rather than specifically for the protection of shareholders. Due to the breadth of this regulatory framework, our costs of compliance continue to increase in order to monitor and satisfy these requirements.

To the extent that this section describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. These statutes and regulations, as well as related policies, are subject to change by Congress, state legislatures and federal and state regulators. Changes in statutes, regulations or regulatory policies applicable to us, including the interpretation or implementation thereof, could have a material effect on our business or operations.

Federal Bank Holding Company Regulation

General. The Company is a bank holding company as defined in the Bank Holding Company Act of 1956, as amended (“BHCA”), and is therefore subject to regulation, supervision and examination by the Federal Reserve. In general, the BHCA limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to banking. The Company must file reports with and provide the Federal Reserve such additional information as it may require. Under the Financial Services Modernization Act of 1999, a bank holding company may apply to the Federal Reserve to become a financial holding company, and thereby engage (directly or through a subsidiary) in certain expanded activities deemed financial in nature, such as securities brokerage and insurance underwriting.

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

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

Transactions with Affiliates. Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Company’s ability to obtain funds from the Bank for its cash needs, including funds for payment of dividends, interest and operational expenses.

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

Support of Subsidiary Banks. Under Federal Reserve policy, the Company is expected to act as a source of financial and managerial strength to the Bank.  This means that the Company is required to commit, as necessary, resources to support the Bank. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.

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

Federal and State Regulation of Pacific Continental Bank

General. The Bank is an Oregon commercial bank operating in Oregon and Washington with deposits insured by the FDIC.  As a result, the Bank is subject to supervision and regulation by the Oregon Department of Consumer and Business Services and the FDIC. These agencies have the authority to prohibit banks from engaging in what they believe constitute unsafe or unsound banking practices.  Additionally, the Bank’s branches in Washington are subject to supervision and regulation by the Washington Department of Financial Institutions and must comply with applicable Washington laws regarding community reinvestment, consumer protection, fair lending and intrastate branching.

Community Reinvestment.  The Community Reinvestment Act of 1977 requires that, in connection with examinations of financial institutions within their jurisdiction, the Federal Reserve or the FDIC evaluate the record of the financial institution in meeting the credit needs of its local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of the institution. A bank’s community reinvestment record is also considered by the applicable banking agencies in evaluating mergers, acquisitions and applications to open a branch or facility.

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

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

Safety and Soundness Standards.  Federal law imposes certain non-capital safety and soundness standards upon banks. These standards cover internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution that fails to meet these standards must develop a plan acceptable to its regulators, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions.

State Assessments. Washington state banks and out of state banks with branches in Oregon that hold public funds are considered public depositories and are subject to pro rata assessments for the loss of public deposits held at a failed Washington or Oregon bank, respectively, that exceed federal deposit insurance limits and other coverage. Due to the current economic climate it is anticipated that there will be bank failures nationwide, and we may face increased costs if a Washington or Oregon state public depository bank fails and we are assessed for a net losses of such public deposits held at the failed institution.

Interstate Banking and Branching

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”) relaxed prior interstate branching restrictions under federal law by permitting nationwide interstate banking and branching under certain circumstances. Generally, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area. Federal banking agency regulations prohibit banks from using their interstate branches primarily for deposit production and the federal banking agencies have implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.

Oregon and Washington have both enacted “opting in” legislation in accordance with the Interstate Act provisions allowing banks to engage in interstate merger transactions, subject to certain “aging” requirements. Oregon restricts an out-of-state bank from opening de novo branches. However, once an out-of-state bank has acquired a bank within Oregon, either through merger or acquisition of all or substantially all of the bank's assets, the out-of-state bank may open additional branches within Oregon. Under Washington law, an out-of-state bank may, subject to Department of Financial Institutions’ approval, open de novo branches in Washington or acquire an in-state branch so long as the home state of the out-of-state bank has reciprocal laws with respect to de novo branching or branch acquisitions.

Dividends

The principal source of the Company’s cash is from dividends received from the Bank, which are subject to government regulation and limitations. Regulatory authorities may prohibit banks and bank holding companies from paying dividends in a manner that would constitute an unsafe or unsound banking practice or would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. Oregon law also limits a bank’s ability to pay dividends that are greater than retained earnings without approval of the Oregon Department.


                                                                                        
 
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Capital Adequacy

Regulatory Capital Guidelines.  Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies.

Tier I and Tier II Capital.  Under the guidelines, an institution’s capital is divided into two broad categories, Tier I capital and Tier II capital.  Tier I capital generally consists of common stockholders’ equity, surplus and undivided profits.  Tier II capital generally consists of the allowance for loan losses, hybrid capital instruments, and subordinated debt.  The sum of Tier I capital and Tier II capital represents an institution’s total capital.  The guidelines require that at least 50% of an institution’s total capital consist of Tier I capital.

Risk-based Capital Ratios.  The adequacy of an institution’s capital is gauged primarily with reference to the institution’s risk-weighted assets.  The guidelines assign risk weightings to an institution’s assets in an effort to quantify the relative risk of each asset and to determine the minimum capital required to support that risk.  An institution’s risk-weighted assets are then compared with its Tier I capital and total capital to arrive at a Tier I risk-based ratio and a total risk-based ratio, respectively.  The guidelines provide that an institution must have a minimum Tier I risk-based ratio of 4% and a minimum total risk-based ratio of 8%.

Leverage Ratio.  The guidelines also employ a leverage ratio, which is Tier I capital as a percentage of average total assets, less intangibles.  The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company may leverage its equity capital base. The minimum leverage ratio is 3%; however, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, regulators expect an additional cushion of at least 1% to 2%.

Prompt Corrective Action. Under the guidelines, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. The categories range from “well capitalized” to “critically undercapitalized.”  Institutions that are “undercapitalized” or lower are subject to certain mandatory supervisory corrective actions.

In 2007, the federal banking agencies, including the FDIC and the Federal Reserve, approved final rules to implement new risk-based capital requirements. Presently, this new advanced capital adequacy framework, called Basel II, is applicable only to large and internationally active banking organizations. Basel II changes the existing risk-based capital framework by enhancing its risk sensitivity. Whether Basel II will be expanded to apply to banking organizations that are the size of the Company or the Bank is unclear at this time, and what effect such regulations would have on us cannot be predicted, but we do not expect our operations would be significantly impacted.

Regulatory Oversight and Examination

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

Banks are subject to periodic examinations by their primary regulators. Bank examinations have evolved from reliance on transaction testing in assessing a bank’s condition to a risk-focused approach. These examinations are extensive and cover the entire breadth of operations of the bank. Generally, safety and soundness examinations occur on an 18-month cycle for banks under $500 million in total assets that are well capitalized and without regulatory issues, and 12-months otherwise. Examinations alternate between the federal and state bank regulatory agency or may occur on a combined schedule. The frequency of consumer compliance and CRA examinations is linked to the size of the institution and its compliance and CRA ratings at its most recent examinations. However, the examination authority of the Federal Reserve and the FDIC allows them to examine supervised banks as frequently as deemed necessary based on the condition of the bank or as a result of certain triggering events.

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Recent Legislation

Emergency Economic Stabilization Act of 2008.  In response to the recent financial crisis, the United States government passed the Emergency Economic Stabilization Act of 2008 (the “EESA”) on October 3, 2008, which provides the United States Department of the Treasury (the “Treasury”) with broad authority to implement certain actions intended to help restore stability and liquidity to the U.S. financial markets.

Insurance of Deposit Accounts. The EESA included a provision for a temporary increase from $100,000 to $250,000 per depositor in deposit insurance effective October 3, 2008 through December 31, 2009. After December 31, 2009, deposit accounts are expected to again be insured by the FDIC, generally up to a maximum of $100,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts.

The FDIC imposes an assessment against institutions for deposit insurance. This assessment is based on the risk category of the institution and ranges from 5 to 43 basis points of the institution’s deposits. In December, 2008, the FDIC adopted a rule that raises the current deposit insurance assessment rates uniformly for all institutions by 7 basis points (to a range from 12 to 50 basis points) for the first quarter of 2009. The rule also gives the FDIC the authority to alter the way it calculates federal deposit insurance assessment rates beginning in the second quarter of 2009 and thereafter, and as necessary, to implement emergency special assessments to maintain the deposit insurance fund.

In 2006, federal deposit insurance reform legislation was enacted that (i) required the FDIC to merge the Bank Insurance Fund and the Savings Association Insurance Fund into a newly created Deposit Insurance Fund; (ii) increases the amount of deposit insurance coverage for retirement accounts; (iii) allows for deposit insurance coverage on individual accounts to be indexed for inflation starting in 2010; (iv) provides the FDIC more flexibility in setting and imposing deposit insurance assessments; and (v) provides eligible institutions credits on future assessments.

Troubled Asset Relief Program. Pursuant to the EESA, the Treasury has the ability to purchase or insure up to $700 billion in troubled assets held by financial institutions under the Troubled Asset Relief Program (“TARP”). On October 14, 2008, the Treasury announced it would initially purchase equity stakes in financial institutions under a Capital Purchase Program (the “CPP”) of up to $350 billion of the $700 billion authorized under the TARP legislation. The CPP provides direct equity investment of perpetual preferred stock by the Treasury in qualified financial institutions, as well as a warrant to purchase common stock. The Company has decided not to participate in the CPP in light of its strong capital position in part due to a successful common stock offering during the first week of January 2009.

Temporary Liquidity Guarantee Program.   In October 2008, the FDIC announced the Temporary Liquidity Guarantee Program, which has two components--the Debt Guarantee Program and the Transaction Account Guarantee Program. Under the Transaction Account Guarantee Program any participating depository institution is able to provide full deposit insurance coverage for non-interest bearing transaction accounts, regardless of the dollar amount. Under the program, effective November 14, 2008, insured depository institutions that have not opted out of the FDIC Temporary Liquidity Guarantee Program will be subject to a 0.10% surcharge applied to non-interest bearing transaction deposit account balances in excess of $250,000, which surcharge will be added to the institution’s existing risk-based deposit insurance assessments. Under the Debt Guarantee Program, qualifying unsecured senior debt issued by a participating institution can be guaranteed by the FDIC. The Company and the Bank chose to participate in both components of the FDIC Temporary Liquidity Guaranty Program.

American Recovery and Reinvestment Act of 2009.   On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law. ARRA is intended to help stimulate the economy and is a combination of tax cuts and spending provisions applicable to a broad range of areas with an estimated cost of $787 billion. The impact that ARRA may have on the US economy, the Company and the Bank cannot be predicted with certainty.

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Proposed Legislation

As of early 2009, additional legislation has been promulgated or is pending under EESA which is intended to provide among other things, an injection of more capital from Treasury into financial institutions through the Capital Assistance Program, establishment of a public-private investment fund for the purchase of troubled assets and expansion of the Term Asset-Backed Securities Loan Facility to include commercial mortgage backed-securities.

Proposed legislation is introduced in almost every legislative session that would dramatically affect the regulation of the banking industry. In light of the 2008 financial crisis and a new administration in the Executive Branch of the federal government, it is anticipated that legislation reshaping the regulatory landscape could be proposed in 2009. We cannot predict if any such legislation will be adopted or if it is adopted how it would affect the business of the Company or the Bank. Past history has demonstrated that new legislation or changes to existing laws or regulations usually results in a greater compliance burden and therefore generally increases the cost of doing business.

Corporate Governance and Accounting Legislation

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

To deter wrongdoing, the Act (i) subjects bonuses issued to top executives to disgorgement if a restatement of a company's financial statements was due to corporate misconduct; (ii) prohibits an officer or director misleading or coercing an auditor; (iii) prohibits insider trades during pension fund “blackout periods”; (iv) imposes new criminal penalties for fraud and other wrongful acts; and (v) extends the period during which certain securities fraud lawsuits can be brought against a company or its officers.

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

Anti-terrorism Legislation

USA Patriot Act of 2001.  The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, intended to combat terrorism, was renewed with certain amendments in 2006 (the “Patriot Act”).  Certain provisions of the Patriot Act were made permanent and other sections were made subject to extended “sunset” provisions. The Patriot Act, in relevant part, (i) prohibits banks from providing correspondent accounts directly to foreign shell banks; (ii) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals; (iii) requires financial institutions to establish an anti-money-laundering compliance program; and (iv) eliminates civil liability for persons who file suspicious activity reports.  The Act also includes provisions providing the government with power to investigate terrorism, including expanded government access to bank account records.  While the Patriot Act has had minimal affect on our record keeping and reporting expenses, we do not believe that the renewal and amendment will have an adverse effect on our business or operations.

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Financial Services Modernization

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

Financial Services Regulatory Relief Act of 2006. In 2006, the President signed the Financial Services Regulatory Relief Act of 2006 into law (the “Relief Act”). The Relief Act amends several existing banking laws and regulations, eliminates some unnecessary and overly burdensome regulations of depository institutions and clarifies several existing regulations. The Relief Act, among other things, (i) authorizes the Federal Reserve Board to set reserve ratios; (ii) amends regulations of national banks relating to shareholder voting and granting of dividends; (iii) amends several provisions relating to loans to insiders, regulatory applications, privacy notices, and golden parachute payments; and (iv) expands and clarifies the enforcement authority of federal banking regulators. Our business, expenses, and operations have not been significantly impacted by this legislation.

Effects of Government Monetary Policy

Our earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve implements national monetary policy for such purposes as curbing inflation and combating recession, and its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the Federal Reserve, and establishment of reserve requirements against certain deposits, influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary policies, such as the recent lowering of the Federal Reserve’s discount rate, and their impact on us cannot be predicted with certainty.


 
 
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Statistical Information

Selected Quarterly Information

The following chart contains data for the last eight quarters ending December 31, 2008. All data, except number of shares and per share data, is in thousands of dollars.



YEAR
  
2008
                      
2007
                    
QUARTER
  
Fourth
    
Third
    
Second
    
First
    
Fourth
    
Third
    
Second
    
First
  
Interest income
   $ 16,544     $ 16,680     $ 16,215     $ 16,506     $ 17,350     $ 17,419     $ 17,751     $ 16,647  
Interest expense
     3,350       4,377       4,057       4,890       6,157       6,441       6,813       6,329  
Net interest income
     13,194       12,203       12,158       11,616       11,193       10,978       10,938       10,318  
Provision for loan loss
     1,050       1,050       925       575       275       125       125       200  
Noninterest income
     1,042       1,047       1,163       1,017       1,030       997       949       948  
Noninterest expense
     7,435       7,497       7,463       7,167       6,591       6,399       6,513       6,358  
Net income
     3,833       3,020       3,007       3,079       3,307       3,421       3,211       2,996  
                                                                 
PER COMMON
                                                                
SHARE DATA (1)
                                                                
Net income (basic)
   $ 0.32     $ 0.25     $ 0.25     $ 0.26     $ 0.28     $ 0.29     $ 0.26     $ 0.25  
Net income (diluted)
   $ 0.32     $ 0.25     $ 0.25     $ 0.26     $ 0.28     $ 0.29     $ 0.26     $ 0.25  
Cash dividends
   $ 0.10     $ 0.10     $ 0.10     $ 0.10     $ 0.09     $ 0.09     $ 0.09     $ 0.08  
                                                                 
WEIGHTED AVERAGE SHARES OUTSTANDING
                                          
Basic
     12,039,081       11,978,460       11,962,560       11,940,064       11,896,187       11,848,059       11,814,931       11,761,039  
Diluted
     12,095,066       12,033,898       12,030,063       12,005,710       11,995,087       11,981,303       11,971,279       11,967,135  
                                                                 
                                                                 
(1) All prior year per share data has been retroactively adjusted for the 10% stock dividend paid in June 2007.
          

Investment Portfolio

The following chart contains information regarding the Company’s investment portfolio.  All of the Company’s investment securities are accounted for as available-for-sale and are reported at estimated fair value.  The difference between estimated fair value and amortized cost, net of deferred taxes, is recorded as a separate component of stockholders’ equity.
 


INVESTMENT PORTFOLIO
                  
ESTIMATED FAIR VALUE
                  
   
 
  
 December 31,
        
   
2008
    
2007
    
2006
  
   
(dollars in thousands)
        
US Treasury, US Government agencies and corporations
   $ 2,029     $ 10,541     $ 14,501  
Obligations of states and political subdivisions
     7,485       7,514       5,596  
Other mortgage-backed securities
     45,419       35,939       18,686  
     Total
   $ 54,933     $ 53,994     $ 38,783  
                         


 
 
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The following chart presents the fair value of each investment category by maturity date and includes a weighted average yield for each period.  Mortgage-backed securities have been classified based on their December 31, 2008 projected average life.
 
SECURITIES AVAILABLE-FOR-SALE
               
After One
    
After Five
              
               
Year But
    
Years But
              
   
Within
    
Within
    
Within
    
After Ten
  
   
One Year
    
Five Years
    
Ten Years
    
Years
  
   
Amount
    
Yield
    
Amount
    
Yield
    
Amount
    
Yield
    
Amount
    
Yield
  
   
(dollars in thousands)
                                
US Treasury, US Government
                                                
     agencies and agency
                                                
      mortgage-backed securities
   $ 16,984       4.19 %   $ 27,875       6.32 %   $ 1,691       5.52 %   $ 898       6.29 %
Obligations of states and
                                                                
      political subdivisions
     1,026       3.39 %     1,498       4.34 %     4,961       3.87 %     -          
Total
   $ 18,010       4.15 %   $ 29,373       6.21 %   $ 6,652       4.29 %   $ 898       6.29 %
                                                                 

Loan Portfolio

Loans represent a significant portion of the Company’s total assets.  Average balance and average rates paid by category of loan for the fourth quarter and full year 2008 is included in the Company’s “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included later in this report.  The following tables contain information related to the Company’s loan portfolio, including loans held for sale, for the five-year period ended December 31, 2008.



LOAN PORTFOLIO
  
   
December 31,
  
   
2008
    
2007
    
2006
    
2005
    
2004
  
   
(dollars in thousands)
                    
                               
Commercial loans
   $ 233,513     $ 188,940     $ 169,566     $ 160,988     $ 107,538  
Real estate loans
     717,119       627,140       590,855       507,479       341,111  
Real estate loans held for sale
     410       -       2,140       642       2,072  
Consumer loans
     7,455       8,226       9,168       12,463       10,380  
      958,497       824,306       771,729       681,572       461,101  
Deferred loan origination fees, net
     (1,730 )     (1,984 )     (2,489 )     (2,609 )     (2,061 )
      956,767       822,322       769,240       678,963       459,040  
Allowance for loan losses
     (10,980 )     (8,675 )     (8,284 )     (7,792 )     (5,224 )
    $ 945,787     $ 813,647     $ 760,956     $ 671,171     $ 453,816  
                                         


The following table presents loan portfolio information by loan category related to maturity and repricing sensitivity.  Variable rate loans are included in the time frame in which the interest rate on the loan could be first adjusted.  At December 31, 2008, the Bank had approximately $280,000 of variable rate loans at their floors that are included in the below analysis.  Real Estate loans include Loans Held for Sale
 

 
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MATURITY AND REPRICING DATA FOR LOANS
  
                         
   
Commercial
    
Real Estate
    
Consumer
    
Total
  
   
(dollars in thousands)
  
Three months or less
   $ 88,576     $ 306,399     $ 5,143     $ 400,118  
Over three months through 12 months
     3,518       46,267       432       50,217  
Over 1 year through 3 years
     27,758       128,628       489       156,875  
Over 3 years through 5 years
     49,594       166,595       818       217,007  
Over 5 years through 15 years
     62,177       53,672       476       116,325  
Thereafter
     1,890       15,968       97       17,955  
   Total loans
   $ 233,513     $ 717,529     $ 7,455     $ 958,497  
                                 


Loan Concentrations

At December 31, 2008, loans to dental professionals totaled $122,205 and represented 12.8% of outstanding loans.  At December 31, 2008, residential construction loans totaled $74,532 and represented 7.8% of outstanding loans.  In addition, at December 31, 2008, unfunded loan commitments for residential construction totaled $19,818.  Approximately 75.0% of the Bank’s loans are secured by real estate.    Management believes the granular nature of the portfolio, from industry mix, geographic location and loan size, continues to disperse risk concentration to some degree.

Nonperforming Assets

The following table presents nonperforming loans and assets as of the date shown.

NONPERFORMING  ASSETS

   
 
    
 December 31,
              
   
2008
    
2007
    
2006
    
2005
    
2004
  
   
 
      (dollars in thousands)              
                               
Nonaccrual loans
   $ 4,137     $ 4,122     $ -     $ 180     $ 1,004  
90 or more days past due and still accruing
     -       -       -       -       213  
   Total nonperforming loans
     4,137       4,122       -       180       1,217  
Government guarantees
     (239 )     (451 )     -       (28 )     (101 )
   Net nonperforming loans
     3,898       3,671       -       152       1,116  
Foreclosed assets
     3,806       423       -       131       262  
   Total nonperforming assets
   $ 7,704     $ 4,094     $ -     $ 283     $ 1,378  
                                         
Nonperforming assets as a percentage of
                                        
  of total assets
     0.71 %     0.43 %     0.00 %     0.04 %     0.27 %

If interest on nonaccrual loans had been accrued, such income would have been approximately $173, $140, and $14, respectively, for years 2008, 2007 and 2006.  The above table does not include $2,234 of impaired loans less than 90 days past due and still accruing interest as of December 31, 2008.

Allowance for Loan Loss

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

 
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ALLOWANCE FOR LOAN LOSS
  
   
December 31,
  
   
2008
    
2007
    
2006
    
2005
    
2004
  
   
(dollars in thousands)
                    
Balance at beginning of year
   $ 8,675     $ 8,284     $ 7,792     $ 5,224     $ 5,225  
  Charges to the allowance
                                        
      Real estate loans
     (1,235 )     -       -       (214 )     (79 )
      Consumer loans
     (118 )     (46 )     (71 )     (106 )     (269 )
      Commercial
     (124 )     (350 )     (152 )     (316 )     (168 )
  Total charges to the allowance
     (1,477 )     (396 )     (223 )     (636 )     (516 )
  Recoveries against the allowance
                                        
      Real estate loans
     128       15       4       37       73  
      Consumer loans
     23       27       20       56       54  
      Commercial
     31       20       91       31       70  
  Total recoveries against the allowance
     182       62       115       124       197  
                                         
  Acquisition
     -       -       -       2,014       -  
  Provisions
     3,600       725       600       1,100       500  
  Unfunded commitments *
     -       -       -       (34 )     (182 )
Balance at end of the year
   $ 10,980     $ 8,675     $ 8,284     $ 7,792     $ 5,224  
                                         
                                         
Net charge offs as a percentage of  total
                                        
   average loans
     0.15 %     0.04 %     0.01 %     0.10 %     0.08 %
 

* Allowance for unfunded commitments is presented as part of the other liabilities in the balance sheet and has been omitted from this table since implementation of this accounting practice in 2005.

The following table sets forth the allowance for loan losses allocated by loan type at December 31, 2008:


Real estate loans
   $ 7,586  
Consumer loans
     63  
Commercial
     2,253  
Unallocated
     1,078  
         
Allowance for loan losses
   $ 10,980  
         

During 2008, the Bank recorded a provision for loan losses of $3,600 compared to $725 for the year 2007.  The increase in the loan loss provision was related to loan growth and moderate deterioration in the overall credit quality of the loan portfolio during 2008.  At December 31, 2008, the recorded investment in certain loans totaling $6,132, net of government guarantees, was considered impaired.  A specific reserve of $887 is provided for these loans and is included in the $10,980 allowance for loan losses at December 31, 2008.

Deposits

Deposits represent a significant portion of the Company’s liabilities.  Average balance and average rates paid by category of deposit is included in the Company’s “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report.  The chart below details the Company’s time deposits at December 31, 2008.  The Company does not have any foreign deposits.  Variable rate deposits are listed by first repricing opportunity.

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TIME DEPOSITS
                  
   
Time Deposits
    
Time Deposits
        
   
of $100,000
    
of less than
    
Total
  
   
Or more
     $
100,000
    
Time Deposits
  
   
(dollars in thousands)
  
Three months or less
   $ 45,558     $ 43,940     $ 89,498  
Over three months through twelve months
     8,153       25,521       33,674  
Over one year through three years
     9,596       11,886       21,482  
Over three years
     3,788       2,103       5,891  
    $ 67,095     $ 83,450     $ 150,545  
                         


Short-term Borrowings

The Company uses short-term borrowings to fund fluctuations in deposits and loan demand.  The Company’s subsidiary, Pacific Continental Bank, has access to both secured and unsecured overnight borrowing lines.  At December 31, 2008, the Bank had lines totaling approximately $495,188.  The Federal Home Loan Bank of Seattle (FHLB) also provides a secured borrowing line using a blanket pledge of commercial real estate loans.  The Bank’s FHLB borrowing limit at December 31, 2008 was 30% of assets or $327,253, subject to sufficient collateral and stock investment.  At December 31, 2008, available unsecured borrowing lines with various correspondent banks and a secured line with the Federal Reserve Bank of San Francisco was approximately $167,935.


 
SHORT-TERM BORROWINGS
                        
                         
   
2008
    
2007
    
2006
    
2005
  
   
(dollars in thousands)
              
                         
Federal Funds Purchased, FHLB CMA, Federal Reserve,
                        
           & Short Term Advances
                        
   Average interest rate
                        
      At year end
     0.48 %     4.39 %     5.55 %     4.33 %
      For the year
     2.25 %     5.25 %     5.31 %     3.35 %
   Average amount outstanding for the year
   $ 182,301     $ 93,733     $ 73,171     $ 17,693  
   Maximum amount outstanding at any month end
   $ 213,225     $ 151,360     $ 99,410     $ 34,825  
   Amount outstanding at year end
   $ 193,000     $ 151,360     $ 99,410     $ 24,000  


Long-term Borrowings

In addition to the short-term borrowings, at December 31, 2008, the Bank had other FHLB borrowings totaling $45,500 with a weighted average interest rate of 4.14% and a remaining average maturity of approximately 2.3 years.

The Company’s long-term borrowings consist of $8,248 in junior subordinated debentures originated on November 28, 2005 and due on January 7, 2036.  The interest rate on the debentures is 6.265% until November 2010 after which it is converted to a floating rate of three-month LIBOR plus 135 basis points.


 
 
-17-
 


The following is a discussion of the most significant risks and uncertainties that may affect our business, financial condition and future results.

We cannot predict the effect of the national economic situation on our future results of operations or stock trading price.

The national economy and the financial services sector in particular, are currently facing challenges of a scope unprecedented in recent history.  No one can predict the severity or duration of this national downturn, which has adversely impacted the markets we serve.  Any further deterioration in our markets would have an adverse effect on our business, financial condition, results of operations and prospects, and could also cause the trading price of our stock to decline.

We cannot predict the effect of recent and pending federal legislation.

On October 3, 2008, Congress enacted the Emergency Economic Stabilization Act of 2008 (“EESA”), which provides the United States Treasury Department (“Treasury”) with broad authority to implement action intended to help restore stability and liquidity to the US financial markets.  The EESA also increases the amount of deposit account insurance coverage from $100,000 to $250,000 effective until December 31, 2009.

As of early 2009, additional legislation has been promulgated or is pending under EESA which is intended to provide, among other things, an injection of capital from the Treasury into financial institutions through the Capital Assistance Program, establishment of a public-private investment fund for the purchase of troubled assets, and the expansion of the Term Asset-Backed Securities Loan Facility to include commercial mortgage backed-securities.

The full effect of the broad legislation already enacted and related legislation expected to be enacted in the near future on the national economy and financial institutions, particularly on mid-sized institutions like us, cannot now be predicted.

Our ability to access markets for funding and acquire and retain customers could be adversely affected to the extent the financial service industry’s reputation is damaged.

Reputation risk is the risk to liquidity, earnings and capital arising from negative publicity regarding the financial services industry.  The financial services industry continues to be featured in negative headlines about the global and national credit crisis and the resulting stabilization legislation enacted by the U.S. federal government.  These reports can be damaging to the industry’s image and potentially erode consumer confidence in insured financial institutions, such as our banking subsidiary.

Fluctuating interest rates can adversely affect our profitability

Our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”) 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 our interest rate spread, and, in turn, our profitability.  We seek to manage our interest rate risk within well established guidelines.  Generally, the Company seeks an asset and liability structure that insulates net interest income from large deviations attributable to changes in market rates.

The current economic downturn in the market areas we serve may cause us to have lower earnings and could increase our credit risk associated with our loan portfolio.

-18-
 
The inability of borrowers to repay loans can erode our earnings.  Substantially all of our loans are to businesses and individuals in Washington and Oregon, and a continuing decline in the economy of these market areas could impact us adversely.  Recently, a series of large Puget Sound-based businesses, including Microsoft, Starbucks, and Boeing, have announced or began to implement substantial employee layoffs and scaled back plans for future growth.  Additionally, the recent acquisition of Washington Mutual by JPMorgan Chase & Co. has also resulted in substantial employee layoffs, and is expected to result in a substantial increase in office space availability in downtown Seattle.  Oregon has also seen a similar pattern of large lay offs in major metropolitan areas, a continued decline in housing prices, and a significant increase in the state’s unemployment rate.  A further deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have an adverse impact on our prospects, results of operations and financial condition:

·  
loan delinquencies may increase further, migrating into our substantial commercial real estate and business lending portfolios;
 
·  
collateral for loans made may decline further in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans;
 
·  
demand for banking products and services may decline; and
 
·  
low cost or non-interest bearing deposits may decrease.
 

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

We maintain an allowance for loan losses in an amount that we believe is adequate to provide for losses inherent in the portfolio.  While we strive to carefully manage and monitor credit quality and to identify loans that may become nonperforming, at any time there are loans included in the portfolio that will result in losses, but that have not been identified as nonperforming or potential problem loans.  By managing our credit quality, we attempt to identify deteriorating loans before they become nonperforming assets and adjust the loan loss reserve accordingly.  However, because future events are uncertain, there may be loans that deteriorate to a nonperforming status in an accelerated time frame.  As a result, future additions to the allowance may be necessary.  Because the loan portfolio contains a significant number of commercial and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans may cause a significant increase in nonperforming loans, requiring an increase to the loan loss allowance.  Additionally, future additions to the allowance may be required based on changes in the loans comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions or as a result of incorrect assumptions by management in determining the allowance.  Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review our allowance for loan losses.  These regulatory agencies may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from ours.  Any increase in the allowance for loan losses could have a negative effect on our financial condition and results of operation.

Concentration in real estate market

We have a high concentration of loans secured by real estate.  While the Pacific Northwest typically lags the national economy, the affects of the economic deterioration are now significantly impacting our market area.  Our business activities and credit exposure are concentrated in loans secured by real estate.  Further decline in the real estate markets that we serve could negatively affect our business because the collateral securing those loans may decrease in value.  A continued downturn in the local economy could have a material adverse effect both on the borrowers’ ability to repay these loans, as well as the value of the real property held as collateral.  Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we be would more likely to suffer losses on defaulted loans.

Tightening of credit markets and liquidity risk

A continued tightening of the credit market and the inability to obtain adequate money to fund continued loan growth may negatively affect our asset growth and liquidity position and, therefore, our earnings capability.  In addition to core deposit growth, maturity of investment securities and loan payments, the Company also relies on alternative funding sources through correspondent banking and a borrowing line with the FHLB to fund loans.  In the event the current economic downturn continues, particularly in the housing market, these resources could be negatively affected, both as to price and availability, which would limit and or raise the cost of the funds available to the Company.
-19-

If the goodwill we have recorded in connection with acquisitions becomes impaired, it could have an adverse impact on our earnings and capital.
 
Accounting standards require that we account for acquisitions using the purchase method of accounting.  Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carried on the acquirer’s balance sheet as goodwill.  At December 31, 2008, we had approximately $22,031 of goodwill on our balance sheet.  In accordance with generally accepted accounting principles, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists.  Such evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of common stocks of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable acquisitions.  There can be no assurance that future evaluations of goodwill will not result in findings of impairment and write-downs, which could be material.
 
We may be required in the future to recognize an impairment with respect to investment securities, including the FHLB stock we hold.
 
Under the current economic downturn, investment portfolios continue to record significant unrecognized losses.  The Company’s current securities portfolio contains credit risk associated with whole loan private mortgage-backed securities.  The Company may continue to observe declines in the fair market value of these securities.  The company evaluates the securities portfolio for any other than temporary impairment under EITF 03-1 on a monthly basis, and as of December 31, 2008, we did not recognize any securities as other than temporarily impaired.  There can be no assurance, however, that future evaluations of the securities portfolio will not require us to recognize an impairment charge with respect to such holdings.

In addition, as a condition to membership in the Federal Home Loan Bank of Seattle (“FHLB”), we are required to purchase and hold a certain amount of FHLB stock.  Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB.  The FHLB stock held by the Company is carried at cost and is subject to recoverability testing under applicable accounting standards.  The FHLB recently reported that due to ongoing turmoil in the capital and mortgage markets, it will likely report a risk-based capital deficiency as of December 31, 2008.  The FHLB has indicated that it believes that it has adequate capital to cover the risks reflected on its balance sheet.  Accordingly, as of December 31, 2008, we did not recognize an impairment charge related to our FHLB stock holdings.  There can be no assurance, however, that future negative changes to the financial condition of the FHLB may not require us to recognize an impairment charge with respect to such holdings.

The FDIC has increased insurance premiums to rebuild and maintain the federal deposit insurance fund and we may separately incur state statutory assessments in the future.
 
Based on recent events and the state of the economy, the FDIC has increased federal deposit insurance premiums by 7 basis points for the first quarter of 2009.  The increase of these premiums will add to our cost of operations and could have a significant impact on the Company.  New rules governing deposit insurance premiums are expected to go into effect on April 1, 2009. These new rules are intended to make assessments more balanced by requiring riskier institutions to pay a larger share.

On February 27, 2009, the FDIC adopted an interim rule imposing an emergency special assessment of 20 basis points on insured institutions, and granting the FDIC the authority to impose an additional emergency special assessment after June 30, 2009 of up to 10 basis points if necessary.  The assessment will be calculated on June 30, 2009 deposit balances and collected on September 30, 2009.  Based on the Company’s December 31, 2008 deposits subject to FDIC insurance assessments, the special assessment will be approximately $1.5 million.  Depending on any future losses that the FDIC insurance fund may suffer due to failed institutions, there can be no assurance that there will not be additional significant premium increases or special assessments in order to replenish the fund.

-20-
Further, under Oregon and Washington state laws, the Company may incur additional costs if one or more Oregon or Washington state banks that hold public deposits fail, since, as a public depositary, we are subject to Oregon and Washington statutory pro-rata assessments to cover any net losses in public deposits not otherwise covered by federal deposit insurance or other means.

We operate in a highly regulated environment and may be adversely affected by changes in federal state and local laws and regulations.
 
We are subject to extensive regulation, supervision and examination by federal and state banking authorities.  Any change in applicable regulations or federal, state or local legislation could have a substantial impact on us and our operations.  Additional legislation and regulations that could significantly affect our powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations.  Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties.  These powers recently have been utilized more frequently due to the serious national, regional and local economic conditions we are facing.  The exercise of regulatory authority may have a negative impact on our financial condition and results of operations.


None


The principal properties of the registrant are comprised of the banking facilities owned by the Bank.  The Bank operates fourteen full service facilities.  The Bank owns a total of eight buildings and, with the exception of two buildings, owns the land on which these buildings are situated.  Significant properties owned by the Bank are as follows:

1)  
Three-story building and land with approximately 30,000 square feet located on Olive Street in Eugene, Oregon.

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

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

4)  
Three-story building and land with approximately 31,000 square feet located in Springfield, Oregon.  The Bank occupies approximately 5,500 square feet of the first floor and approximately 5,900 square feet on the second floor and leases out, or is seeking to lease out, the remaining space.

5)  
Building and land with approximately 3,500 square feet located in Beaverton, Oregon.

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

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

8)  
Building with approximately 6,800 square feet located at the Nyberg Shopping Center in Tualatin, Oregon.  The building is on leased land.

The Bank leases facilities for branch offices in Downtown Seattle, Washington, Downtown Bellevue, Washington, Downtown Portland, Oregon, and Vancouver, Washington.  During 2008, the Bank expanded its leased facilities in Downtown Bellevue and Downtown Portland.  In addition, the Bank leases a portion of an adjoining building to the High Street office for administrative and training functions.  Management considers all owned and leased facilities adequate for current use.

-21-

As of the date of this report, neither the Company nor the Bank or any of its subsidiaries is party to any material pending legal proceedings, including proceedings of governmental authorities, other than ordinary routine litigation incidental to the business of the Bank.


There were no matters submitted to a vote of security holders during the fourth quarter of 2008.

PART II

Equity Securities                                                                                                                     

Issuer Purchases of Securities

The Company did not repurchase any shares of its common stock during the fourth quarter of 2008.  The Company had no sales of securities during the past three years, other than those issued pursuant to its stock option plans.

Dividends

The Company pays cash dividends on a quarterly basis, typically in March, June, September and December 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 loan concentrations 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.   The Company declared and paid cash dividends of $0.40 per share for the year 2008.  That compares to cash dividends of $0.35 per share paid for the year 2007, when adjusted for the 10% stock dividend paid in June 2007.

Equity Compensation Plan Information

 
Year Ended December 31, 2008
 
Number of Shares to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (2)
Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights (2)
Number of Shares Remaining Available for Future Issuance Under Equity Compensation Plans (2)
Equity compensation plans approved by security holders(1)
895,095
$ 14.24
174,906
       
Equity compensation plans not approved by security holders
0
$0
0

(1)  
Under the Company’s respective equity compensation plans, the Company may grant incentive stock options and non-qualified stock options, restricted stock, restricted stock units and stock appreciation rights to its employees and directors, however only employees may receive incentive stock options.

(2)  
All amounts have been adjusted to reflect subsequent stock splits and stock dividends.


 
 
-22-
 

Market Information

The Company’s common stock trades on the NASDAQ Global Market under the symbol PCBK.  At March 6, 2009, the Company had 12,862,691 shares of common stock outstanding held by approximately 1,000 shareholders.

The high, low and closing sales prices (based on daily closing price) for the last eight quarters are shown in the table below.  All share prices for the first and second quarters of 2007 have been retroactively adjusted to reflect the 10% stock dividend paid in June 2007.

YEAR
  
2008
        
2007
    
QUARTER
Fourth
Third
Second
First
  
Fourth
Third
Second
First
Market value:
                  
   High
$15.00
$15.22
$14.93
$14.44
  
$16.00
$16.41
$17.27
$18.95
   Low
11.58
9.26
10.99
13.75
  
12.00
14.32
15.18
16.86
   Close
14.97
14.64
10.99
13.90
  
12.52
15.57
16.20
17.03

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


                                    STOCK PERFORMANCE GRAPH
 
The above graph and following table compares the total cumulative shareholder return on the Company’s Common Stock, based on reinvestment of all dividends, to the cumulative total returns of the Russell 2000
 
 
-23-
Index and SNL Securities $500 to $1 Billion Bank Asset Size Index.  The graph assumes $100 invested on December 31, 2003, in the Company’s Common Stock and each of the indices.
 
   
Period Ending
  
Index
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
Pacific Continental Corporation
100.00
126.31
129.69
161.66
117.02
144.10
Russell 2000
100.00
118.33
123.72
146.44
144.15
95.44
SNL Bank $500M-$1B Index
100.00
123.42
121.31
140.38
102.26
84.81

 
-24-
 


ITEM 6                                Selected Financial Data

Selected financial data for the past five years is shown in the table below.
($ in thousands, except for per share data)

   
2008
    
2007
    
2006
    
2005
    
2004
  
For the year
                              
 Net interest income
   $ 49,271     $ 43,426     $ 40,057     $ 30,240     $ 24,952  
 Provision for loan losses
   $ 3,600     $ 725     $ 600     $ 1,100     $ 500  
 Noninterest income
   $ 4,269     $ 3,925     $ 4,401     $ 4,083     $ 4,463  
 Noninterest expense
   $ 29,562     $ 25,861     $ 23,791     $ 18,134     $ 16,041  
 Income taxes
   $ 7,439     $ 7,830     $ 7,412     $ 5,510     $ 4,925  
 Net income
   $ 12,939     $ 12,935     $ 12,655     $ 9,578     $ 7,948  
 Cash dividends
   $ 4,797     $ 4,175     $ 3,381     $ 2,556     $ 2,164  
                                         
Per common share data (1)
                                        
 Net income:
                                        
  Basic
   $ 1.08     $ 1.09     $ 1.09     $ 0.98     $ 0.84  
  Diluted
   $ 1.08     $ 1.08     $ 1.08     $ 0.95     $ 0.82  
Cash dividends
   $ 0.40     $ 0.35     $ 0.29     $ 0.25     $ 0.23  
Market value, end of year
   $ 14.97     $ 12.52     $ 17.68     $ 14.45     $ 14.32  
                                         
At year end
                                        
 Assets
   $ 1,090,843     $ 949,271     $ 885,351     $ 791,794     $ 516,630  
 Loans, less allowance for loan loss (2)
   $ 945,787     $ 813,647     $ 760,957     $ 671,171     $ 453,817  
 Core deposits
   $ 615,832     $ 615,892     $ 580,210     $ 529,794     $ 381,601  
 Total deposits
   $ 722,437     $ 644,424     $ 641,272     $ 604,271     $ 403,791  
 Shareholders' equity
   $ 116,165     $ 107,509     $ 95,735     $ 81,412     $ 49,392  
 Tangible Equity (3)
   $ 93,261     $ 84,382     $ 72,109     $ 57,211     $ 49,116  
                                         
Average for the year
                                        
 Assets
   $ 1,019,040     $ 903,932     $ 825,671     $ 573,717     $ 463,509  
 Earning assets
   $ 945,856     $ 832,451     $ 755,680     $ 533,930     $ 431,374  
 Loans, less allowance for loan losses
   $ 882,742     $ 785,132     $ 712,563     $ 501,541     $ 398,739  
 Core deposits
   $ 613,244     $ 590,714     $ 533,861     $ 425,716     $ 352,693  
 Total deposits
   $ 669,624     $ 654,631     $ 605,814     $ 461,013     $ 379,618  
 Interest-paying liabilities
   $ 732,466     $ 627,569     $ 567,708     $ 372,880     $ 290,569  
 Shareholders' equity
   $ 111,868     $ 103,089     $ 90,238     $ 54,528     $ 46,043  
                                         
Financial ratios
                                        
 Return on average:
                                        
  Assets
     1.27 %     1.43 %     1.53 %     1.67 %     1.71 %
  Equity
     11.57 %     12.55 %     14.02 %     17.57 %     17.26 %
  Tangible Equity (3)
     14.56 %     16.23 %     19.12 %     18.25 %     17.26 %
 Avg shareholders' equity / avg assets
     10.98 %     11.40 %     10.93 %     9.50 %     9.93 %
 Dividend payout ratio
     37.07 %     32.28 %     26.72 %     26.69 %     27.23 %
 Risk-based capital:
                                        
  Tier I capital
     10.02 %     10.01 %     9.93 %     9.32 %     10.19 %
  Total capital
     11.11 %     10.97 %     10.98 %     10.48 %     11.29 %
                                         
                                         
(1) Per common share data is retroactively adjusted to reflect the 10% stock dividend
 and 5-for-4 stock split of 2007 and 2004, respectively.
  
(2) Outstanding loans include loans held for sale.
                  
(3) Tangible equity excludes goodwill and core deposit intangible related to acquisitions.
  

 
-25-
 


The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition than can be obtained from reading the Consolidated Financial Statements alone.  The discussion should be read in conjunction with the audited financial statements and the notes included later in this report.  All numbers, except per share data, are expressed in thousands of dollars.

In addition to historical information, this report may contain 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 about management’s plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations in the forward-looking statements, including those set forth in this report, or the documents incorporated by reference:

o  
the risks associated with lending and potential adverse changes in credit quality;
o  
increased loan delinquency rates;
o  
the risks presented by a continued economic slowdown, which could adversely affect credit quality, loan collateral values, investment values, liquidity levels, and loan originations;
o  
changes in market interest rates, which could adversely affect our net interest income and profitability;
o  
legislative or regulatory changes that adversely affect our business or our ability to complete pending or prospective future acquisitions;
o  
reduced demand for banking products and services;
o  
the risks presented by public stock market volatility, which could adversely affect the Company’s stock value and the ability to raise capital in the future;
o  
competition from other financial services companies in our markets; and
o  
the Company’s success in managing risks involved in the foregoing.

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Risk Factors in Item 1A. Please take into account that forward-looking statements speak only as of the date of this report or documents incorporated by reference. The Company does not undertake any obligation to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved.


 
 
-26-
 

HIGHLIGHTS


               
% Change
          
% Change
  
   
2008
    
2007
    
2008 vs. 2007
    
2006
    
2007 vs. 2006
  
Operating revenue (1)
   $ 53,540     $ 47,351       13 %   $ 44,458       7 %
Net income
   $ 12,939     $ 12,935       0 %   $ 12,655       2 %
                                         
Earnings per share (2)
                                        
   Basic
   $ 1.08     $ 1.09       -1 %   $ 1.09       0 %
   Diluted
   $ 1.08     $ 1.08       0 %   $ 1.08       0 %
                                         
Assets, period-end
   $ 1,090,843     $ 949,271       15 %   $ 885,351       7 %
Deposits, period-end
   $ 722,437     $ 644,424       12 %   $ 641,272       0 %
                                         
Return on assets
     1.27 %     1.43 %             1.53 %        
Return on equity
     11.57 %     12.55 %             14.02 %        
Return on tangible equity (3)
     14.56 %     16.23 %             19.12 %        
                                         
(1)  Operating income is defined as net interest income plus noninterest income.
          
                                         
(2) Per share data for 2006 was retroactively adjusted to reflect the 10% stock dividend paid in June 2007.
  
                                         
(3) Tangible equity excludes goodwill and core deposit intangible related to acquisitions.
  


Net income for the year 2008 was $12,939, an increase of $4 over the $12,935 reported for the year 2007.  Net income improvement in 2008 over 2007 was modest due to a significant increase in the provision for loan losses, plus growth in noninterest expenses, which offset increased operating revenues.  Operating revenue for the year 2008 was up 13% over the year 2007 and was primarily driven by growth in net interest income, which accounted for 92% of total operating revenue in 2008.  The improvement in 2008 net interest income was the result of 14% growth in average earning assets combined with a stable net interest margin.

The Company earned $12,935 in 2007 compared to $12,655 in 2006.  Growth in operating revenue was primarily responsible for the increased earnings in 2007 over 2006. Operating revenues were $47,351 in 2007, up $2,893 or 7% over 2006.  Growth in operating revenues resulted from increased net interest income, which accounted for 92% of total operating revenue in 2007.  While average earning assets increased 10% in 2007 over 2006, growth in net interest income in 2007 was slowed by an 8 basis point compression in the net interest margin.

Period-end assets at December 31, 2008 were $1,090,843, compared to $949,271 at December 31, 2007.  Core deposits, which are defined as demand deposits, interest checking, money market accounts, and local time deposits (including local time deposits over $100 thousand) constitute 85% of December 31, 2008 outstanding deposits.  Non-interest bearing deposits were $178,957 or 25% of total deposits at year-end December 31, 2008.

During 2009, the Company believes the following factors could impact reported financial results:

§  
The current national, regional, and local recession and the effect on loan demand, the credit quality of existing clients with lending relationships, and vacancy rates of commercial real estate properties, since a significant portion of our loan portfolio is secured by real estate.

§  
A slowing real estate market and increases in residential home inventories for sale and the impact on residential construction lending, delinquency and default rates of existing residential construction loans in the Bank’s portfolio, residential mortgage lending, and refinancing activities of existing homeowners.

-27-
§  
The ability to grow core deposits during 2009 in a highly competitive environment where many financial institutions are experiencing liquidity problems.

§  
The availability of alternative funding sources due to disruption in the financial and capital markets flowing from the significant downturn in the housing industry

§  
The ability to manage noninterest expense growth in light of anticipated significant increases in regulatory costs.

§  
The ability to attract and retain qualified and experienced bankers in all markets.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

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 for the year ended December 31, 2008 in Item 8 of this report.  Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements should be considered critical under the SEC definition:

Allowance for Loan Losses and Reserve for Unfunded Commitments

The allowance for 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.

Goodwill and Intangible Assets

At December 31, 2008, the Company had $22,904 in goodwill and other intangible assets.  In accordance with Financial Accounting Standard 142, Goodwill and Other Intangible Assets, assets with indefinite lives are no longer amortized, but instead are periodically tested for impairment.  Management performs an impairment analysis of the intangible assets with indefinite lives at least annually and has determined that there was no impairment as of December 31, 2008, 2007, and 2006.

Share-based Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123(R), Share Based Payment, a revision to the previously issued guidance on accounting for stock options and other forms of equity-based forms of compensation issued to employees.  This standard became effective in the first quarter of 2006.  The Company uses the Black-Scholes option pricing model to measure fair value under SFAS 123(R) which is further discussed in Note 1 of the Notes to Consolidated Financial Statements in Item 8 below.

The Company adopted SFAS 123(R) using the modified prospective method.  Therefore, previously reported financial data was not restated, and expenses related to equity-based payments granted and vesting during 2006, 2007, and 2008 were recorded as compensation expense.


 
 
-28-
 

Recent Accounting Pronouncements

Recent accounting pronouncements are discussed in Note 1 of the Notes to the Consolidated Financial Statements for the year ended December 31, 2008 in item 8 of this report.  None of these pronouncements are expected to have a significant effect on the Company’s financial condition or results of operations.

RESULTS OF OPERATIONS

Net Interest Income

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

4th Quarter 2008 Compared to 4th Quarter 2007

Two tables follow which analyze the changes in net interest income for the fourth quarter 2008 and fourth quarter 2007.  Table I “Average Balance Analysis of Net Interest Earnings”, provides information with regard to average balances of assets and liabilities, as well as associated dollar amounts of interest income and interest expense, relevant average yields or rates, and net interest income as a percent of average earning assets.  Table II “Analysis of Changes in Interest Income and Interest Expense”, shows the increase (decrease) in the dollar amount of interest income and interest expense and the differences attributable to changes in either volume or rates.

The Bank’s net interest margin for the fourth quarter 2008 was 5.28% compared to 5.15% for the fourth quarter 2007.   Table I shows that earning asset yields for the fourth quarter 2008 of 6.63% were down 135 basis points from fourth quarter 2007 earning asset yields due primarily to a 144 basis point decline in the yield on net loans.  The decline in loan yields was due to the rapid decline in market interest rates during 2008, which lowered yields on the Bank’s variable rate loan portfolio.  However, the Bank’s practice of including floors on most of its variable rate loans mitigated additional declines in loan yields during this falling rate environment.  During the third and fourth quarters 2008, loan yields stabilized due to the activation of interest rate floors on approximately $280,000 of the Bank’s variable rate loan portfolio, thus protecting the net interest margin.

Table I shows that the rates paid on interest-bearing core deposits moved down faster than yields on earning assets as evidenced by the 168 basis point decline from 3.24% to 1.56%.  In addition, the cost of alternative funding has moved down at a faster rate than core deposits, down 296 basis points from 4.88% to 1.92%.  This rapid fall in the cost of alternative funding was due to a planned strategy to maintain a relatively short maturity structure on the Bank’s alternative funding, which permitted the Bank to refinance this funding at consistently lower rates during a rapidly declining interest rate environment.  Overall, the cost of interest-bearing liabilities of the Bank, which includes both core deposits and alternative funding, has fallen by 205 basis points in fourth quarter 2008 from fourth quarter 2007.

Table I also shows the difference between the cost of interest-bearing core deposits and alternative funding.  Overall, interest-bearing core deposits have a rate of 1.56% or 36 basis points lower than alternative funding costs at 1.92%.  However, this spread between core deposit rates and alternative funding rates has compressed significantly during the last half of 2008 when compared to the first half of the year when this spread ranged between 140 and 150 basis points.  This narrowing spread is again the result of the relatively short maturity structure of the Bank’s alternative funding, Federal Reserve actions to lower rates during the fourth quarter 2008, and the relatively high cost of core deposits in a very competitive rate environment.

Table II shows the changes in net interest income due to rate and volume for the quarter ended December 31, 2008.  Interest income including loan fees for the fourth quarter 2008 declined by $806 from the same period last year.  Higher volumes of earning assets increased interest income by $2,605, while lower yields on earning assets, primarily loans, decreased interest income by $3,411.  The rate/volume analysis shows that interest expense for the quarter ended December 31, 2008 decreased by $2,807 from last year, as
 
 
-29-
changes in mix and higher volumes caused interest expense to increase by $1,496, which was more than offset by a decrease in interest expense of $4,303 due to lower rates.  Most of the decline in interest expense was due to lower rates and was in the Bank’s core deposit base, which illustrates the Bank’s ability to quickly reprice its core deposits.  In addition, the Bank also benefited from the short maturity structure of its alternative funding, which permitted refinancing at lower rates in a rapidly falling interest rate environment.
 

 
-30-
 
 
Table I
Average Balance Analysis of Net Interest Earnings
(dollars in thousands)

         
Quarter Ended
                
Quarter Ended
        
   
 
    
December 31, 2008
          
 
    
December 31, 2007
        
         
Interest
    
Average
          
Interest
    
Average
  
   
Average
    
Income or
    
Yields or
    
Average
    
Income or
    
Yields or
  
   
Balance
    
Expense
    
Rates
    
Balance
    
Expense
    
Rates
  
Interest Earning Assets
                                    
Federal funds sold and interest-
                                    
 bearing deposits in banks
   $ 497     $ 2       1.60 %   $ 809     $ 10       4.90 %
Securities available for sale:
                                                
 Taxable (1)
     57,972       627       4.30 %     52,756       622       4.68 %
 Tax-exempt
     5,187       49       3.76 %     5,247       49       3.71 %
Loans, net of allowance
                                                
  for loan losses(2)(3)(4)
     929,522       15,866       6.79 %     803,999       16,669       8.23 %
 Total interest earning assets
     993,178       16,544       6.63 %     862,811       17,350       7.98 %
                                                 
Non Earning Assets
                                                
Cash and due from banks
     17,928                       19,623                  
Premises and equipment
     20,892                       20,856                  
Goodwill & other intangibles
     22,935                       23,159                  
Interest receivable and other
     14,845                       6,925                  
 Total non interest assets
     76,600                       70,563                  
                                                 
  Total assets
   $ 1,069,778                     $ 933,374                  
                                                 
Interest-Bearing Liabilities
                                                
Money market and NOW accounts
   $ 382,144     $ (1,367 )     -1.42 %   $ 378,845     $ (3,066 )     -3.21 %
Savings deposits
     21,058       (39 )     -0.74 %     20,650       (82 )     -1.58 %
Time deposits - core (5)
     44,776       (355 )     -3.15 %     38,313       (424 )     -4.39 %
 Total interest-bearing core deposits
     447,978       (1,761 )     -1.56 %     437,808       (3,572 )     -3.24 %
                                                 
Time deposits - non-core
     72,052       (536 )     -2.96 %     49,588       (651 )     -5.21 %
Federal funds purchased
     9,005       (24 )     -1.06 %     16,579       (212 )     -5.07 %
FHLB & FRB borrowings
     239,599       (904 )     -1.50 %     135,748       (1,594 )     -4.66 %
Junior subordinated debentures
     8,248       (125 )     -6.03 %     8,248       (128 )     -6.16 %
 Total interest-bearing alternative funding
     328,904       (1,589 )     -1.92 %     210,163       (2,585 )     -4.88 %
 Total interest-bearing liabilities
     776,882       (3,350 )     -1.72 %     647,971       (6,157 )     -3.77 %
                                                 
Noninterest-Bearing Liabilities
                                                
Demand deposits
     170,897                       173,706                  
Interest payable and other
     7,040                       4,326                  
 Total noninterest liabilities
     177,937                       178,032                  
  Total liabilities
     954,819                       826,003                  
Stockholders' equity
     114,959                       107,371                  
Total liabilities and stockholders' equity
   $ 1,069,778                     $ 933,374                  
Net Interest Income
           $ 13,194                     $ 11,193          
Net Interest Income as a Percent of Earning Assets
       5.28 %                     5.15 %        
(1) Federal Home Loan Bank stock is included in securities available for sale.
                          
(2) Nonaccrual loans have been included in average balance totals.
                                  
(3) Interest income includes recognized loan origination fees of $224 and $447 for the three months ended
          
December 31, 2008 and 2007, respectively.
                                          
(4) Total includes loans held for sale.
                                                
(5) Core time deposits include all non-public time deposits, including non-public time deposits over $100.
          

 
-31-
 

Table II
Analysis of Changes in Interest Income and Interest Expense
(dollars in thousands)


 
Three Months Ended
December 31, 2008 compared to December 31, 2007
  
   
Increase (decrease) due to
        
   
Volume
    
Rate
    
Net
  
Interest earned on:
                  
Federal funds sold and interest
                  
 bearing deposits in banks
   $ (4 )   $ (4 )   $ (8 )
Securities available-for-sale:
                        
 Taxable
     60       (55 )     5  
 Tax-exempt
     (1 )     1       -  
Loans, net of allowance for loan losses
     2,550       (3,353 )     (803 )
                         
 Total interest income
   $ 2,605     $ (3,411 )   $ (806 )
                         
                         
Interest paid on:
                        
Money market and NOW accounts
     (18 )     1,717       1,699  
Savings deposits
     (1 )     44       43  
Time deposits - core
     (70 )     139       69  
 Total interest-bearing core deposits
     (89 )     1,900       1,811  
                         
                         
Time deposits - non-core
     (292 )     407       115  
Federal funds purchased
     97       91       188  
FHLB & FRB borrowings
     (1,212 )     1,902       690  
Junior subordinated debentures
     -       3       3  
 Total interest-bearing alternative funding
     (1,407 )     2,403       996  
                         
 Total interest expense
   $ (1,496 )   $ 4,303     $ 2,807  
                         
 Net interest income
   $ 1,109     $ 892     $ 2,001  

2008 Compared to 2007

Two tables follow which analyze the changes in net interest income for the years 2008, 2007, and 2006.  Table III “Average Balance Analysis of Net Interest Earnings”, provides information with regard to average balances of assets and liabilities, as well as associated dollar amounts of interest income and interest expense, relevant average yields or rates, and net interest income as a percent of average earning assets.  Table IV, “Analysis of Changes in Interest Income and Interest Expense”, shows the increase (decrease) in the dollar amount of interest income and interest expense and the differences attributable to changes in either volume or rates.

The net interest margin for the full year 2008 was 5.21%, a decline of 1 basis point from the 5.22% net interest margin reported for the year 2007.  Table III shows that earning asset yields declined by 134 basis points for the year 2008 when compared to 2007 from 8.31% to 6.97%.  The decline in earning assets yields was due primarily to the 141 basis point drop in yields on loans, which resulted from the rapidly declining interest rate environment experienced throughout 2008 that lowered yields on the Bank’s variable rate loan portfolio.  As noted above, the Bank’s use of interest rate floors on its variable rate loan portfolio mitigated further decline in loan yields during the last half of 2008.

Table III also shows the overall cost of interest-bearing liabilities for the year 2007 was down 182 basis points from 4.10% in 2007 to 2.28% in 2008.  This decline can be also be attributed to the falling rate environment during 2008, plus the relatively short-maturity structure of the Bank’s alternative funding, which permitted rapid refinancing of funding at much lower rates throughout the year.  Table III also illustrates the difference between the cost of interest-bearing core deposits for the year 2008 as compared to the cost of interest-bearing alternative funding.  The cost of interest-bearing core deposits was 1.85% or 108 basis points less than the 2.93% cost of alternative funding.

-32-
The year-to-date December 31, 2008 rate/volume analysis shows that interest income including loan fees declined by $3,221 from last year.  Higher volumes of earning assets increased interest income by $9,047 and lower yields on loans decreased interest income by $12,268.  The rate/volume analysis shows that interest expense for the year 2008 decreased by $9,066 from last year, as higher volumes on all deposit categories caused interest expense to increase by $5,045, which was more than offset by lower rates, which decreased interest expense by $14,111.

2007 Compared to 2006

The net interest margin for the full year 2007 was 5.22%, a decline of 8 basis points from the 5.30% net interest margin reported for the year 2006.  Table III shows that earning asset yields improved by 11 basis points for the year 2007 when compared to 2006 from 8.20% to 8.31%.  Compression in the net interest margin was primarily due to the increase in the Bank’s cost of funding, which more than offset the growth in earning asset yields.  Table III shows the overall cost of interest-bearing liabilities for the year 2007 was up 24 basis points from 3.86% in 2006 to 4.10% in 2007.  Table III also illustrates the difference between the cost of interest-bearing core deposits for the year 2007 as compared to the cost of interest-bearing alternative funding.  The cost of interest-bearing core deposits was 3.61% or 150 basis points less than the 5.11% cost of alternative funding.

The year-to-date December 31, 2007 rate/volume analysis shows that interest income, including loan fees, improved by $7,194 over last year.  Higher volumes of earning assets increased interest income by $6,301 and higher yields on loans increased interest income by $893.  The rate/volume analysis shows that interest expense for the year 2007 increased by $3,825 over last year, as higher volumes on all deposit categories caused interest expense to increase by $2,157, combined with higher rates, which increased interest expense by $1,668.


 

 
-33-
 
 
Table III
Average Balance Analysis of Net Interest Earnings

   
 
      
2008
          
 
      
2007
          
 
      
2006
        
   
Average
    
Interest
    
Average
    
Average
    
Interest
    
Average
    
Average
    
Interest
    
Average
  
   
Balance
    
Income/(Expense)
    
Yield/(Cost)
    
Balance
    
Income/(Expense)
    
Yield/(Cost)
    
Balance
    
Income/(Expense)
    
Yield/(Cost)
  
   
(dollars in thousands)
    
(dollars in thousands)
    
(dollars in thousands)
  
Interest Earning Assets
                                                      
Federal funds sold and interest-
                                                      
 bearing deposits in banks
   $ 554     $ 20       3.61 %   $ 981     $ 51       5.20 %   $ 960     $ 44       4.58 %
Securities available for sale:
                                                                        
 Taxable (1)
     57,260       2,682       4.68 %     41,112       1,837       4.47 %     38,855       1,546       3.98 %
 Tax-exempt
     5,300       196       3.70 %     5,226       156       2.99 %     3,302       125       3.79 %
Loans, net of allowance for loan
                                                                        
   losses(2)(3)(4)
     882,742       63,047       7.14 %     785,132       67,122       8.55 %     712,563       60,257       8.46 %
                                                                         
 Total interest earning assets
     945,856       65,945       6.97 %     832,451       69,166       8.31 %     755,680       61,972       8.20 %
                                                                         
Non Earning Assets
                                                                        
Cash and due from banks
     18,241                       21,662                       23,272                  
Premises and equipment
     20,955                       19,755                       17,694                  
Goodwill & other intangibles
     23,018                       23,376                       24,057                  
Interest receivable and other
     10,970                       6,688                       4,968                  
 Total non interest earning assets
     73,184                       71,481                       69,991                  
                                                                         
  Total assets
   $ 1,019,040                     $ 903,932                     $ 825,671                  
                                                                         
Interest-Bearing Liabilities
                                                                        
Money market and NOW accounts
   $ 379,657     $ (6,584 )     -1.73 %   $ 364,780     $ (13,358 )     -3.66 %   $ 307,054     $ (10,551 )     -3.44 %
Savings deposits
     21,228       (183 )     -0.86 %     24,309       (486 )     -2.00 %     23,559       (360 )     -1.53 %
Time deposits - core
     42,566       (1,427 )     -3.35 %     32,589       (1,381 )     -4.24 %     40,989       (1,466 )     -3.58 %
 Total interest-bearing core deposits
     443,451       (8,194 )     -1.85 %     421,678       (15,225 )     -3.61 %     371,602       (12,377 )     -3.33 %
                                                                         
Time deposits - non-core
     56,380       (1,948 )     -3.46 %     63,918       (3,347 )     -5.24 %     71,954       (3,504 )     -4.87 %
Federal funds purchased
     22,094       (578 )     -2.62 %     10,128       (539 )     -5.32 %     7,580       (380 )     -5.01 %
FHLB & FRB borrowings
     202,293       (5,456 )     -2.70 %     123,597       (6,121 )     -4.95 %     108,324       (5,144 )     -4.75 %
Trust preferred
     8,248       (498 )     -6.04 %     8,248       (508 )     -6.16 %     8,248       (510 )     -6.18 %
 Total interest-bearing alternative funding
     289,015       (8,480 )     -2.93 %     205,891       (10,515 )     -5.11 %     196,106       (9,538 )     -4.86 %
 Total interest-bearing liabilities
     732,466       (16,674 )     -2.28 %     627,569       (25,740 )     -4.10 %     567,708       (21,915 )     -3.86 %
                                                                         
Noninterest-Bearing Liabilities
                                                                        
Demand deposits
     169,792                       169,035                       162,259                  
Interest payable and other
     4,914                       4,239                       5,466                  
 Total noninterest-bearing liabilities
     174,706                       173,274                       167,725                  
  Total liabilities
     907,172                       800,843                       735,433                  
Stockholders' equity
     111,868                       103,089                       90,238                  
Total liabilities and stockholders' equity
   $ 1,019,040                     $ 903,932                     $ 825,671                  
                                                                         
Net Interest Income
           $ 49,271                     $ 43,426                     $ 40,057          
                                                                         
Net Interest Income as a Percent of
                                                                        
   Earning Assets
             5.21 %                     5.22 %                     5.30 %        
                                                                         
(1) Federal Home Loan Bank stock is included in securities available for sale.
                                                          
(2) Nonaccrual loans have been included in average balance totals.
                                                          
(3) Interest income includes recognized loan origination fees of $1,843, $2,065 and $2,099 for the years ended 2008, 2007, and 2006, respectively.
                          
(4) Total includes loans held for sale.
                                                                        
(5) Core time deposits include all local time deposits, including local time deposits over $100.
                                                  
                                                                         

 
-34-
 

Table IV
Analysis of Changes in Interest Income and Interest Expense

   
2008 compared to 2007
Increase (decrease) due to
    
2007 compared to 2006
Increase (decrease) due to
  
   
Volume
    
Rate
    
Net
    
Volume
    
Rate
    
Net
  
   
(dollars in thousands)
  
Interest earned on:
                                    
Federal funds sold and interest
                                    
   bearing deposits in banks
   $ (22 )   $ (9 )   $ (31 )   $ 1     $ 6     $ 7  
Securities available-for-sale:
                                                
   Taxable
     722       123       845       90       201       291  
   Tax-exempt
     2       38       40       73       (42 )     31  
Loans, net of allowance for loan
                                                
   losses
     8,345       (12,420 )     (4,075 )     6,137       728       6,865  
                                                 
   Total interest income
   $ 9,047     $ (12,268 )   $ (3,221 )   $ 6,301     $ 893     $ 7,194  
                                                 
Interest paid on:
                                                
Money market and NOW accounts
     (545 )     7,319       6,774       (1,984 )     (823 )     (2,807 )
Savings deposits
     62       241       303       (11 )     (115 )     (126 )
Time deposits
     (423 )     377       (46 )     300       (215 )     85  
 Total interest-bearing core deposits
     (906 )     7,937       7,031       (1,695 )     (1,153 )     (2,848 )
                                                 
Time deposits - non-core
     395       1,004       1,399       391       (234 )     157  
Federal funds purchased
     (637 )     598       (39 )     (128 )     (31 )     (159 )
FHLB borrowings
     (3,897 )     4,562       665       (725 )     (252 )     (977 )
Trust preferred
     -       10       10       -       2       2  
 Total interest-bearing alternative funding
     (4,139 )     6,174       2,035       (462 )     (515 )     (977 )
   Total interest expense
   $ (5,045 )   $ 14,111     $ 9,066     $ (2,157 )   $ (1,668 )   $ (3,825 )
                                                 
   Net interest income
   $ 4,002     $ 1,843     $ 5,845     $ 4,144     $ (775 )   $ 3,369  
                                                 


Provision for Possible Loan Losses

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

The provision for loan losses totaled $3,600 in 2008, $725 in 2007, and $600 in 2006.  The increase in the provision for 2008 when compared to 2007 was due to loan growth, moderate deterioration in credit quality, and an increase in unallocated reserves in light of significant economic uncertainty.  The increase in the provision for 2007 when compared to 2006 was due to loan growth and some increased economic uncertainty.

At December 31, 2008, the Bank had $7,704 or 0.71% of total assets in nonperforming assets, net of government guarantees compared to $4,094 or 0.43% of total assets at December 31, 2007.  Nonperforming assets at December 31, 2008 consist of $3,898 of nonaccrual loans (net of $239 in government guarantees) and $3,806 of other real estate owned. Nonperforming assets do not include $2,234 of impaired loans less than 90 days past due and continuing to accrue interest as of December 31, 2008.  At December 31, 2008, approximately $1,181 of the nonaccrual loans were consumer residential construction loans.  Other real estate owned consisted of 17 completed consumer construction residential properties and seven individual residential building lots.  Losses on these or any future nonperforming loans in the consumer residential construction segment of the loan portfolio are mitigated due to a cash-secured 20% principal guarantee for each of these loans. In addition, no special allocation to the allowance for loan losses for these specific loans is expected.

-35-
The allowance for loan losses at December 31, 2008 was $10,980 (1.15% of outstanding loans, net of loans held for sale) compared to $8,675 (1.05% of loans) and $8,284 (1.08% of loans) at years end 2007 and 2006, respectively.  At December 31, 2008, the Bank also has reserved $196 for possible losses on unfunded loan commitments, which is classified in other liabilities.  The 2008 ending allowance includes $887 in specific allowance for $6,132 in impaired loans (net of government guarantees).  At December 31, 2007, the Company had $3,671 of impaired loans (net of government guarantees) with a specific allowance assigned of $160.

Net loan charge offs were $1,295 in 2008 compared to $334 in 2007, and $108 in 2006.  Net charge offs as a percentage of average loans were 0.15%, 0.04%, and 0.01% for 2008, 2007, and 2006, respectively.

Noninterest Income

Noninterest income is derived from sources other than fees and interest on earning assets.  The Company’s primary sources of noninterest income are service charge fees on deposit accounts, merchant bankcard activity, income derived from mortgage banking services, and gains on the sale of loans.

2008 Compared to 2007

Noninterest income in 2008 was $4,269, up $344 or 9% from the $3,925 reported for the year 2007.  The increase in 2008 noninterest income when compared to 2007 was primarily attributable to a $267 increase in service charges on deposit accounts and a $193 increase in other fee income, principally bankcard processing fee income.  Service charges on deposit accounts increased due to lower earnings credit rate, which increased fees on analyzed business accounts.  Bankcard processing fee income accounted for $114 of this increase.  Increases in these categories were partially offset by a $15 decrease in mortgage banking income.  The decline in mortgage banking income was attributable to a significant slow down in the residential housing market.  The other income category in 2008 was $330, an $87 or 21% decrease from the $417 reported in the other income category for the year 2007.  The decrease in the other income category was due to collection of approximately $70 in loan referral fees during the year 2007.

2007 Compared to 2006

Noninterest income in 2007 was $3,925, down $476 or 11% from the $4,401 reported for the year 2006.  Excluding the one-time gain of $335 on the sale of property included in 2006 results, noninterest income in 2007 was down $141 or 3% from 2006.  The following discussion excludes the effect of the gain on sale of property in 2006.  The $141 decline in 2007 noninterest income when compared to 2006 was primarily due to a $435 decrease in mortgage banking income.  The decline in mortgage banking income was attributable to a significant slow down in the residential housing market.  The decline in mortgage banking income was partially offset by increases in service charges on deposit accounts, other fee income, principally bankcard processing fee income, and the other income category.  Service charges on deposit accounts increased $76 or 6% due to lower earnings credit rate, which increased fees on analyzed business accounts.  Other fee income, principally bankcard processing fee income in 2007 increased $135 or 9% over 2006.  Bankcard processing fee income accounted for $53 of this increase, while other service charge income, primarily wire transfer fees accounted for $68 of this increase.  The other income category in 2007 was $417, a $94 or 29% increase over the $323 reported in the other income category for the year 2006.  The increase in the other income category was due to collection of approximately $70 in loan referral fees during the year 2007.

 
 
-36-
 



Noninterest Expense

Noninterest expense represents all expenses other than the provision for loan losses and interest costs associated with deposits and other interest-bearing liabilities.  It incorporates personnel, premises and equipment, data processing and other operating expenses.

2008 Compared to 2007

Noninterest expense for the year 2008 was $29,562, up $3,701 or 14% over the $25,861 reported for the year 2007.  Personnel expense in 2008 was up $2,422 and accounted for 65% of the total increase in noninterest expense in the year.  Total salary expense was up $1,699 or 16% and benefits and taxes were up $780 or 16% over last year.  Approximately $442 of the increase in salary expense was due to lower loan origination costs, which are a direct offset to salary expense.  Higher benefits and taxes expense in 2008 resulted from increased group insurance, and accruals for officer incentives.  The other expense category accounted for the majority of the remaining increase in noninterest expense in 2008 over 2007.  Other expenses were $5,490 in 2008, up $588 or 12% over 2007 other expenses of $4,902.  The increase in the other expense category can be attributed to the following areas: 1) increased FDIC assessment of $231; 2) increased travel expense of $89; 3) increased other real estate expense of $125 due to increases in other real estate owned; and 4) increased repossession and collection expense of $23 related to increases in non-performing loans.

2007 Compared to 2006

Noninterest expense for the year 2007 was $25,861, up $2,070 or 9% over the $23,791 reported for the year 2006.  All noninterest expense categories showed an increase in 2007 when compared to 2006.  Personnel expense in 2007 was up $1,089 and accounted for 53% of the total increase in noninterest expense in the year.  Total salary expense was up $515 or 5% and benefits and taxes were up $823 or 20% over last year due to performance increases for existing employees, increased group insurance, and increased accruals for officer incentives.  These increases were partially offset by a decline in commission expense in 2007 from 2006.  The other expense category accounted for the majority of the remaining increase in noninterest expense in 2007 over 2006.  Other expenses were $4,902 in 2007, up $708 or 17% over 2006 other expenses of $4,194.  The increase in the other expense category can be attributed to the following areas: 1) increased FDIC assessment of $146; 2) increased communications expense (primarily armored car and courier services) of $133; 3) increased other data processing expense of $199 due to new contracts in place; 4) increased expense related to the unfunded loan commitment of $196; and 5) increased local taxes (Multnomah County and State of Washington B&O taxes) of $107.

BALANCE SHEET

Loans

At December 31, 2008, outstanding loans, net of deferred loan fees and excluding loans held for sale, were $956,357, up $134,035 over outstanding loans of $822,322 at December 31, 2007.  A summary of loan growth by market for the year 2008 follows:



   
Balance
    
Balance
    
$ Increase
    
% Increase
  
   
Dec. 31, 2008
    
Dec. 31, 2007
    
(Decrease)
    
(Decrease)
  
                         
Eugene Market
   $ 237,604     $ 217,962     $ 19,642       9.01 %
                                 
Portland Market
     432,961       389,053       43,908       11.29 %
                                 
Seattle Market
     285,792       215,307       70,485       32.74 %
                                 
  Total
   $ 956,357     $ 822,322     $ 134,035       16.30 %
                                 

 
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The Seattle market was primarily responsible for the majority of the growth in outstanding loans for the Company during 2008, but both the Portland and Eugene markets also showed solid year-over-year loan growth.  The growth in all three markets can be attributed to increased commercial real estate lending and loans to dental professionals throughout the year, combined with a lessening of competition for loans.  Throughout 2008, many financial institutions experiencing credit quality problems and significantly reduced their lending activities, thus increasing the opportunity for the Bank to grow its loan portfolio.  More information on the loan portfolio can be found in statistical information in Item 1 and in Note 4 of the Notes to Consolidated Financial Statements in Item 8 below.

Goodwill and Intangible Assets

At December 31, 2008, the Company had a recorded balance of $22,031 in goodwill from the November 30, 2005 acquisition of NWB Financial Corporation and its wholly-owned subsidiary Northwest Business Bank (NWBF).  In addition, at December 31, 2008 the Company had $873 core deposit intangible assets resulting from the acquisition of NWBF.  The core deposit intangible was determined to have an expected life of approximately seven years and is being amortized over that period using the straight-line method.  During 2008, the Company amortized $223 of the core deposit intangible.  In accordance with Statement of Financial Accounting Standard (“SFAS”) 142, Goodwill and Other Intangible Assets, the Company does not amortize goodwill or other intangible assets with indefinite lives, but instead periodically tests these assets for impairment.  Management performed an impairment analysis at December 31, 2008 and determined there was no impairment of the goodwill at the time of the analysis.

Deposits

Outstanding deposits at December 31, 2008 were $722,437, an increase of $78,013 over outstanding deposits of $644,424 at December 31, 2007.  Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and local time deposits, including local time deposits in excess of $100 thousand, were $615,832, down $60 from outstanding core deposits of $615,892 at December 31, 2007.  At December 31, 2008 and 2007, respectively, core deposits represented 85% and 96% of total deposits, respectively.  A summary of deposit growth by market for the year 2008 follows:


   
Balance
    
Balance
    
$ Increase
    
% Increase
  
   
Dec. 31, 2008
    
Dec. 31, 2007
    
(Decrease)
    
(Decrease)
  
                         
Eugene Market core deposits
   $ 406,098     $ 405,351     $ 747       0.18 %
                                 
Portland Market core deposits
     110,287       109,698       589       0.54 %
                                 
Seattle Market core deposits
     99,447       100,843       (1,396 )     -1.38 %
                                 
 Total core deposits
     615,832       615,892       (60 )     -0.01 %
                                 
Other deposits
     106,605       28,532       78,073       273.63 %
                                 
  Total
   $ 722,437     $ 644,424     $ 78,013       12.11 %
                                 
 
Outstanding core deposits at December 31, 2008 in all three markets were virtually flat from one year ago primarily due to the highly competitive environment for these deposits with other financial institutions in all three of the Bank’s primary markets.  This increased competition for core deposits, primarily based on price, was driven by liquidity problems experienced by the entire industry during the last six months of 2008 as financial markets experienced significant disruption.  In addition, core deposit growth was affected by a deterioration in economic conditions in all three markets that negatively impacted the cash flow, and thus the deposit levels of many of the Bank’s existing clients.  As a result of no growth in core deposits, the Bank experienced growth of more than $78,000 in other deposits, which consisted primarily of brokered and public time deposits.


 
 
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Junior Subordinated Debentures

The Company had $8,248 in junior subordinated debentures at December 31, 2008, which were issued in conjunction with the acquisition of NWBF.  At December 31, 2008, the entire $8,248 in junior subordinated debentures had an interest rate of 6.265% that is fixed through November 2010.  As of December 31, 2008, the entire balance of the junior subordinated debentures qualified as Tier 1 capital under regulatory capital purposes.  Additional information regarding the terms of the junior subordinated debentures, including maturity/repricing dates and interest rate, is included in Note 12 of the Notes to Consolidated Financial Statements in Item 8 below.

CAPITAL RESOURCES

Capital is the stockholders’ investment in the Company.  Capital grows through the retention of earnings and the issuance of new stock through the exercise of stock options.  Capital formation allows the Company to grow assets and provides flexibility in times of adversity.

Stockholders’ equity at December 31, 2008 was $116,165, an increase of $8,656 or 8% from December 31, 2007.  The increase in stockholders’ equity during 2008 was due to the retention of approximately $8,142 net income for the year and the exercise of stock options and the related tax benefit accounted for another $1,504.

The Federal Reserve Board and the FDIC have in place guidelines for risk-based capital requirements applicable to U.S. banks and bank holding companies.  These risk-based capital guidelines take into consideration risk factors, as defined by regulation, associated with various categories of assets, both on and off-balance sheet.  Under the guidelines, capital strength is measured in two tiers, which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios.  These guidelines require a minimum of 8% total risk-based capital ratio, of which 4% must be Tier I capital.  The regulations also specify that a 10% total risk-based capital ratio is required to be designated “well-capitalized” (the highest FDIC capital rating) by the FDIC.  The Company’s Tier I capital, which consists of stockholders’ equity and qualifying trust preferred securities, less other comprehensive income, goodwill (net of the deferred tax associated with goodwill), and deposit-based intangibles, totaled $102,424 at December 31, 2008.  Tier II capital components include all, or a portion of the allowance for loan losses and the portion of trust preferred securities in excess of Tier I statutory limits.  The total of Tier I and Tier II capital components is referred to as Total Risk-Based Capital, and was $113,600 at December 31, 2008.  The Bank’s total risk-based capital ratio was 11.11%, at December 31, 2008 compared to 10.97% at December 31, 2007.

Subsequent to year-end December 31, 2008, the Company raised approximately $9,700 of additional capital through a private equity placement of 750 thousand shares of stock at $13.50 per share.  This additional capital is expected to increase the Company’s total risk-based capital ratio to more than 12% at the end of first quarter 2009.  In addition, during December 2008, the Company was granted preliminary approval under TARP by the Treasury to receive $30 million of additional capital in the form of preferred stock.  In January 2009, the Company announced it had determined not to participate in this program.

The Company pays cash dividends on a quarterly basis, typically in March, June, September and December 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.  The Company declared and paid cash dividends of $0.40 per share for the year 2008.  That compares to dividends of $0.35 per share for the year 2007 when adjusted for the 10% stock dividend paid in June 2007.

The Board of Directors, at its February 17, 2009 meeting, approved a dividend of $0.10 per share for stockholders of record as of March 3, 2009.  If continued for each quarter during 2009, this would result in no change in 2009 dividends over 2008 dividends.

-39-
The Company projects that earnings retention and existing capital will be sufficient to fund anticipated organic asset growth, while maintaining a well-capitalized designation from all regulatory agencies.

OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

In the normal course of business, the Bank commits to extensions of credit and issues letters of credit.  The Bank 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 Bank’s exposure to credit loss is represented by the contractual amount of the instruments.  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established by the contract.  Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  At December 31, 2008, the Bank had $182,609 in commitments to extend credit.

Letters of credit written are conditional commitments issued by the Bank to guarantee performance of a customer to a third party.  The credit risk involved is essentially the same as that involved in extending loan facilities to customers.  At December 31, 2008, the Bank had $2,298 in letters of credit and financial guarantees written.

The Bank also has internal guidance lines of credit established for certain borrowers, primarily in the residential construction industry.  These guidance lines are not contractual commitments to extend credit, and may be terminated by the Bank for any reason without any obligation to the borrower.  These lines provide the Bank’s lenders limits on future extensions of credit to certain borrowers.  The Bank uses the same credit policies in establishing internal guidance lines as it does for other credit products.  At December 31, 2008, the Bank had established unused and uncommitted guidance lines totaling approximately $1,387 compared to unused and uncommitted guidance lines of $38,321 at December 31, 2007.

The Company has certain other financial commitments.  These future financial commitments are outlined below:
Contractual Obligations
            
 
    
 
    
 
  
(dollars in thousands)
  
Total
    
Less than One Year
    
1 - 3 Years
    
3 - 5 Years
    
More than 5 Years
  
                               
Junior subordinated debenture
   $ 8,248     $ -     $ -     $ -     $ 8,248  
FHLB borrowings
     194,500       159,500       21,500       11,500       2,000  
Federal Reserve borrowings
     20,000       20,000       -       -       -  
Time Deposits
     150,545       123,172       21,482       5,891       -  
Operating lease obligations
     6,848       954       1,177       932       3,785  
    $ 380,141     $ 303,626     $ 44,159     $ 18,323     $ 14,033  

LIQUIDITY

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 time deposits in excess of $100. Additional liquidity and funding sources are provided through the sale of loans, sales of securities, access to national CD markets, and both secured and unsecured borrowings.

The Company uses a number of measurements to monitor its liquidity position on a daily, weekly, and monthly basis.  During the third and fourth quarters of 2008 during significant disruption of financial markets that created liquidity problems for a number of financial institutions, the Company heightened its liquidity monitoring and also put into place a number of programs to increase its core deposit base, including deposit promotions in all three markets.

-40-
Core deposits at December 31, 2008 were 85% of total deposits compared to 96% at December 31, 2007.  Core deposits at December 31, 2008 were virtually flat with one year ago due to increased competition for core deposits by all financial institutions, combined with deteriorating economic conditions.  Loan growth was funded primarily through alternative funding sources, including overnight borrowed funds, Federal Home Loan Bank advances, Federal Reserve Bank of San Francisco advances, public deposits available from the State of Oregon and State of Washington, national market time deposits, and brokered time deposits.

The Company has deposit relationships with several large clients, which are closely monitored by Bank officers.  At December 31, 2008, 29 large deposit relationships with the Bank account for $206,026 or 29% of total deposits.  The single largest client represented 8% of total deposits at December 31, 2008.  The loss of this deposit relationship or other large deposit relationships could cause an adverse effect on short-term liquidity.  The Company expects to maintain these relationships and believes it has sufficient sources of liquidity to mitigate the loss of one or more of these clients.

Borrowing lines have been established at various correspondent banks, the Federal Home Loan Bank of Seattle and with the Federal Reserve Bank of San Francisco.  At December 31, 2008, the Bank had secured and unsecured borrowing lines totaling approximately $495,188 consisting of $327,253 with the Federal Home Loan Bank of Seattle, $118,000 with various correspondent banks, and $49,935 with the Federal Reserve Bank of San Francisco.  The Federal Home Loan Bank borrowing line is limited to the amount of collateral pledged.  At December 31, 2008, the Bank had collateral pledged to the FHLB in the form of commercial real estate loans, first and second lien single family residential loans, multi-family loans, and mortgage-backed securities that had a discounted collateral value of approximately $273,978 for this line.  The $49,935 borrowing line with the Federal Reserve Bank of San Francisco is also secured through the pledging of commercial loans under the Bank’s Borrower-In-Custody program.  The $118,000 in borrowing lines with correspondent banks is unsecured.  At December 31, 2008, the Bank had $194,500 in borrowings outstanding from the FHLB of Seattle and $24,000 outstanding on its overnight correspondent bank lines, and $20,000 outstanding with the Federal Reserve Bank of San Francisco.  In addition, the Bank is part of the State of Oregon and State of Washington community bank time deposit program and at December 31, 2008 had approximately $500 available from these sources.  The Bank’s loan portfolio also contains approximately $31,689 in guaranteed government loans, which can be sold on the secondary market.

Subsequent to the end of the year, as a result of a financial institution failure in the State of Washington, the Bank was assessed $9 thousand for uninsured public deposits at the failed institution.  The assessment was based upon the Bank’s pro rata share of public deposits as of December 31, 2008, which amounted to less than one-tenth of one percent.  However, due to the increased risk of future bank failures in Washington, the Bank chose to exit the public deposit pool in order to minimize its exposure to possible assessments for uninsured deposits.  The Bank will continue to have a potential liability for uninsured deposits for a period of one year following its exit from the state public deposit pool.

INFLATION

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


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

-41-
Interest rate risk generally arises when the maturity or repricing structure of the Company’s assets and liabilities differ significantly.  Asset and liability management, which among other things addresses such risk, is the process of developing, testing and implementing strategies that seek to maximize net interest income while maintaining sufficient liquidity.  This process includes monitoring contractual maturity and prepayment expectations together with expected repricing of assets and liabilities under different interest rate scenarios.  Generally, the Company seeks a structure that insulates net interest income from large deviations attributable to changes in market rates.

Interest rate risk is managed through the monitoring of the Company’s balance sheet by subjecting various asset and liability categories to interest rate shocks and gradual interest rate movements over a one-year period of time.  Interest rate shocks use an instantaneous adjustment in market rates of large magnitudes on a static balance sheet to determine the effect such a change in interest rates would have on the Company’s net interest income and capital for the succeeding twelve-month period.  Such an extreme change in interest rates and the assumption that management would take no steps to restructure the balance sheet does limit the usefulness of this type of analysis.  This type of analysis tends to provide a best-case or worst-case scenario.  In addition to the interest rate shock analysis, the company also prepares a rolling four quarter forecast of the balance sheet and income statement using a flat rate scenario i.e. rates unchanged and a most-likely rate scenario where rates are projected to change based on management’s analysis of expected economic conditions and interest rate environment.  This analysis takes into account growth in loans and deposits and management strategies that could be employed to maximize the net interest margin and net interest income.

The Company utilizes in-house asset/liability modeling software, ProfitStar to determine the effect changes in interest rates have on net interest income. Interest rate shock scenarios are modeled in a parallel shift of the yield curve in 100 basis point increments (plus or minus) in the federal funds rate.  Although certain assets and liabilities may have similar repricing characteristics, they may not react correspondingly to changes in market interest rates.  In the event of a change in interest rates, prepayment of loans and early withdrawal of time deposits would likely deviate from those previously assumed.  Increases in market rates may also affect the ability of certain borrowers to make scheduled principal payments.

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

During the first six months of 2008, the model indicated that the Company was asset sensitive and projected rising margins in a rising rate environment.  However during the last six months of 2008 and at December 31, 2008, the Profit Star model showed the Company had become liability sensitive, meaning that in a rising rate environment, the net interest margin and net interest income would decline.  The change in the Company’s interest rate risk position was due primarily to the activation of floors on approximately $280,000 of variable rate loans, combined with the relatively short maturity structure of the Company’s alternative funding.    The following table shows the estimated impact of interest rate changes plus 300 basis points and minus 300 basis points on net interest income in 100 basis point increments.  The base figure of $54,940 used in the analysis differs from actual net interest income for 2008 due to instruments being priced at offering rates, factoring in run-off assumptions. Due to the various assumptions used for this modeling and potential balance sheet strategies management may implement to mitigate interest rate risk, no assurance can be given that projections will reflect actual results.


 
 
-42-
 

Interest Rate Shock Analysis
Net Interest Income and Market Value Performance
($ in thousands)

Projected
    
Net Interest Income
  
Interest
    
Estimated
    
$ Change
    
% Change
  
Rate Change
    
Value
    
From Base
    
From Base
  
  +300     $ 49,100     $ (5,840 )     (10.63 )%
  +200       50,475       (4,465 )     (8.13 )%
  +100       51,657       (3,283 )     (5.98 )%
Base
       54,940       0       0.00 %
  -100       56,926       1,986       3.62 %
  -200       57,574       2,634       4.79 %
  -300       57,581       2,641       4.81 %

 
 
-43-
 


 

 





Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders
Pacific Continental Corporation and Subsidiary


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

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

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

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


-44-

 
 
Report of Independent Registered Public Accounting Firm


Page Two
 

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


Portland, Oregon
March 12, 2009







 
 
-45-
 

 Pacific Continental Corporation and Subsidiaries
Consolidated Balance Sheets



   
December 31,
    
December 31,
  
   
2008
    
2007
  
ASSETS
            
  Cash and due from banks
   $ 20,172     $ 23,809  
  Federal funds sold
     69       1,857  
  Interest-bearing deposits with banks
     214       410  
            Total cash and cash equivalents
     20,455       26,076  
                 
  Securities available-for-sale
     54,933       53,994  
  Loans held for sale
     410       -  
  Loans, less allowance for loan losses and net deferred fees
     945,377       813,647  
  Interest receivable
     4,021       3,652  
  Federal Home Loan Bank stock
     10,652       3,795  
  Property, plant and equipment, net of accumulated depreciation
     20,763       20,876  
  Goodwill and other intangible assets
     22,904       23,127  
  Other real estate owned
     3,806       423  
  Other assets
     7,522       3,681  
                 
            Total assets
   $ 1,090,843     $ 949,271  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                
  Deposits
                
    Noninterest-bearing demand
   $ 178,957     $ 175,941  
    Savings and interest-bearing checking
     392,935       401,714  
    Time $100,000 and over
     67,095       31,856  
    Other time
     83,450       34,913  
       Total deposits
     722,437       644,424  
                 
  Federal funds purchased
     44,000       5,360  
  Federal Home Loan Bank borrowings
     194,500       179,500  
  Junior subordinated debentures
     8,248       8,248  
  Accrued interest and other payables
     5,493       4,230  
            Total liabilities
     974,678       841,762  
                 
Commitments and contingencies (Notes 5, 16, and 18)
                
                 
Stockholders' equity
                
  Common stock, 25,000,000 shares authorized
     80,019       77,909  
     issued & outstanding:  12,079,691 at December 31, 2008
                
     and 11,934,866 at December 31, 2007
                
  Retained earnings
     37,764       29,622  
  Accumulated other comprehensive loss
     (1,618 )     (22 )
      116,165       107,509  
                 
           Total liabilities and stockholders’ equity
   $ 1,090,843     $ 949,271  
                 
See accompanying notes.
                


 
 
-46-
 

Pacific Continental Corporation and Subsidiaries
Consolidated Statements of Income


   
Year Ended December 31,
        
   
2008
    
2007
    
2006
  
Interest and dividend income
                  
  Loans
   $ 63,047     $ 67,122     $ 60,257  
  Securities
     2,787       1,973       1,667  
  Dividends on Federal Home Loan Bank stock
     91       21       4  
  Federal funds sold & Interest-bearing deposits with banks
     20       50       44  
      65,945       69,166       61,972  
                         
Interest expense
                        
  Deposits
     10,142       18,572       15,881  
  Federal Home Loan Bank & Federal Reserve borrowings
     5,456       6,160       5,144  
  Junior subordinated debentures
     498       508       510  
  Federal funds purchased
     578       500       380  
      16,674       25,740       21,915  
                         
     Net interest income
     49,271       43,426       40,057  
                         
Provision for loan losses
     3,600       725       600  
     Net interest income after provision for loan losses
     45,671       42,701       39,457  
                         
Noninterest income
                        
  Service charges on deposit accounts
     1,676       1,409       1,333  
  Other fee income, principally bankcard
     1,823       1,630       1,495  
  Loan servicing fees
     85       99       109  
  Mortgage banking income
     355       370       805  
  Other noninterest income
     330       417       659  
      4,269       3,925       4,401  
                         
Noninterest expense
                        
  Salaries and employee benefits
     18,089       15,667       14,578  
  Premises and equipment
     3,990       3,281       3,065  
  Bankcard processing
     546       524       510  
  Business development
     1,447       1,487       1,444  
  Other noninterest expense
     5,490       4,902       4,194  
      29,562       25,861       23,791  
                         
Income before provision for income taxes
     20,378       20,765       20,067  
Provision for income taxes
     7,439       7,830       7,412  
                         
     Net income
   $ 12,939     $ 12,935     $ 12,655  
                         
Earnings per share
                        
   Basic
   $ 1.08     $ 1.09     $ 1.09  
   Diluted
   $ 1.08     $ 1.08     $ 1.08  
See accompanying notes.
                        


 
 
-47-
 

Pacific Continental Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
For the Years Ended December 31, 2008, 2007, and 2006

   
Number
    
Common
    
Retained
    
Accumulated
Other
Comprehensive
  
   
of Shares
    
Stock
    
Earnings
    
Loss
    
Total
  
                               
Balance, January 1, 2006
     10,233,580     $ 53,319     $ 28,451     $ (358 )   $ 81,412  
                                         
Net income
                     12,655               12,655  
Other comprehensive income:
                                        
Unrealized gains on securities
                             184          
Deferred income taxes
                             (71 )        
                                         
Other comprehensive income
                             113       113  
                                         
Comprehensive income
                                     12,768  
Stock options exercised and related tax benefit
     413,684       4,350                       4,350  
Share-based payments
             586                       586  
Cash dividends
                     (3,381 )             (3,381 )
                                         
Balance, December 31, 2006
     10,647,264       58,255       37,725       (245 )     95,735  
                                         
Net income
                     12,935               12,935  
Other comprehensive income:
                                        
Unrealized gains on securities
                             362          
Deferred income taxes
                             (139 )        
                                         
Other comprehensive income
                             223       223  
                                         
Comprehensive income
                                     13,158  
Stock options exercised and related tax benefit
     212,823       2,240                       2,240  
Stock dividend - 10%
     1,074,779       16,863       (16,863 )                
Share-based payments
             551                       551  
Cash dividends
                     (4,175 )             (4,175 )
                                         
Balance, December 31, 2007
     11,934,866       77,909       29,622       (22 )     107,509  
                                         
Net income
                     12,939               12,939  
Other comprehensive loss:
                                        
Unrealized losses on securities
                             (2,555 )        
Deferred income taxes
                             959          
                                         
Other comprehensive loss
                             (1,596 )     (1,596 )
                                         
Comprehensive income
                                     11,343  
Stock options exercised and related tax benefit
     144,825       1,521                       1,521  
Share-based payments
             589                       589  
Cash dividends
                     (4,797 )             (4,797 )
                                         
Balance, December 31, 2008
     12,079,691     $ 80,019     $ 37,764     $ (1,618 )   $ 116,165  
                                         
                                         
See accompanying notes.
                                        

 
-48-
 

 
Pacific Continental Corporation and Subsidiaries
Consolidated Statements of Cash Flows



   
Years Ended December 31,
        
   
2008
    
2007
    
2006
  
                   
Cash flows from operating activities:
                  
Net income
   $ 12,939     $ 12,935     $ 12,655  
                         
Adjustments to reconcile net income to net cash
                        
from operating activities:
                        
Depreciation and amortization, net of accretion
     1,396       1,399       1,673  
Gain on sale of property
     -       -       (335 )
Loss on sale or write-down of property and equipment
     (25 )     -       6  
Provision for loan losses
     3,600       725       600  
Losses (Gains) on foreclosed assets
     119       -       (42 )
Deferred income taxes
     (1,633 )     (334 )     (1,049 )
Share-based compensation
     626       577       586  
Excess tax benefit of stock options exercised
     (59 )     (201 )     (272 )
Change in:
                        
Interest receivable
     (369 )     346       (654 )
Deferred loan fees
     (270 )     (450 )     (121 )
Capitalized loan servicing rights
     -       -       5  
Production of mortgage loans held-for-sale
     (13,103 )     (11,235 )     (31,988 )
Proceeds from the sale of mortgage loans held-for-sale
     12,693       13,375       30,490  
Accrued interest payable and other liabilities
     637       214       (1,157 )
Income taxes payable
     (1,258 )     451       891  
Other assets
     3,139       (801 )     (233 )
                         
Net cash provided by operating activities
     18,432       17,001       11,055  
                         
Cash flow from investing activities:
                        
Proceeds from maturities of available for sale
                        
     investment securities
     18,618       10,868       6,686  
Purchase of available for sale investment securities
     (21,923 )     (25,584 )     (6,167 )
Loans made net of principal collections received
     (130,457 )     (92,445 )     (86,667 )
Proceeds from sales of loans
     -       37,809       4,232  
Purchase of loans
     (12,120 )     (118 )     (6,315 )
Cash paid for acquisitions
     (3 )     (15 )     (12,749 )
Purchase of property
     (1,314 )     (3,670 )     (2,906 )
Proceeds from sale of property
     -       -       403  
Proceeds on sale of foreclosed assets
     2,642       -       194  
Purchase of energy tax credits
     (1,000 )     -       -  
Purchase of FHLB stock
     (6,857 )     (315 )     -  
                         
Net cash used by investing activities
     (152,414 )     (73,470 )     (103,289 )
                         
Cash flow from financing activities:
                        
Change in deposits
     78,014       3,152       37,321  
Change in federal funds purchased and FHLB
                        
     short-term borrowings
     52,640       (1,050 )     28,410  
Proceeds from FHLB term advances originated
     1,744,500       689,500       489,002  
FHLB advances paid-off
     (1,743,500 )     (639,804 )     (462,002 )
Proceeds from stock options exercised
     1,445       1,943       3,547  
Income tax benefit for stock options exercised
     59       201       272  
Dividends paid
     (4,797 )     (4,175 )     (3,381 )
                         
Net cash provided by financing activities
     128,361       49,767       93,169  
                         
Net increase (decrease) in cash and cash equivalents
     (5,621 )     (6,702 )     935  
                         
Cash and cash equivalents, beginning of year
     26,076       32,778       31,843  
                         
Cash and cash equivalents, end of year
   $ 20,455     $ 26,076     $ 32,778  
                         
Supplemental information:
                        
Noncash investing and financing activities:
                        
Transfers of loans to foreclosed assets
   $ 6,706     $ 423     $ 22  
Change in unrealized gain (loss) on securities, net of
                        
    deferred income taxes
     (1,596 )     223       113  
Adjustment to acquired NWBF Goodwill
     -       -       (353 )
Cash paid during the year for:
                        
Income taxes
   $ 7,822     $ 7,349     $ 7,325  
Interest
   $ 16,526     $ 25,959     $ 21,793  
                         
See accompanying notes.
                        

 
-49-
 

Pacific Continental Corporation and Subsidiaries
Notes to Consolidated Financial Statements




1.    Summary of Significant Accounting Policies:

Principles of Consolidation – The consolidated financial statements include the accounts of Pacific Continental Corporation (the “Company”), a bank holding company, and its wholly-owned subsidiary, Pacific Continental Bank (the “Bank”) and the Bank’s wholly-owned subsidiaries, PCB Service Corporation (which owns and operates bank-related real estate but is currently inactive) and PCB Loan Services Corporation (which owns and operates certain repossessed or foreclosed collateral but is currently inactive).  The Bank provides commercial banking, financing, mortgage lending and other services in Western Oregon and Western Washington.  All significant intercompany accounts and transactions have been eliminated in consolidation.

In November 2005, the Company formed a wholly-owned Delaware statutory business trust subsidiary, Pacific Continental Corporation Capital Trust (the “Trust”), which issued $8,248 of guaranteed undivided beneficial interests in the Pacific Continental’s Junior Subordinated Deferrable Interest Debentures (“Trust Preferred Securities”).  Pacific Continental has not consolidated the accounts of the Trust in its consolidated financial statements in accordance with FASB FIN 46R, Consolidation of Variable Interest Entities.  As a result, the junior subordinated debentures issued by Pacific Continental to the issuer trust, totaling $8,248 are reflected on Pacific Continental’s consolidated balance sheet at December 31, 2008, under the caption, “Junior Subordinated Debentures”.  Pacific Continental also recognized its $248 investment in the Trust, which is recorded among “Other Assets” in its consolidated balance sheet at December 31, 2008.

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

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

The Bank is required to maintain certain reserves as defined by regulation.  Such reserves totaling $1,196 and $3,779 were maintained within the Bank’s cash balances at December 31, 2008 and 2007, respectively.

Securities Available-for-Sale – Securities available-for-sale are held for indefinite periods of time and may be sold in response to movements in market interest rates, changes in the maturity or mix of Bank assets and liabilities or demand for liquidity.  Although management determines the appropriate classification of securities at the time of purchase, the Bank classified all securities as available-for-sale throughout 2008 and 2007.  Securities classified as available-for-sale are reported at estimated fair value.  The difference between estimated fair value and amortized cost is recorded as a separate component of stockholders’ equity (accumulated other comprehensive income or loss).  Fair values for these investment securities are based on available market prices.  Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method.   Interest income on securities available-for-sale is included in income using the level yield method.

-50-
Declines in fair value of individual available-for-sale securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value.  The related write-downs would be included in earnings as realized losses.  Management believes that all unrealized losses on investment securities at December 31, 2008 and 2007 are temporary.
 
Loans Held for Sale and Mortgage Banking Activities – The Bank originates residential mortgage loans for resale in the secondary market.  Sales are without recourse and the Bank generally does not retain mortgage servicing rights.  Loans held for sale are carried at the lower of cost or market.  Market value is determined on an aggregate loan basis.

Loans and Income Recognition – Loans are stated at the amount of unpaid principal plus loan premiums for purchased loans, reduced by net deferred loan origination fees, discounts associated with retained portions of loans sold, and an allowance for loan losses.  Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding.  Accrual of interest is discontinued on contractually delinquent loans when management believes, after considering economic and business conditions and collection efforts that the borrower’s financial condition is such that collection of the interest is doubtful.  Interest income is subsequently recognized only to the extent cash payments are received or the principal balance of the loan is brought current.  Loan origination fees, net of origination costs and discounts, are amortized over the lives of the loans as adjustments to yield.

Allowance for Loan Losses – The allowance for loan losses is established through a provision for loan losses charged to expense.  Loans are charged against the allowance for loan losses when management believes that the collectibility of principal is unlikely.  The allowance is an amount that management considers adequate to absorb possible losses on existing loans that may become uncollectible based on evaluations of the collectibility of loans and prior loss experience.  The evaluations take into consideration such factors as changes in the nature of the loan portfolio, overall portfolio quality, review of specific loans, estimated value of underlying collateral, and current economic conditions that may affect the borrower’s ability to pay.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant subsequent revision as more information becomes available.

A loan is considered impaired when management believes that it is probable that all amounts will not be collected according to the contractual terms.  An impaired loan is valued using the present value of expected cash flows discounted at the loan’s effective interest rate, the observable market price of the loan or the estimated fair value of the loan’s collateral or related guaranty.  Loans deemed impaired are specifically allocated for in the allowance for loan losses if the value of the impaired loan is less than the recorded investment in the loan.

Federal Home Loan Bank Stock – The investment in Federal Home Loan Bank (“FHLB”) stock is carried at par value, which approximates its fair value.  As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets or FHLB advances.  As of December 31, 2008, the minimum required investment was approximately $8,570.  The Bank may request redemption at par value of any stock in excess of the amount the Bank is required to hold.  Stock redemptions are at the discretion of the FHLB.

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

Improvements to foreclosed assets are capitalized.  Subsequent to foreclosure, management performs periodic valuations and the assets’ carrying value may be adjusted to the lower of carrying amount or fair value, less costs to sell.  Write downs to net realizable value, if any, or any disposition gains or losses are included in noninterest income or expense.

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

-51-
Depreciation and amortization is computed by the straight-line method over the estimated useful lives of the assets.  Estimated useful lives are 30 to 40 years for buildings, 3 to 10 years for furniture and equipment, and up to the lesser of the useful life or lease term for leasehold improvements.
 
Goodwill and Other Intangible Assets– Goodwill represents the excess of cost over the fair value of net assets acquired in business combinations.  Under Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets, the Bank does not amortize the balance of goodwill, but completes periodic assessments of goodwill impairment.  Goodwill impairment is deemed to exist if the net book value of a reporting unit giving rise to the recognition of goodwill exceeds estimated fair value.  The Bank’s assessments have not identified impairment of goodwill such that the net book value of the applicable reporting unit exceeded its estimated fair value as of December 31, 2008 and 2007.
 

Advertising – Advertising costs are charged to expense during the year in which they are incurred.  Advertising expenses were $756, $883 and $845 for the years ended December 31, 2008, 2007 and 2006, respectively.

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

The Company adopted the provision of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48) on January 1, 2007.  As a result of the implementation of FIN 48, the Company recognized no liability for unrecognized tax benefits.  The Company files tax returns with the Internal Revenue Service and the Oregon Department of Revenue.  Tax returns for years subsequent to 2004 remain open to examination by these taxing jurisdictions.  The Company’s policy with respect to interest and penalties ensuing from income tax settlements is to recognize them as noninterest expense.

Earnings Per Share – Basic earnings per share are computed by dividing net income by the weighted average number of shares outstanding during the period.  Diluted earnings per share include the effect of common stock equivalents that would arise from the exercise of stock options discussed in Note 15.  Weighted shares outstanding are adjusted retroactively for the effect of stock dividends.

Weighted average shares outstanding at December 31 are as follows:
 


   
2008
    
2007
    
2006
  
                   
Basic
     11,980,211       11,830,369       11,586,295  
Common stock equivalents attributable
                        
to stock-based compensation plans
     48,102       110,816       180,880  
                         
Diluted
     12,028,313       11,941,185       11,767,175  
                         


Share-Based Payment Plans – The Company adopted Financial Accounting Standards Board Statement No. 123R, “Share-Based Payment” (“SFAS 123R”) effective January 1, 2006.  SFAS 123R requires companies to measure and recognize compensation expense for all share-based payments at the grant date based on the fair value of the award, as defined in SFAS 123R, and include such costs as an expense in our income statements over the requisite service (vesting) period.  The Company adopted SFAS 123R using the modified prospective application, whereby the provisions of the statement have been applied prospectively only from the date of adoption for new (issued subsequent to December 31, 2005) and unvested stock option awards for which the requisite service is rendered after the date of adoption.  Thus, the Company recognizes as expense the fair value of stock options issued prior to January 1, 2006, but vesting after January 1, 2006, over the remaining vesting period.  In addition, compensation expense must be recognized for any awards modified, repurchased, or cancelled after the date of adoption.  The Company uses the Black-Scholes option pricing model to measure fair value.

-52-
 
Fair Value Measurements – SFAS No. 157, Fair Value Measurements, 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. SFAS No. 157 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.

Recently Issued Accounting Pronouncements – In December 2007, FASB issued SFAS No. 141 (revised), Business Combinations. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquired entity and the goodwill acquired. Furthermore, acquisition-related and other costs will now be expensed rather than treated as cost components of the acquisition. SFAS No. 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We do not expect the adoption of SFAS No. 141R will have a material impact on our consolidated financial statements as related to business combinations consummated prior to January 1, 2009. We expect the adoption of SFAS No. 141R will increase the costs charged to operations for acquisitions consummated on or after January 1, 2009.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment to ARD No 51. SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The standard also requires additional disclosures that clearly identify and distinguish between the interest of the parent’s owners and the interest of the noncontrolling owners of the subsidiary. This statement is effective on January 1, 2009 for the Company, to be applied prospectively. We do not expect the adoption of SFAS No. 160 will have a material impact on the Company’s consolidated financial statements.

In March 2008, FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133. SFAS No. 161 expands the disclosure requirements in SFAS No. 133 about an entity’s derivative instruments and hedging activities. This includes enhanced disclosures regarding how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Provisions of this statement are to be applied prospectively, and comparative disclosures for earlier periods are encouraged. We have adopted the provisions of SFAS 161 for the year ended December 31, 2008, and the impact was not material to our consolidated financial statements.

-53-
 
In May 2008, FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. Under SFAS 162, the U.S. GAAP hierarchy will now reside in the accounting literature established by the FASB. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements in conformity with U.S. GAAP for nongovernmental entities. This statement is effective 60 days after the U.S. Securities and Exchange Commission approves the Public Company Accounting Oversight Board’s amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. We do not expect the adoption of SFAS No 162 will have a material impact on the Company’s consolidated financial statements.

In June 2008, FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP EITF 03-6-1 concludes that nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and shall be included in the computation of EPS pursuant to the two-class method. This statement is effective for fiscal years beginning after December 15, 2008, to be applied retrospectively. Certain of the Company’s nonvested restricted stock awards qualify as participating securities as described under this pronouncement. The adoption of FSP EITF 03-6-1 will reduce both basic and diluted earnings per common share by $0.01 for the year ended December 31, 2007.

In October 2008, FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP No. 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The FSP does not change existing generally accepted accounting principles. This FSP was effective immediately upon issuance, including prior periods for which financial statements have not been issued. The impact of adoption did not have a material impact on the Company’s consolidated financial statements.

On January 12, 2009, FASB issued FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20. FSP EITF 99-20-1 addresses certain practice issues in EITF No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, by making its other-than-temporary impairment assessment guidance consistent with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. FSP EITF 99-20-1 removes the reference to the consideration of a market participant’s estimates of cash flows in EITF 99-20, and instead requires an assessment of whether it is probable, based on current information and events, that the holder of the security will be unable to collect all amounts due according to the contractual terms. If it is probable that there has been an adverse change in estimated cash flows, an other-than-temporary impairment is deemed to exist, and a corresponding loss shall be recognized in earnings equal to the entire difference between the investment’s carrying value and its fair value at the balance sheet date of the reporting period for which the assessment is made. This FSP is effective for interim and annual reporting periods ending after December 15, 2008, and shall be applied prospectively. The impact of adoption did not have a material impact on the Company’s consolidated financial statements.

Reclassifications – Certain amounts contained in the 2007 and 2006 consolidated financial statements have been reclassified where appropriate to conform to the financial statement presentation used in 2008.  These reclassifications had no effect on previously reported net income.

 
 
-54-
 


2.    Securities Available-for-Sale:

The amortized cost and estimated fair values of securities available-for-sale at December 31, 2008 are as follows:
 


                           
Securities in
    
Securities in
  
                           
Continuous
    
Continuous
  
                           
Unrealized
    
Unrealized
  
                           
Loss
    
Loss
  
         
Gross
    
Gross
    
Estimated
    
Position for
    
Position For
  
   
Amortized
    
Unrealized
    
Unrealized
    
Fair
    
Less Than
    
12 Months
  
   
Cost
    
Gains
    
Losses
    
Value
    
12 Months
    
or Longer
  
                                     
Unrealized Loss Positions
                                    
                                     
Obligations of states and
                                    
political subdivisions
   $ 3,573     $ -     $ 27     $ 3,546     $ 3,546     $ -  
Mortgage-backed securities
     19,710       -       3,165       16,545       14,400       2,145  
                                                 
    $ 23,283     $ -     $ 3,192     $ 20,091     $ 17,946     $ 2,145  
                                                 
Unrealized Gain Positions
                                                
                                                 
Obligations of U.S.
                                                
 Government agencies
   $ 1,994     $ 35     $ -     $ 2,029                  
Obligations of states and
                                                
political subdivisions
     3,856       83       -       3,939                  
Mortgage-backed securities
     28,390       484       -       28,874                  
                                                 
      34,240       602       -       34,842                  
                                                 
    $ 57,523     $ 602     $ 3,192     $ 54,933                  
                                                 
                                                 
                                                 

At December 31, 2008, there were 32 investment securities in unrealized loss positions.  The unrealized loss associated with the $2,145 in a continuous unrealized loss position for twelve months or longer was $658 at December 31, 2008.  In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rate 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 current economic conditions.  The projected average life of the securities portfolio is approximately three years.  Although yields on these securities may be below market rates during that period, no loss of principal is expected.

The amortized cost and estimated fair values of securities available-for-sale at December 31, 2008 are as follows:



         
Gross
    
Gross
    
Estimated
  
   
Amortized
    
Unrealized
    
Unrealized
    
Fair
  
   
Cost
    
Gains
    
Losses
    
Value
  
                         
Obligations of U.S. Government agencies
   $ 1,994     $ 35     $ -     $ 2,029  
Obligations of states and political subdivisions
     7,429       83       27     $ 7,485  
Mortgage-backed securities
     48,100       484       3,165       45,419  
              602                  
    $ 57,523     $ 1,204     $ 3,192     $ 54,933  
                                 

 
 
-55-
 

The amortized cost and estimated fair values of securities available-for-sale at December 31, 2007 are as follows:



         
Gross
    
Gross
    
Estimated
  
   
Amortized
    
Unrealized
    
Unrealized
    
Fair
  
   
Cost
    
Gains
    
Losses
    
Value
  
                         
Obligations of U.S Government agencies
   $ 10,532     $ 31     $ 22     $ 10,541  
Obligation of states and political subdivisions
     7,461       72       19       7,514  
Mortgage-backed securities
     36,037       118       216       35,939  
                                 
    $ 54,030     $ 221     $ 257     $ 53,994  
                                 
                                 
 
The amortized cost and estimated fair value of securities at December 31, 2008 and 2007 by contractual maturity are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations.


   
2008
          
2007
        
         
Estimated
          
Estimated
  
   
Amortized
    
Fair
    
Amortized
    
Fair
  
   
Cost
    
Value
    
Cost
    
Value
  
                         
Due in one year or less
   $ 3,024     $ 3,055     $ 7,965     $ 7,950  
Due after one year through 5 years
     1,484       1,498       4,764       4,804  
Due after 5 years through 10 years
     4,916       4,962       5,264       5,301  
Due after 10 years
     -       -       -       -  
Mortgage-backed securities
     48,099       45,418       36,037       35,939  
                                 
    $ 57,523     $ 54,933     $ 54,030     $ 53,994  
                                 

No securities available for sale were sold in 2008, 2007, or 2006.
 
At December 31, 2008, securities with amortized costs of $45,348 (estimated market values of $43,834) were pledged to secure certain Treasury and public deposits as required by law, and to secure borrowing lines.

3.    Loans:

Major classifications of loans, including loans held for sale, at December 31 are as follows:



   
2008
    
2007
  
             
Commercial loans
   $ 233,513     $ 188,940  
Real estate loans
     717,529       627,140  
Consumer loans
     7,455       8,226  
                 
      958,497       824,306  
Deferred loan origination fees
     (1,730 )     (1,984 )
                 
      956,767       822,322  
Allowance for loan losses
     (10,980 )     (8,675 )
                 
    $ 945,787     $ 813,647  
                 

 
-56-
 

 

Allowance for Loan Losses:

A summary of activity in the allowance for loan losses is as follows for the periods indicated:



   
2008
    
2007
    
2006
  
                   
Balance, beginning of year
   $ 8,675     $ 8,284     $ 7,792  
Provision charged to income
     3,600       725       600  
Loans charged against the allowance
     (1,477 )     (396 )     (223 )
Recoveries credited to allowance
     182       62       115  
                         
Balance, end of year
   $ 10,980     $ 8,675     $ 8,284  
                         


It is management’s opinion that the allowance for loan losses is adequate to absorb known and inherent risks in the loan portfolio.  However, actual results may differ from estimates.

Loans considered impaired, net of government guarantees, including all nonaccrual loans, totaled $6,132, $3,671, and $496 at December 31, 2008, 2007, and 2006, respectively.  The specific valuation allowance for loan losses related to these impaired loans was approximately $887, $160, and $109 at December 31, 2008, 2007, and 2006, respectively.  The average recorded investment in impaired loans was approximately $5,136, $1,512, and $637 in 2008, 2007, and 2006, respectively.  Interest income recognized on impaired loans during 2008, 2007, and 2006 was approximately $301, $226, and $72, respectively.  Additional interest income which would have been realized on nonaccrual and impaired loans if they had remained current and still accruing interest would have been approximately $173, $140, and $14 in 2008, 2007 and 2006, respectively.  There were no loans 90 days contractually past due and continuing to accrue interest as of December 31, 2008, 2007, and 2006, respectively.

At December 31, 2008, outstanding loans to dental professionals totaled approximately $122,205 and represented 12.8% of total outstanding loans.  In addition, a substantial portion of the loan portfolio is collateralized by real estate and is, therefore, susceptible to changes in local market conditions.  However, management believes that the loan portfolio is diversified by geographic location and among industry groups.  At December 31, 2008, outstanding residential construction loans totaled approximately $74,532 and represented 7.8% of total outstanding loans.  In addition, at December 31, 2008, unfunded loan commitments for residential construction totaled approximately $19,818.  There are no other industry concentrations in excess of 10% of the total loan portfolio.

4.    Loan Participations and Servicing:

In the normal course of business, the Bank has sold portions of loans to other institutions in order to extend the Bank’s lending capacity or to mitigate risk.  The unpaid principal balances of these serviced loans at December 31, 2008 and 2007 were $36,230 and $28,315, respectively.  These loans are not included in the accompanying consolidated balance sheets and the servicing component of these transactions are not material to the consolidated financial statements.
 

 
 
-57-
 


5.    Property:

The balance of property and accumulated depreciation and amortization at December 31 consists of the following:


   
2008
    
2007
  
             
Land
   $ 3,834     $ 3,834  
Buildings and improvements
     18,348       17,994  
Furniture and equipment
     8,130       9,315  
                 
      30,312       31,143  
Less accumulated depreciation & amortization
     (9,549 )     (10,267 )
                 
    $ 20,763     $ 20,876  
                 


The Bank leases certain facilities for office locations under noncancelable operating lease agreements expiring through 2039.  Rent expense related to these leases totaled $942, $654, and $712 in 2008, 2007 and 2006, respectively.  The Bank leases approximately 52% of its Springfield Gateway building to others under noncancelable operating lease agreements extending through 2012.

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



         
Property
  
   
Lease
    
Leased
  
   
Commitments
    
to Others
  
             
2009
   $ 954     $ 444  
2010
     690       306  
2011
     487       210  
2012
     342       151  
2013
     589       -  
Thereafter
     3,785       -  
                 
    $ 6,847     $ 1,111  
                 


Depreciation expense was $1,488, $1,385, and $1,244 for the years ended December 31, 2008, 2007 and 2006, respectively.
 
The Bank capitalized $39, and $37 of interest expense related to property additions during 2007 and 2006, respectively.  No interest was capitalized for similar property additions in 2008.
 


-58-

 

6.    Goodwill and Core Deposit Intangibles:

The following table summarizes the changes in the Company’s goodwill and core deposit intangible asset for the year ended December 31, 2008.



         
Core
        
         
Deposit
    
Total
  
   
Goodwill
    
Intangible
    
Intangibles
  
                   
Balance, December 31, 2006
   $ 22,306     $ 1,319     $ 23,625  
Sale of Consumer Finance Division loans and offices
     (275 )     -       (275 )
Amortization
     -       (223 )     (223 )
                         
Balance, December 31, 2007
   $ 22,031     $ 1,096     $ 23,127  
Amortization
     -       (223 )     (223 )
                         
Balance, December 31, 2008
   $ 22,031     $ 873     $ 22,904  
                         


The goodwill and core deposit intangible assets relate primarily to the NWB Financial Corporation acquisition in November 2005.  During 2007, the Bank sold the loan portfolio and office locations of its Consumer Finance Division, thus eliminating goodwill recognized on the 2003 purchase of the Coos Bay Consumer Finance office.  In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company does not recognize amortization expense related to its goodwill but completes periodic assessments of goodwill impairment.  Impairment, if deemed to exist, would be charged to noninterest expense in the period identified.  Management completed its annual assessment of goodwill impairment as of December 31, 2008 and determined no impairment currently exists.

Forecasted amortization expense is approximately $223 per year from 2009 through 2012 for the core deposit intangible assets acquired during 2005.

7.    Other Assets:

Other assets are comprised of the following for the periods indicated:



   
2008
    
2007
  
             
Deferred taxes
   $ 4,849     $ 2,208  
Prepaid expenses and other assets
     2,673       1,473  
                 
    $ 7,522     $ 3,681  
                 

 
-59-
 

8.    Deposits:

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



   
2008
    
2007
  
             
Less than three months
   $ 89,498     $ 37,616  
Three months to one year
     33,674       24,689  
One to three years
     21,482       3,526  
Thereafter
     5,891       938  
                 
    $ 150,545     $ 66,769  
                 


9.  Federal Funds Purchased:

The Bank has unsecured federal funds borrowing lines with correspondent banks totaling $118,000 at December 31, 2008 of which $24,000 was outstanding as of December 31, 2008.  The outstanding balance of these overnight funds was due January 2, 2009 and carried an interest rate of 0.45%.  At December 31, 2007, there was $5,360 borrowed against these lines.

The Bank also has a secured federal funds borrowing line available from the Federal Reserve Bank totaling $49,935 at December 31, 2008.  The Federal Reserve Bank borrowing line is secured through the pledging of approximately $66,579 of commercial loans under the Bank’s Borrower-In-Custody program. At December 31, 2008, the outstanding balance was $20,000, consisting of two, equal, advances.   The first is due January 15, 2009 and carries an interest rate of 0.28% and the second is due February 26, 2009 and carries an interest rate of 0.42%.   No balance was outstanding against this line as of December 31, 2007.

10.  Federal Home Loan Bank Borrowings:

The Bank has a borrowing limit with the FHLB equal to 30% of total assets, subject to discounted collateral and stock holdings.  At December 31, 2008, the borrowing line was approximately $327,253.  At December 31, 2008, there was $194,500 borrowed on this line, including an overnight $60,000 Cash Management Advance and $134,500 in term advances.  FHLB stock, funds on deposit with FHLB, and loans are pledged as collateral for borrowings from FHLB.  At December 31, 2008, the Bank had pledged approximately $441,782 in real estate loans and securities to the FHLB ($273,978 in discounted pledged collateral).


 
 
-60-
 

Federal Home Loan Bank borrowings by year of maturity and applicable interest rate are summarized as follows as of December 31:



   
Rate
    
2008
    
2007
  
                   
Cash Management Advance
     0.63 %   $ 60,000     $ 46,000  
2008
     2.99 - 4.65 %     -       110,500  
2009
     0.50 - 5.33 %     99,500       8,000  
2010
     3.03 - 5.28 %     11,500       8,000  
2011
     2.39 - 5.28 %     10,000       2,500  
2012
     3.66 - 5.28 %     4,500       2,500  
2013
     2.93 - 4.27 %     7,000          
2016
     5.05 - 5.05 %     2,000       2,000  
                         
            $ 194,500     $ 179,500  
                         


11.  Junior Subordinated Debentures:

In connection with the November 2005 acquisition of NWB Financial Corporation, the Company formed a wholly-owned Delaware statutory business trust subsidiary, Pacific Continental Corporation Capital Trust (the “Trust”), which issued $8,248 of guaranteed undivided beneficial interests in the Pacific Continental’s Junior Subordinated Deferrable Interest Debentures (“Trust Preferred Securities”).  These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines.  All of the common securities of the Trust are owned by Pacific Continental.  The proceeds from the issuance of the common securities and the Trust Preferred Securities were used by the Trust to purchase $8,248 of junior subordinated debentures of the Company.  The debentures which represent the sole asset of the Trust accrue and pay distributions quarterly at a fixed rate of 6.265% per annum of the stated liquidation value of $1 per capital security.
 
Pacific Continental has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (1) accrued and unpaid distributions required to be paid on the Trust Preferred Securities, (2) the redemption price with respect to any Trust Preferred Securities called for redemption by the Trust, and (3) payments due upon a voluntary or involuntary dissolution, winding up, or liquidation of the Trust.  The Trust Preferred Securities are mandatorily redeemable upon maturity of the debentures on January 7, 2036, or upon earlier redemption as provided in the indenture.  Pacific Continental has the right to redeem the debentures purchased by the Trust in whole or in part, on or after, January, 7, 2011.  As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued interest.  For the years ended December 31, 2008, 2007 and 2006, the Company recognized net interest expense of $498, $508 and $510, respectively, related to the Trust Preferred Securities.
 


 
 
-61-
 

12.  Income Taxes:

The provision for income taxes for the years ended December 31 consists of the following:



   
2008
    
2007
    
2006
  
                   
Currently payable:
                  
Federal
   $ 8,571     $ 7,608     $ 7,626  
State
     501       556       835  
                         
      9,072       8,164       8,461  
                         
Deferred:
                        
Federal
     (1,416 )     (288 )     (905 )
State
     (217 )     (46 )     (144 )
                         
      (1,633 )     (334 )     (1,049 )
                         
Total provision for income taxes
   $ 7,439     $ 7,830     $ 7,412  
                         


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

 



   
2008
          
2007
          
2006
        
                                     
Expected federal income
                                    
tax provision
   $ 7,132       35.00 %   $ 7,268       35.00 %   $ 7,023       35.00 %
State income tax, net of
                                                
federal income tax effect
     660       3.24 %     733       3.53 %     726       3.62 %
Municipal securities tax benefit
     (113 )     -0.55 %     (47 )     -0.23 %     (42 )     -0.21 %
Equity-based compensation
     120       0.59 %     199       0.96 %     184       0.92 %
Benefit of purchased tax credits
     (315 )     -1.55 %     (395 )     -1.90 %     (231 )     -1.15 %
Deferred tax rate adjustments
                                          
and other
     (45 )     -0.22 %     72       0.35 %     (248 )     -1.24 %
                                                 
Provision for income taxes
   $ 7,439       36.51 %   $ 7,830       37.71 %   $ 7,412       36.94 %


    The tax benefit associated with stock option plans reduced taxes payable by $59, $301 and $803 at December 31, 2008, 2007 and 2006, respectively.  Such benefit is credited to common stock.


 
 
-62-
 

The components of deferred tax assets and liabilities at December 31 are as follows:


   
2008
    
2007
    
2006
  
                   
Assets:
                  
Allowance for loan losses
   $ 4,280     $ 3,052     $ 2,811  
Basis adjustments on loans
     365       141       200  
Reserve for self-funded insurance
     66       104       70  
Oregon purchased tax credits
     1,491       1,248       887  
Nonqualified stock options
     128       59       37  
Net unrealized losses on securities
     973       14       153  
Nonaccrual loan interest
     86       -       -  
                         
Total deferred tax assets
     7,389       4,618       4,158  
                         
Liabilities:
                        
Federal Home Loan Bank stock dividends
     582       582       597  
Excess tax over book depreciation
     610       394       330  
Prepaid expenses
     238       179       179  
NWBF acquisition adjustments
     336       439       572  
Other, principally loan orig. costs and deferred fees
     580       816       828  
                         
Total deferred tax liabilities
     2,346       2,410       2,506  
                         
Net deferred tax assets/(liabilities)
   $ 5,043     $ 2,208     $ 1,652  
                         


Purchased tax credits of $1,491 will be utilized to offset future state income taxes.  These credits are recognized over a five year period beginning in the year of purchase and have an eight year carry forward period.  If unused, the credits will expire in the following years:  $614 in 2017, $450 in 2018, $285 in 2019 and $142 in 2020.  It is anticipated that all credits will be fully utilized and, accordingly, Management has not reduced these deferred tax assets by a valuation allowance.  Management also believes that all net deferred tax assets will be recognized in the normal course of operations and, accordingly, deferred tax assets as of December 31, 2008 have not been reduced by a valuation allowance.

The Company adopted the provision of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48) on January 1, 2007.  As a result of the implementation of FIN 48, the Company recognized no liability for unrecognized tax benefits.  The Company files tax returns with the Internal Revenue Service and the Oregon Department of Revenue.  Tax returns for years subsequent to 2004 remain open to examination by these taxing jurisdictions.  The Company’s policy with respect to interest and penalties ensuing from income tax settlements is to recognize them as noninterest expense.

13.  Retirement Plan:

The Bank has a 401(k) profit sharing plan covering substantially all employees.  The plan provides for employee and employer contributions.  The total plan expenses, including employer contributions, were $713, $784 and $748 in 2008, 2007 and 2006, respectively.

14.  Stock Option Plans:

Pursuant to the approval of the 2006 Stock Option and Equity Compensation Plan (the “2006 SOEC Plan”) at the annual stockholders’ meeting in April 2006, incentive stock options, nonqualified stock options, restricted stock, restricted stock units, or stock appreciation rights may be awarded to attract and retain the best available personnel for positions of responsibility with the corporation and its subsidiaries.  Upon adoption of the 2006 SOEC Plan, the Company’s 1999 Employees’ Stock Option Plan (“1999 ESOP Plan”) and the Directors’ Stock Option Plan (“1999 DSOP Plan”) were cancelled and no longer available for future grants.  The exercise price for shares of common stock subject to an option under the SOEC Plan shall not be less than 100% of the fair market value of a share of common stock as of the date of grant of the option; provided, however, that in the case of an incentive stock option granted to an employee who immediately before the grant of such incentive stock option is a stockholder-employee, the incentive stock option exercise price shall be at least 110% of the fair value of the common stock as of the date of grant of the incentive stock option. 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.  For the year ended December 31, 2008, the Company issued 94 incentive stock options, of which 92, 312 have a fair value of $2.59 per unit and 2,000 have a fair value of $2.40 per unit, to selected employees.

-63-
Pursuant to the Company’s 2006 SOEC Plan, stock appreciation rights (SARs) may be granted to employees.  The stock appreciation rights may be settled in cash or cash and common stock as determined at the date of issuance.  The Compensation Committee or the Board of Directors determines vesting provisions when awards are granted, and the awards granted generally vest over three or four years and have a maximum life of ten years.  SARs settled in stock are recognized as equity-based awards while SARs settled in cash are recognized on the balance sheet as liability-based awards, both of which are granted at the fair market value of our common stock at the grant date.  The grant-date fair value of the liability based awards vesting in the current period, along with the change in fair value of the awards during the period, are recognized as compensation expense and as an adjustment to the recorded liability.  For the year ended December 31, 2008, the Company issued 221 SARs, of which 121,475 have a fair value of $2.17 per unit and 7,400 have a fair value of $1.87 per unit and are to be settled in stock and 92,374 have a fair value of $2.59 per unit and 1,440 have a fair value of $1.63 per unit and are to be settled in cash.

Also, pursuant to the Company’s 2006 SOEC Plan, non-qualified options awards and restricted stock awards may be granted to directors.  Stock options may be granted at exercise prices of not less than 100% of the fair market value of our common stock at the grant date.  Restricted stock awards may be granted at the fair market value on the date of the grant.  The maximum life of options granted under this plan is ten years from the grant date.  The Company issued 21,120 nonqualified stock options, with a fair value of $2.65 per option, during the third quarter 2006.  For the year ended December 31, 2007, the Company issued 17,292 nonqualified stock options, with a fair value of $3.09 per option.  For the year ended December 31, 2008, the company issued 4 restricted stock awards to its Directors, with a fair value of $14.44 per share, the closing share price on the date of the grant.

The following tables identify the compensation expenses and tax benefits received by the Company according to the compensation plans and awards described above for the years 2008 and 2007:




   
2008
    
2007
  
   
Comp. Exp.
    
Tax Benefit
    
Comp. Exp.
    
Tax Benefit
  
1999 ESOP Plan
   $ 159     $ -     $ 282     $ -  
1999 DSOP Plan
     -       -       7       3  
2006 SOEC - ISOs
     158       -       108       -  
2006 SOEC - SARS stock
     185       68       128       49  
2006 SOEC - SARS cash
     37       14       26       10  
2006 SOEC - DSOs
     27       10       26       10  
2006 SOEC - DRSA
     60       22       -       -  
   Total
   $ 626     $ 114     $ 577     $ 72  
                                 

 
-64-
 



Stock Options –
The following table provides the weighted-average fair values for stock options, exclusive of the options issued as a result of the NWBF acquisition, granted during the last three years.  These values were estimated using the Black-Scholes option valuation model with the following weighted-average assumptions:

 

   
Year Ended December 31,
        
   
2008
    
2007
    
2006
  
Expected life in years (1)
     7.01       5.61       5.26  
Volatility (1)
     18.93 %     17.87 %     17.97  
Interest Rate (2)
     3.44 %     4.81 %     4.70 %
Yield Rate (3)
     2.77 %     1.58 %     1.77 %
                         
Average Fair-Value
   $ 2.59     $ 4.18     $ 3.78  
                         


(1)  
Volatility is based on historical experience over a period equivalent to the expected life in years.
(2)  
Based on the U.S. Treasury constant maturity interest rate with a term consistent with the expected life of the options granted.
(3)  
The Company has paid cash dividends on common stock since 1985.  Each grant’s dividend yield is calculated by annualizing the most recent quarterly cash dividend and dividing that amount by the market price of the Company’s common stock as of the grant date.

For any future grants, as required by SFAS 123R, the Company will estimate the impact of forfeitures based  on our historical experience with previously granted stock options, and consider the impact of the forfeitures when determining the amount of expense to record for the stock options granted.  For stock options issued prior to the adoption of SFAS 123R, forfeitures were recognized when the stock option was actually forfeited.  The Company generally issues new shares of common stock to satisfy stock option exercises.

A summary of stock option activity adjusted for all stock dividends and splits for all Company plans during the current fiscal year is presented below:


Total Stock Options
  
Shares
(in thousands)
    
Average Price Per Share
    
Weighted-Average Remaining Contractual Life
    
Aggregate Intrinsic Value
  
Outstanding at December 31, 2007
     698     $ 13.46              
Granted
     94       14.44              
Exercised
     (141 )     10.27              
Forfeited or expired
     (23 )     15.71              
Outstanding at December 31, 2008
     628     $ 14.24       4.04     $ 871  
                                 
Exercisable at December 31, 2008
     423     $ 13.35       2.26     $ 819  
                                 

 
-65-
 


Nonvested Options
  
Shares
(in thousands)
Weighted-Average Grant Date Fair Value
Outstanding at December 31, 2007
               233
  
 $           3.48
Granted
    
                 94
  
              2.59
Vested
    
              (111)
  
              4.31
Forfeited or expired
  
                (11)
  
              2.80
Outstanding at December 31, 2008
               205
  
 $           2.66
           



A summary of value received by employees and directors exercising stock options over the last three years is presented below:



   
Year Ended December 31
        
   
2008
    
2007
    
2006
  
Total intrinsic value of
                  
   stock options exercised
   $ 488     $ 1,206     $ 2,883  


Stock Appreciation Rights -
The following table provides the weighted-average fair values for stock appreciation rights (SARs) to be settled in stock.  These are considered to be equity-based awards.  No activity was recognized for the year ended 2005. The values were estimated using the Black-Scholes option valuation model with the following weighted-average assumptions:



   
Year Ended December 31,
        
   
2008
    
2007
    
2006
  
Expected life in years (1)
     6.01       6.00       6.00  
Volatility (1)
     16.99 %     18.68 %     19.51 %
Interest Rate (2)
     3.21 %     4.81 %     4.72 %
Yield Rate (3)
     2.78 %     1.58 %     1.78 %
                         
Average Fair-Value
   $ 2.15     $ 4.45     $ 4.27  
                         

 
(1)  
Volatility is based on historical experience over a period equivalent to the expected life in years.
(2)  
Based on the U.S. Treasury constant maturity interest rate with a term consistent with the expected life of the options granted.
(3)  
The Company has paid cash dividends on common stock since 1985.  Each grant’s dividend yield is calculated by annualizing the most recent quarterly cash dividend and dividing that amount by the market price of the Company’s common stock as of the grant date.


 
 
-66-
 

A summary of SAR – stock awards activity adjusted for all stock dividends during the current fiscal year is presented below:



Total SAR - Stock Awards
  
Awards
(in thousands)
    
Average Price Per Award
    
Weighted-Average Remaining Contractual Life
  
Outstanding at December 31, 2007
     155     $ 17.44        
Granted
     128       14.40        
Exercised
     -       -        
Forfeited or expired
     (17 )     16.58        
Outstanding at December 31, 2008
     266     $ 16.03       8.50  
                         
Exercisable at December 31, 2008
     52     $ 17.09       7.87  
                         



Nonvested SAR - Stock Awards
  
Awards
(in thousands)
Weighted-Average Grant Date Fair Value
Outstanding at December 31, 2007
               137
  
 $           4.22
Granted
    
               128
  
              2.15
Vested
    
                (36)
  
              4.21
Forfeited or expired
  
                (14)
  
              3.63
Outstanding at December 31, 2008
  
               215
  
 $           3.03
           


A summary of SAR – cash awards activity during the current fiscal year is presented below:



Total SAR - Cash Awards
  
Awards
(in thousands)
    
Average Price Per Award
    
Weighted-Average Remaining Contractual Life
  
Outstanding at December 31, 2007
     116     $ 17.41        
Granted
     93       14.43        
Exercised
     -       -        
Forfeited or expired
     (17 )     16.33        
Outstanding at December 31, 2008
     192     $ 16.06       8.48  
                         
Exercisable at December 31, 2008
     39     $ 17.06       7.86  
                         


Nonvested SAR - Cash Awards
  
Awards
(in thousands)
Weighted-Average Grant Date Fair Value
Outstanding at December 31, 2007
               102
  
 $           4.22
Granted
    
                 93
  
              1.85
Vested
    
                (27)
  
              4.15
Forfeited or expired
  
                (15)
  
              3.30
Outstanding at December 31, 2008
  
               153
  
 $           2.88
           

 
-67-
 


 
For any future grants, as required by SFAS 123R, the Company will estimate the impact of forfeitures based on our historical experience with previously granted stock options, and consider the impact of the forfeitures when determining the amount of expense to record for both stock and cash settled SARs.

At December 31, 2008, the Company has estimated unrecognized compensation expense of approximately $432, $427, and $132 for unvested stock options, SAR – stock awards and SAR – cash awards, respectively.  These amounts are based on a forfeiture rate assumption of 20% for all awards granted to employees.  The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested stock options, SAR – stock awards and SAR – cash awards is approximately 2.3, 2.4 and 2.8 years, respectively.

15.  Transactions with Related Parties:

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


   
2008
    
2007
  
             
Balance, beginning of year
   $ 1,462     $ 2,242  
                 
Additions or renewals
     549       249  
Amounts collected
     (248 )     (1,029 )
                 
Balance, end of year
   $ 1,763     $ 1,462  
                 


   In addition, there were $478 in commitments to extend credit to directors and officers at December 31, 2008, which are included among loan commitments, disclosed Note 17.

16.  Financial Instruments with Off-Balance-Sheet Credit Risk:

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

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

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


 
 
-68-
 

Off-balance-sheet instruments at December 31 consist of the following:


   
2008
    
2007
  
             
Commitments to extend credit (principally
            
variable rate)
   $ 182,609     $ 279,655  
Letters of credit and financial guarantees written
     2,298       2,449  
                 


17.  Fair Value Disclosures of Financial Instruments:

The following disclosures are made in accordance with provisions of SFAS No. 107, Disclosures About Fair Value of Financial Instruments.  The use of different assumptions and estimation methods could have a significant effect on fair value amounts.  Accordingly, the estimates of fair value herein are not necessarily indicative of the amounts that might be realized in a current market exchange.

The estimated fair values of the financial instruments at December 31 are as follows:
 


   
2008
          
2007
        
   
Carrying
          
Carrying
        
   
Amount
    
Fair Value
    
Amount
    
Fair Value
  
                         
Financial assets:
                        
Cash and cash equivalents
   $ 20,455     $ 20,455     $ 26,077     $ 26,077  
Securities available for sale
     54,933       54,933       53,993       53,993  
Loans held for sale
     410       410       -       -  
Loans, net of allowance
                                
for loan losses
     945,377       947,091       813,647       809,910  
Interest receivable
     4,021       4,021       3,652       3,652  
Federal Home Loan
                                
Bank stock
     10,652       10,652       3,795       3,795  
                                 
Financial liabilities:
                                
Deposits
     722,437       723,188       644,424       644,293  
Federal funds purchased
     44,000       44,000       5,360       5,360  
Federal Home Loan Bank
                                
borrowings
     194,500       196,001       179,500       179,819  
Junior subordinated debentures
     8,248       7,903       8,248       7,758  
Accrued interest payable
     395       395       324       324  


Cash and Cash Equivalents – The carrying amount approximates fair value.

Securities available for sale and Federal Home Loan Bank stock – 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.  FHLB stock is valued based on the most recent redemption price.

Loans Held for Sale – Fair value represents the anticipated proceeds from the sale of related loans.

Loans – For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are 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.

-69-
Interest receivable and payable – The carrying amounts of accrued interest receivable and payable approximate their fair value.

Deposits – Fair value of demand, interest-bearing demand and savings deposits is the amount payable on demand at the reporting date.  Fair value of time deposits is estimated using the interest rates currently offered for deposits of similar remaining maturities.

Federal Funds Purchased – The carrying amount is a reasonable estimate of fair value because of the short-term nature of these borrowings.

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

Junior Subordinated Debentures – Fair value of Junior Subordinated Debentures is estimated by discounting future cash flows at rates currently available for debt with similar 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.

Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measures”.  This statement 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 non-recurring 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 and 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 shall be adjusted for market consideration when reasonably available.

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


 
 
-70-
 

The table below shows assets measured at fair value as of December 31, 2008:


       
 
  Fair Value
    
   
Carrying Value
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Year Ended December 31,
2008
Total Loss
               
Recurring Items
            
Available-for-sale securities
$       54,933
  
$                   -
$         54,933
$                    -
$                   -
               
Non-Recurring Items
            
Goodwill
$       22,031
      
22,031
-
Loans measured for impairment
          
(net of guarantees)
1,927
  
-
-
1,927
887
Other real estate owned
3,806
  
-
-
3,806
49
               
Total
$       82,697
  
$                   -
$         54,933
$          27,764
$              936


18.  Commitments and Legal Contingencies:

The Company has entered into employment agreements with two key executive officers.  The employment agreements provide for minimum aggregate annual base salaries of $550,000, plus performance adjustments, life insurance coverage, and other perquisites commonly found in such agreements.  The two employment agreements expire in 2011 unless extended or terminated earlier.

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

19.  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 and Tier I capital to risk-weighted assets and of Tier I capital to leverage assets.  Management believes, as of December 31, 2008, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2008 and according to FDIC guidelines, the Bank is considered to be well capitalized.  To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table.  There are no conditions or events since that notification that management believes have changed the institution’s category.

-71-
The Bank’s actual capital amounts and ratios are presented in the table (the Company’s capital ratios do not differ significantly from those of the Bank).



   
Actual
          
 
For Capital
Adequacy Purposes
    
To Be Well
Capitalized Under Prompt Corrective
Action Provisions
  
   
Amount
    
Ratio
    
Amount
    
Ratio
    
Amount
    
Ratio
  
                                     
As of December 31, 2008:
                                    
Total capital (to risk
                                    
weighted assets)
   $ 113,600       11.11 %   $ 81,773       8 %   $ 102,216       10 %
Tier I capital (to risk
                                                
weighted assets)
     102,424       10.02 %     40,887       4 %     61,330       6 %
Tier I capital (to leverage
                                                
assets)
     102,424       9.68 %     42,306       4 %     52,882       5 %
                                                 
As of December 31, 2007:
                                                
Total capital (to risk
                                                
weighted assets)
   $ 101,065       10.97 %   $ 73,720       8 %   $ 92,150       10 %
Tier I capital (to risk
                                                
weighted assets)
     92,194       10.00 %     36,860       4 %     55,290       6 %
Tier I capital (to leverage
                                                
assets)
     92,194       10.11 %     36,491       4 %     45,614       5 %
                                                 



20.  Parent Company Financial Information:

Financial information for Pacific Continental Corporation (Parent Company only) is presented below:

BALANCE SHEETS
December 31


   
2008
    
2007
  
             
Assets:
            
Cash deposited with the Bank
   $ 621     $ 337  
Prepaid expenses
     6       4  
Deferred income taxes
     -       -  
Equity in Trust
     248       248  
Investment in the Bank, at cost plus equity
                
in earnings
     123,670       115,300  
                 
    $ 124,545     $ 115,889  
                 
Liabilities and stockholders' equity:
                
Liabilities
   $ 132     $ 132  
Junior subordinated debentures
     8,248       8,248  
Stockholders' equity
     116,165       107,509  
                 
    $ 124,545     $ 115,889  
                 

 
-72-
 
 
 

STATEMENTS OF INCOME
For the Periods Ended December 31



   
2008
    
2007
    
2006
  
                   
Income:
                  
Cash dividends from the Bank
   $ 4,100     $ 2,610     $ -  
                         
      4,100       2,610       -  
                         
Expenses:
                        
Interest expense
     498       509       510  
Investor relations
     46       52       85  
Legal, registration expense, and other
     94       74       80  
Personnel costs paid to Bank
     110       109       95  
                         
      748       744       770  
                         
Income (loss) before income tax (expense) benefit
                  
          and equity in undistributed
                        
          earnings of the Bank
     3,352       1,866       (770 )
                         
Income tax  (expense) benefit
     (1,274 )     (709 )     293  
Equity in undistributed earnings of the Bank
     10,861       11,778       13,132  
                         
     Net income
   $ 12,939     $ 12,935     $ 12,655  
                         

 
-73-
 

STATEMENTS OF CASH FLOWS
For the Periods Ended December 31


   
2008
    
2007
    
2006
  
                   
Cash flows from operating activities:
                  
Net income
   $ 12,939     $ 12,935     $ 12,655  
Adjustments to reconcile net income
                        
to net cash provided by operating
                        
activities:
                        
Equity in undistributed earnings of
     (10,861 )     (11,778 )     (13,132 )
   the Bank
                        
Other, net
     (2,542 )     (1,609 )     66  
                         
Net cash used in operating activities
     (464 )     (452 )     (411 )
                         
Cash flows from investing activities:
                        
Dividend received from bank subsidiary
     4,100       2,610       -  
                         
Net cash provided by investing activities
     4,100       2,610       -  
                         
Cash flows from financing activities:
                        
Proceeds from stock options exercised
     1,445       1,939       3,547  
Dividends paid
     (4,797 )     (4,175 )     (3,381 )
                         
Net cash provided by (used in) financing activities
     (3,352 )     (2,236 )     166  
                         
Net increase (decrease) in cash
     284       (78 )     (245 )
                         
Cash, beginning of period
     337       415       660  
                         
Cash, end of period
   $ 621     $ 337     $ 415  
                         



 
21.  Subsequent Events:

On January 7, 2009, the Company completed a private placement stock offering for 750,000 shares of common stock at a price of $13.50 per share. The net proceeds from the offering, after placement fees and estimated transaction expenses, are approximately $9.6 million. Proceeds of the offering will be available to support ongoing operating growth and to fund possible future acquisitions.

Effective January 1, 2009, the FDIC has increased federal deposit insurance premiums by 7 basis points.  The increase of these premiums will add to our cost of operations and could have a significant impact on the Company.  New rules governing deposit insurance premiums are expected to go into effect on April 1, 2009. These new rules are intended to make assessments more balanced by requiring riskier institutions to pay a larger share.

In addition, during the first quarter of 2009, the FDIC adopted an interim rule imposing an emergency special assessment of 10 basis points on insured institutions, and granting the FDIC the authority to impose an additional emergency special assessment after June 30, 2009 of up to 10 basis points if necessary.  The assessment will be calculated on June 30, 2009 deposit balances and collected on September 30, 2009.  Based on the Company’s December 31, 2008 deposits subject to FDIC insurance assessments, the special assessment will be approximately $750 thousand.


-74-


None


Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures, as required by Rule 13a-15(b) of the Securities Exchange Act of 1934.  Based on that evaluation, the CEO and CFO have concluded that as of the end of the period covered by this report, our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and timely reported as provided in the SEC rules and forms.  As a result of this evaluation, there were no significant changes in our internal control over financial reporting during the three months ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

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

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

The management of Pacific Continental Corporation has assessed the effectiveness of its internal control over financial reporting at December 31, 2008.  To make this assessment, the Company used the criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this assessment, the Company believes that as of December 31, 2008, the internal control system over financial reporting met those criteria.

The Company’s independent auditors, Moss Adams, L.L.P., have issued an attestation report on the Company’s internal control over financial reporting.  The attestation report can be found on pages 35 and 36 of this document.


None

PART III


The information regarding “Directors and Executive Officers of the Registrant” of the Company is incorporated by reference from the sections entitled “ELECTION OF DIRECTORS—Nominees for Director,” “MANAGEMENT” and “COMPLIANCE WITH SECTION 16(a) FILING REQUIREMENTS” of the Company’s 2009 Annual Meeting Proxy Statement (the “Proxy Statement”).

-75-
 
In September of 2003, consistent with the requirements of The Sarbanes-Oxley Act of 2002, the Company adopted a Code of Ethics applicable to senior financial officers including the principal executive officer.  The Code of Ethics was amended in 2007 to reflect non-material changes and is filed as Exhibit 14 to the Company’s Annual Report on Form 10-K for the year-end December 31, 2008.  The Code of Ethics can also be accessed electronically by visiting the Company’s website.

Information regarding the Company’s Audit Committee financial expert appears under the section entitled “INFORMATION REGARDING THE BOARD OF DIRECTORS AND ITS COMMITTEES – Certain Committees of the Board of Directors” in the Company’s Proxy Statement and is incorporated by reference.


The information regarding “Executive Compensation” is incorporated by reference from the sections entitled “COMPENSATION DISCUSSION AND ANALYSIS,” “EXECUTIVE COMPENSATION” and “DIRECTOR COMPENSATION” of the Proxy Statement.


The information regarding “Security Ownership of Certain Beneficial Owners and Management” is incorporated by reference from the section entitled “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT” of the Proxy Statement.


The information regarding “Certain Relationships and Related Transactions” is incorporated by reference from the section entitled “TRANSACTIONS WITH MANAGEMENT” of the Proxy Statement.


For information concerning principal accountant fees and services as well as related pre-approval policies, see “AUDITORS – Fees Paid to Independent Accountants” in the Company’s Proxy Statement, which is incorporated by reference.

 
 
-76-
 


(a)(1)                 See Index to Consolidated Financial Statements filed under item 8 of this report.

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

(a)(2)                 Exhibit Index

Exhibit
3.1                    Amended Articles of Incorporation (1)
3.2                    Amended and Restated Bylaws (2)
10.1                  1999 Employee Stock Option Plan (3)
10.2                  1999 Director’s Stock Option Plan (3)
10.3                  2006 Stock Option and Equity Compensation Plan (4)
10.4                  Form of Restricted Stock Award Agreement (4)
10.5                  Form of Stock Option Award Agreement (4)
10.6                  Form of Restricted Stock Unit Agreement (4)
10.7                  Form of Stock Appreciation Rights Agreement (4)
10.8                  Change of Control/Salary Continuation Agreement for Michael Reynolds (5)
10.9                  Change of Control/Salary Continuation Agreement for Daniel Hempy (5)
10.10                 Change of Control/Salary Continuation Agreement for Basant Singh (6)
10.11                 Executive Employment Agreement for Roger Busse (7)
10.12                 Executive Employment Agreement for Hal Brown (7)
10.13                 NWB Financial Corporation Employee Stock Option Plan (8)
10.14                 NWB Financial Corporation Director Stock Option Plan (8)
        10.15
Director Fee Schedule, Effective January 1, 2009
        10.16
Director Stock Trading Plan (7)
 
10.17
Form of Common Stock Purchase Agreement between the Company and each of the Purchasers, dated as of January 6, 2009 (9)
 
10.18
Form of Registration Rights Agreement between the Company and each of the Purchasers, dated as of January 6, 2009 (9)
14                     Code of Ethics for Senior Financial Officers and Principal Executive Officer (7)
21                     Subsidiars (See Part I, Item 1. Business of this Form 10K)
23.1                  Accountants Consent of Moss Adams L.L.P.
31.1                  302 Certification, Hal Brown, President and Chief Executive Officer
 
31.2 
302 Certification, Michael A. Reynolds, Executive Vice President and Chief Financial Officer
32                     Certifications Pursuant to 18 U.S.C. Section 1350
(1)
Incorporated by reference to Exhibit 3 of the Company’s Quarterly Report on 10-Q for the Quarter ended June 30, 2007.
(2)
Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the Quarter ended September 30, 2008.
(3)
Incorporated by reference to Exhibits 99.1 - 99.4 of the Company’s S-8 Registration Statement (File No. 333-109501).
(4)
Incorporated by reference to Exhibits 99.1 - 99.5 of the Company’s S-8 Registration Statement (File No. 333-134702).
(5)
Incorporated by reference to Exhibits 10.1 and 10.2 of the Company’s Quarterly Report on 10-Q for the Quarter ended March 31, 2005.
(6)
Incorporated by reference to Exhibit 10.10 of the Registration Statement on Form S-4 (File No. 333-128968).
(7)
Incorporated by reference to Exhibits 10.11, 10.12, 10.16 and 14 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.
(8)
Incorporated by reference to Exhibits 99.1 and 99.2 of the Company’s S-8 Registration Statement (File No. 333-130886).
(9)
Incorporated by reference to Exhibits 10.1 and 10.2 of the Company’s Current Report on Form 8-K filed January 8, 2009.
 
 
 
-77-
 
 
(a)(3)               Financial Statement Schedules

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned on March 13, 2009.

PACIFIC CONTINENTAL CORPORATION
(Company)



By:    /s/ Hal M. Brown
Hal Brown
Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated on the 13th day of March, 2009.

Principal Executive Officer


By   /s/  Hal M. Brown                                          Chief Executive Officer
Hal Brown                                                      and Director

Principal Financial and Accounting Officer


By /s/  Michael A. Reynolds                               Executive Vice President and
Michael A. Reynolds                                   Chief Financial Officer

Remaining Directors


By   /s/ Robert A. Ballin                                         Chairman of the Board
Robert A. Ballin

By   /s/  Donald G. Montgomery                           Vice Chairman                                   By   /s/  Michael D. Holzgang         Director
Donald G. Montgomery                                                                                                     Michael D. Holzgang


By   /s/ Larry G. Campbell                                         Director                               By   /s/  Donald L. Krahmer, Jr.         Director
Larry G. Campbell                                                                                                                Donald L. Krahmer, Jr.


By   /s/ Cathi Hatch                                                    Director                                           By   /s/  John H. Rickman            Director
Cathi Hatch                                                                                            John H. Rickman


By   /s/  Michael S. Holcomb                                    Director                               By  /s/  R. Jay Tejera                             Director
Michael S. Holcomb                                                                                    R. Jay Tejera


By   /s/  Michael E. Heijer                                           Director
Michael E. Heijer

 
 
-78-
 
 



 
I, Hal Brown, certify that:
1.  
I have reviewed this Form 10-K of Pacific Continental Corporation;
 
2.  
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.  
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.  
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
 
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
 
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
 
(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
 
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date:  March 13, 2009
/s/ Hal Brown
 
Hal Brown, Chief Executive Officer


-79-
 
 
 



CERTIFICATION
 
I, Michael A. Reynolds, certify that:
1.  
I have reviewed this Form 10-K of Pacific Continental Corporation;
 
2.  
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.  
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.  
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
 
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
 
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
 
(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
 
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date:  March 13, 2009                                                  /s/ Michael A. Reynolds
                                                                    Michael A. Reynolds, Executive Vice President & CFO

-80-
 
 
 

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002



In connection with the Annual Report of Pacific Continental Corporation (the “Company”) on Form 10-K for the period ending December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Hal M. Brown, Chief Executive Officer, and Michael A. Reynolds, Chief Financial Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)  
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)  
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


/s/ Hal M. Brown
/s/ Michael A. Reynolds
Hal M. Brown
Michael A. Reynolds
Chief Executive Officer
Chief Financial Officer

Dated:  March 13, 2009

-81-