10-Q 1 v409837_10q.htm FORM 10-Q

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2015

 

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

 

Commission File Number: 000-29829

 

PACIFIC FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

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

 

1101 S. Boone Street

Aberdeen, Washington 98520-5244

(Address of principal executive offices) (Zip Code)

 

(360) 533-8870

(Registrant's telephone number, including area code)

 

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

 

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

Yes x No ¨

 

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

 

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

 

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

 

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

 

 
 

 

Form 10-Q

Table of Contents

 

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

 

1
 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, except per share data)

(UNAUDITED)

 

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

 

See accompanying notes.

 

2
 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except per Share Data)

(UNAUDITED)

 

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

 

See accompanying notes.

 

3
 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(UNAUDITED)

 

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

 

See accompanying notes.

 

4
 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(Dollars in Thousands, Except Share Amounts)

(UNAUDITED)

 

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

 

See accompanying notes.

 

5
 

 

PACIFIC FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(UNAUDITED)

 

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

 

See accompanying notes.

 

6
 

 

PACIFIC FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

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

(Unaudited)

(Dollars in thousands, except per share amounts)

 

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

7
 

 

 

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

 

NOTE 2 – EARNINGS PER SHARE

 

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

 

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

 

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

 

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

 

8
 

 

NOTE 3 – INVESTMENT SECURITIES

 

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

 

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

(Dollars in Thousands)

 

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

 

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

 

9
 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

10
 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

11
 

 

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

 

Loans

 

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

 

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

 

Allowance for losses and credit quality

 

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

 

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

  

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

 

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

  

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

 

12
 

 

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

 

Allowance for Loan Losses

 

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

 

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

 

Allowance for Loan Losses

 

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

 

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

 

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

 

13
 

 

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

 

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

 

Credit Quality Indicators

 

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

 

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

 

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

 

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

 

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

 

14
 

 

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

 

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

 

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

 

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

 

15
 

 

Impaired Loans

 

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

 

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

 

16
 

 

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

 

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

 

Aging Analysis

 

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

 

(Dollars in Thousands)

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

 

17
 

 

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

 

(Dollars in Thousands)

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

 

Modifications

 

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

 

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

 

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

 

18
 

 

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

 

Restructured loans by type current and subsequently defaulted
(Dollars in Thousands)

 

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

 

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

 

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

 

Restructured loans by type and geographic region

(Dollars in Thousands)

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

 

19
 

 

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

 

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

 

NOTE 5 – ACCUMULATED OTHER COMPREHENSIVE INCOME

 

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

 

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

 

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

 

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

 

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

 

20
 

 

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

 

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

 

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

 

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

 

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

 

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

 

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NOTE 6 – STOCK BASED COMPENSATION

 

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

 

Stock Options

 

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

 

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

 

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

 

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

 

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

 

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

 

22
 

 

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

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

 

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

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

 

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

 

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

 

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

 

(1) related to non-vested stock options

 

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Restricted Stock Units

 

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

 

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

 

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

 

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

 

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

 

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

 

(1) related to non-vested RSU's

 

24
 

  

NOTE 7 – COMMITMENTS AND CONTINGENCIES

 

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

 

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

 

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

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Many of the commitments expire without being drawn upon; therefore total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.

 

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

 

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

 

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

 

25
 

 

NOTE 8 – FAIR VALUE MEASUREMENTS

 

Fair Value Hierarchy

 

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

 

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

 

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

 

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

 

Investment Securities Available-for-Sale

 

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

 

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

 

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

 

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

 

26
 

  

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

 

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

 

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

 

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

 

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

 

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

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

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

 

27
 

  

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

28
 

  

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

 

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

 

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

  

Fair Value of Financial Instruments

 

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

 

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

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

 

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

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

 

Federal Home Loan Bank Stock

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

 

Pacific Coast Bankers’ Bancshares Stock

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

 

Loans, net and Loans held for sale

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

 

Deposits

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

 

Short-term borrowings

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

 

29
 

 

Long-term borrowings

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

 

Junior subordinated debentures

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

 

Off-Balance-Sheet Instruments

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

 

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

 

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

 

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

 

30
 

  

NOTE 9 – JUNIOR SUBORDINATED DEBENTURES

 

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

 

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

 

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

 

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

 

(Dollars in Thousands)                    
        Issued         Maturity  
Trust Name   Issue Date   Amount     Rate   Date  
                         
Pacific Financial Corporation Statutory Trust I   December 2005     5,000     LIBOR + 1.45% (1)     March 2036  
                         
Pacific Financial Corporation Statutory Trust II   June 2006       8,000     LIBOR + 1.60% (2)     July 2036  
        $ 13,000              

 

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

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

 

NOTE 10 – RECENTLY ISSUED ACCOUNTING STANDARDS

 

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

 

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

 

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

 

NOTE 11 – INCOME TAXES

 

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

 

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

 

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

 

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

 

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

 

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

 

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

33
 

  

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

OPERATING RESULTS

 

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

 

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

 

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

 

34
 

  

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, except per share data)

(UNAUDITED)

  

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

Common Stock, par value $1 25,000,000 shares authorized, 10,380,492 shares issued and outstanding at 03/31/2015, 10,371,460 at 12/31/2014, and 10,182,083 at 03/31/2014

   10,380    10,371    10,182    0%   2%
Additional paid-in-capital   43,056    42,991    41,852    0%   3%
Retained earnings   20,352    19,256    17,535    6%   16%
Accumulated other comprehensive income (loss)   349    (135)   (974)   359%   136%
Total shareholders' equity   74,137    72,483    68,595    2%   8%
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  $762,096   $744,807   $717,440    2%   6%

 

35
 

  

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except per Share Data)

(UNAUDITED)

 

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

  

36
 

  

Noninterest Income

 

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

 

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

 

Noninterest Expense

 

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

 

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

 

37
 

  

Income Taxes

 

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

 

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

 

LIQUIDITY

 

Cash and Cash Equivalents and Investment Securities

(Unaudited)

(Dollars in Thousands)

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

 

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

 

LOANS

 

Loans by category

(Unaudited)

(Dollars in Thousands)

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

 

38
 

  

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

 

DEPOSITS

 

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

 

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

 

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

 

CAPITAL

 

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

 

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

 

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

 

39
 

 

 

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

 

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

 

*: Includes Basel III Capital Conservation Buffer

 

PACIFIC FINANCIAL CORPORATION

(Dollars in Thousands, Except per Share Data)

(UNAUDITED)

 

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

  

(1) Net interest income divided by average shares outstanding

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

(3) Shareholder equity divided by shares outstanding

(4) Shareholder equity less intangibles divided by shares outstanding

 

40
 

  

Net Interest Margin

 

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

 

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

 

(Dollars in Thousands) (Unaudited)

Average Interest Earning Balances: 

   For the Three Months Ended 
   March 31, 2015   December 31, 2014   March 31, 2014 
  

Average Balance

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

 

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

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

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

 

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

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

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

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

 

41
 

  

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

 

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

 

42
 

  

ASSET QUALITY

 

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

 

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

 

Adversely classified loans and securities

(Unaudited)

(Dollars in Thousands)

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

 

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

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

30-89 Days Past Due by type
(Dollars in Thousands)

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

 

43
 

  

Non-performing assets

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

 

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

 

Other real estate owned and foreclosed assets

(Unaudited)

(Dollars in Thousands)

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

 

Other real estate owned and foreclosed assets by type

(Unaudited)

(Dollars in Thousands) 

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

 

ALLOWANCE FOR LOAN LOSSES

 

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

 

44
 

  

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

 

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

 

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

 

Liquidity and Sources of Funds

 

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

 

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

 

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

 

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

 

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

 

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

 

Off-Balance Sheet Arrangements

 

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

 

Critical Accounting Policies

 

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

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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

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

 

ITEM 4. CONTROLS AND PROCEDURES

 

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

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

  

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CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

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

 

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

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

 

ITEM 1A. RISK FACTORS

 

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

 

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

 

(a) None

 

(b) [Not applicable.]

 

(c) None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

(a) [Not applicable.]

 

(b) [Not applicable.]

 

ITEM 4. MINE SAFETY DISCLOSURES

 

(a) [Not applicable.]

 

ITEM 5. OTHER INFORMATION

 

None.

 

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ITEM 6. EXHIBITS

 

EXHIBIT NO.   EXHIBIT
     
10.1  

Amended and Restated Employment Agreement dated as of May 1, 2015, between Bank of the Pacific and Denise Portmann. Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated April 29, 2015.

31.1   Certification of CEO under Rule 13a – 14(a) of the Exchange Act.
31.2   Certification of CFO under Rule 13a – 14(a) of the Exchange Act.
32.1   Certification of CEO under 18 U.S.C. Section 1350.
32.2   Certification of CFO under 18 U.S.C. Section 1350.
101.   INS XBRL Instance Document
101.   SCH XBRL Taxonomy Extension Schema Document
101.   CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.   DEF XBRL Taxonomy Extension Definition Linkbase Document
101.   LAB XBRL Taxonomy Extension Label Linkbase Document
101.   PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

48
 

 

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

 

DATED: May 14, 2015

 

Pacific Financial Corporation

 

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

 

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

 

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