To Our Shareholders
March 21, 2014
My Fellow Shareholders:
In 2013 we continued to build on our momentum by
remaining disciplined with our business strategy and
investing for our future by growing our capabilities and
our capacity. At year-end we delivered our sixteenth
consecutive quarter of solid earnings, generating net
income of $3.7 million for the year, or $0.37 per share.
We again rewarded our shareholders with a 20-cent
cash dividend in December, equating to a yield of
more than 2.98% at current market levels.
Our solid financial results were driven by positive
year-over-year loan growth, steady deposit inflows,
substantial improvements in credit quality and a strong
capital position. We achieved several milestones in
2013, and positioned the company to continue building
our franchise and profitability. Highlights include:
Dennis A. Long
President & CEO
• At the beginning of 2013, our growth objectives were enhanced through the acquisition of
three branches from Sterling Savings Bank in Aberdeen, Washington, Astoria, Oregon and
Seaside, Oregon. As part of the transaction, we acquired 2,800 new accounts, $37 million in
deposits, and $4 million in performing loans. This transaction was completed in the second
quarter of 2013, when we consolidated 2 of the 3 branches to maximize efficiencies. These
acquisitions have assimilated nicely into our franchise and are now fully integrated into
our operations.
• During the first quarter of 2013, we also opened a new loan production office in Vancouver,
WA, and in the third quarter opened another loan production office in DuPont, WA, adding to
the LPO we opened in Burlington, WA in 2012.
• At the same time, we began construction to open a full-service branch in Warrenton, Oregon,
which was completed at the end of 2013 -- further expanding our presence in the coastal
communities of Washington and Oregon.
Total Net Loans and Deposits
(Dollars in Millions)
800,000
600,000
567,695
544,954
548,050
548,243
400,000
483,543
465,208
478,307
451,788
607,347
504,072
200,000
0
Total Net Loans
Total Deposits
2009
2010
2011
2012
2013
• We strengthened our balance sheet during the year. Total assets increased 10% year-over-year,
and total deposits were up 11%, while noninterest-bearing demand deposits grew 26% from
a year ago. Although much of our deposit growth was acquired from the Sterling acquisition,
we also generated substantial organic deposit growth.
• Total net loans grew 13% year-over-year, reaching all-time highs. We believe that, despite the
headwinds created by low interest rates and the uncertainties of the regulatory environment,
there are still solid opportunities ahead.
• The trends in our asset quality metrics are continuing to improve. Nonperforming assets
(NPAs) declined 19% year-over-year, and fell 128% over a 5-year period. Other-real-estate-
owned and repossessed assets dropped 69% from a year ago, reflecting an overall improvement
in the quality of our loan portfolio. Pacific Financial, as well as the industry as a whole, is
expected to benefit from a fairly stable credit environment as the economy steadily improves.
• Although our net interest margin (NIM) contracted 21 basis points from a year ago, it expanded
11 basis points in the fourth quarter of 2013. The contraction in NIM year-over-year was
primarily due to the downward pressure on asset yields. However, the steady redeployment of
lower yielding securities into higher yielding loans throughout the year led to the improvement
in NIM for the fourth quarter. That being said, we continue to maintain a strong NIM at 3.91%
and expect the NIM to improve in 2014 through anticipated loan growth.
• Our capital ratios remain solid and well above the regulatory requirements for a well-
capitalized financial institution, again demonstrating our strong balance sheet. As a result of
our strong capital, we are well-positioned to strategically and effectively deploy our capital.
Capital Ratios
December 31
Total Risk-based
Tier 1 Risk-based
Tier 1 Leverage
Pacific Financial
Corporation
2013
14.1%
12.9%
9.8%
Pacific Financial
Corporation
2012
16.2%
14.9%
10.7%
Well-Capitalized
Financial Institutional
Regulatory Guidelines
10.0%
6.0%
5.0%
• As part of our strategic transition plan, and to further strengthen our franchise, we promoted
Denise Portmann to the position of President and Chief Executive Officer of Bank of the
Pacific on January 1, 2014. At the beginning of February 2014, we hired an outstanding Chief
Financial Officer, Doug Biddle, to fill the position that Ms. Portmann had previously held for
twelve years.
Looking forward, we are optimistic about the coming year and the economic environment in the
Northwest. The business communities in which we operate are continuing to improve, and we are
seeing new opportunities to serve and build our banking franchise. The investments we made this year,
while reducing our efficiencies in the short run, should begin to generate new revenues and additional
operating effectiveness in the coming years. Our goals are to continue to grow loans and deposits, and
improve our operating efficiencies, which will fuel profitability in the coming years.
We have an outstanding management team, exceptional Board of Directors and highly engaged employees
who have been resilient and dedicated in both strong and difficult economic cycles. With our sound
business strategies and prudent business model, we are in an excellent position to continue building for
the future and create additional shareholder value. We thank you for your ongoing support and loyalty to
Pacific Financial Corporation, and look forward to you joining us at our annual meeting on Wednesday,
April 23, 2014, at 7:00 p.m. Pacific Time, at 1101 South Boone Street, Aberdeen, Washington.
Sincerely,
Gary C. Forcman
Chairman of the Board
Pacific Financial Corporation
Dennis A. Long
President and Chief Executive Officer
Pacific Financial Corporation
[This page intentionally left blank.]
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(cid:2) Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2013; or
□ 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
(State or Other Jurisdiction of
Incorporation or Organization)
91-1815009
(IRS Employer
Identification No.)
1101 S. Boone Street
Aberdeen, Washington 98520-5244
(Address of Principal Executive Offices) (Zip Code)
Registrant’s telephone number, including area code: (360) 533-8870
Securities Registered Pursuant to Section 12(b) of the Exchange Act: None
Securities Registered Pursuant to Section 12(g) of the Exchange Act:
Common Stock, par value $1.00 per share
Indicate by check mark whether the registrant
Act. Yes (cid:4) No (cid:2)
is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange
Act. Yes (cid:4) No (cid:2)
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 periods that the Registrant was required to file such
reports), and (2) has been subject to such requirements for the past 90 days. Yes (cid:2) No (cid:4)
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes (cid:2) No (cid:4)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. □
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definition of ‘‘large accelerated filer,’’ ‘‘accelerated filer’’ and ‘‘smaller reporting company’’ in rule 12b of the
Exchange Act.
Large accelerated filer □
Smaller reporting company (cid:2)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:4) No (cid:2)
Non-accelerated filer □
Accelerated filer □
The aggregate market value of the common stock held by non-affiliates of the registrant at June 30, 2013, was $49,989,017.
The number of shares outstanding of the registrant’s common stock, $1.00 par value as of February 28, 2014, was 10,182,083 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement filed in connection with its annual meeting of shareholders to be held April 23, 2014 are
incorporated by reference into Part III of this Form 10-K.
PACIFIC FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2013
TABLE OF CONTENTS
PART I
Forward Looking Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 1.
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 1A.
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Item 8.
Item 9.
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Mine Safety Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management’s Discussion and Analysis of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . .
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 9A.
Controls and Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART III
Item 10.
Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . .
Item 11.
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 13.
Certain Relationships and Related Transactions and Director Independence . . . . .
Item 14.
Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART IV
Item 15.
Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . .
Page
1
2
17
24
25
25
25
26
27
28
57
57
58
58
58
59
59
59
59
60
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
F-1 − F-50
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
61
i
Forward Looking Information
PART I
This document contains forward-looking statements that are subject to risks and uncertainties. These statements
are based on the current 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,’’ ‘‘expects,’’ ‘‘anticipates,’’
‘‘intends,’’ ‘‘plans,’’ ‘‘estimates’’ or similar expressions.
Any forward-looking statements in this document are subject to risks relating to, among other things, the
factors described under the heading ‘‘Risk Factors’’ in Item 1A below, as well as the following:
1.
2.
3.
4.
5.
6.
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;
stagnant 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, and additional workout and
other real estate owned (‘‘OREO’’) 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; and
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.
integration of three bank branches and related assets acquired from Sterling Savings Bank that may
cost more or be less beneficial to us than expected.
Our management believes our forward-looking statements 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, financial condition,
and share value are beyond our ability to predict or control. We undertake no obligation to update forward-
looking statements.
1
ITEM 1. Business
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 located
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 16 branches located in
communities in Grays Harbor, Pacific, Whatcom, Skagit and Wahkiakum counties in the state of Washington
and three in Clatsop County, Oregon. In addition,
the Bank operates three loan production offices in
Burlington, Dupont and Vancouver, Washington and has a residential real estate mortgage department. During
second quarter 2013, the Bank completed the acquisition of three branches from Sterling Savings Bank. Total
deposits assumed were $37,634,000 and loans acquired totaled $3,989,000. Of the three branches purchased,
two were consolidated into existing Pacific branches to maximize branch efficiencies resulting in one new
branch in Astoria, Oregon. Separately, the Company opened a full-service branch in Warrenton, Oregon in
October 2013 that further expands operations on the northern Oregon coast.
Pacific Financial Corporation is a reporting company with the Securities and Exchange Commission (‘‘SEC’’),
and the Company’s common stock is listed on the OTC Bulletin BoardTM under the symbol PFLC.OB.
Revenue, net income and total assets for the Company for the years ended December 31, 2013, 2012, and 2011
are presented below:
(dollars in thousands)
Revenue:
For Year Ended December 31,
2012
2011
2013
Net Interest Income . . . . . . . . . . . . . . . . . . . . . . .
Non-interest Income . . . . . . . . . . . . . . . . . . . . . .
Total Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 23,800
9,955
33,755
$
3,731
$705,039
$ 24,011
9,391
33,402
$
4,785
$643,594
$ 23,685
7,614
31,299
$
2,818
$641,254
For additional selected financial information, please see ‘‘Item 6. Selected Financial Data’’ below.
Pacific’s filings with the SEC, including its annual report on Form 10-K, quarterly reports on Form 10-Q,
periodic current reports on Form 8-K and amendments to these reports, are available free of charge through
links from our website at http://www.bankofthepacific.com to the SEC’s site at http://www.sec.gov, as soon as
reasonably practicable after filing with the SEC. You may also access our filings with the SEC directly from
the EDGAR database found on the SEC’s website. By making reference to our website above and elsewhere in
this report, we do not intend to incorporate any information from our site into this report.
The Bank
Bank of the Pacific was organized in 1978 and opened for business in 1979 to meet the need for a regional
community bank with local interests to serve the small to medium-sized businesses and professionals in the
coastal region of western Washington. The Bank initially focused on coastal communities in western
Washington, but it has expanded into the Bellingham, Washington area and, more recently, communities along
the northern Oregon coast and Vancouver, Washington. Products and services offered by the Bank include
personal and business deposit products and services and various loan and credit products as described in
greater detail below.
2
Deposit Products and Services
The Bank’s primary sources of deposits are individuals and businesses in its local markets. Bank management
has made a concerted effort to attract deposits in our local market areas through competitive pricing and
delivery of quality products. The Bank offers a traditional array of deposit products, including non-interest
bearing checking accounts,
interest-bearing checking and savings accounts, money market accounts, and
certificates of deposits. These accounts earn interest at rates established by management based on competitive
market factors and management’s strategic objectives in regards to the types or maturities of deposit liabilities
from time to time. Services which accompany the deposit products include sweep accounts, wire services,
safety deposit boxes, online banking, mobile banking, and cash management and other treasury management
services.
The Bank provides 24-hour online banking to its customers with access to account balances and transaction
histories, plus an electronic check register to make account management and reconciliation easier. The online
banking system is compatible with budgeting software like Intuit’s Quicken(cid:5) or Microsoft’s Money(cid:5). In
addition, the online banking system includes the ability to transfer funds, make loan payments, reorder checks,
and request statement reprints, provides loan calculators and allows for e-mail exchanges with representatives
of the Bank. Also, for a nominal fee, customers can request stop payments and pay an unlimited number of
bills online. These services, along with rate and other information, can be accessed through the Bank’s website
at http://www.bankofthepacific.com.
In addition to providing accounts and services to local customers, the Bank utilizes brokered deposits from
time to time, which are deposits that are acquired from outside the region. The Bank also participates in the
Certificate of Deposit Account Registry Service (‘‘CDARS’’) which uses a deposit-matching program to
distribute deposit balances in excess of insurance or other limits across participating banks. Our participation in
CDARS is intended to enhance our ability to attract and retain customers and increase deposits by providing
additional FDIC coverage to customers. Due to the nature of the placement of the funds, CDARS deposits are
classified as ‘‘brokered deposits’’ by regulatory agencies. Brokered deposits for the three years ended
December 31, 2013, 2012 and 2011 were as follows:
Year Ended
2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Brokered
Deposits
$17,788,000
$19,239,000
$13,000,000
CDARS
$3,903,000
$5,191,000
$5,294,000
Total
Outstanding
$21,691,000
$24,430,000
$18,294,000
Percentage of
Total Deposits
3.6%
4.5%
3.3%
In determining whether to take brokered deposits, the Bank considers current market interest rates, profitability
to the Bank, and matching deposits and loan products. Brokered deposits in excess of ten percent of total
deposits are subject to additional FDIC assessment premiums. Our balance of brokered deposits (excluding
CDARS) bears interest at 0.65% to 1.70% and matures as follows: 2014 — $809,000; 2015 — $5,000,000;
2016 — $7,000,000; 2017 — $3,239,000; 2018 — $1,245,000 and 2019 — $495,000.
The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (‘‘FDIC’’) up to applicable legal
limits under the Deposit Insurance Fund. The Bank is a member of the Federal Home Loan Bank (‘‘FHLB’’)
and is regulated by the Washington Department of Financial Institutions, Division of Banks (‘‘Washington
Division’’), and the FDIC.
The Company is not dependent on any significant individual customers, entities or group of related entities for
deposits. There are no deposit relationships exceeding two percent of total deposits.
3
Lending Activities
General. Lending products offered by the Bank include real estate loans, commercial loans, agriculture loans,
installment loans, and residential mortgage loans. The majority of the Company’s loan portfolio is comprised
of real estate loans, which constitute $388,729,000, or 75.9%, of total loans outstanding. Commercial real
estate loans represent $222,888,000, or 51.2%, and residential construction, land development and other land
loans represent $29,096,000, or 5.7% at December 31, 2013. See ‘‘Footnote 4 — Loans’’ in the audited
consolidated financial statements included under Item 15 of this report for balances in each of our lending
categories as of December 31, 2013 and 2012.
The Bank originates loans primarily in its local markets. Loans to borrowers outside of Washington and
Oregon total $67,181,000, or 13.1%, of total loans at December 31, 2013. Of this amount, $37,823,000, or
7.4% of total
that were not
loans, are government guaranteed loans purchased in the secondary market
originated by us. Additionally, our loan portfolio includes $3,302,000 in loans purchased from and originated
by other financial institutions, representing 0.6% of total loans.
lending limits. As part of our credit administration process, we routinely engage external
Underwriting and Credit Administration. The Bank’s lending activities are guided by policies that are
reviewed and approved annually by our board of directors. These policies address the types of loans,
underwriting standards, structure and pricing considerations, and compliance with laws, regulations and
internal
loan
specialists to perform asset quality reviews. These reviews consist of sampling loans to review individual
borrower loan files for adherence to policy and underwriting standards, proper loan administration, and asset
quality. In addition, the management executive committee and credit administration staff meet quarterly with
loan personnel to review loan risk assessments on loans greater than $500,000 with an internal risk rating of
watch or worse. See the subheading ‘‘Classification of Loans’’ in this section below.
Our loan policies also establish loan approval authority for certain officers individually. Loan officer lending
authority ranges from $5,000 to $500,000 for certain loan officers. Credit risk officers can approve loans up to
$2,500,000. The chief credit officer can approve loans up to $3,000,000. Loans greater than $3,000,000 must
be approved by a five member Management Loan Committee made up of the chief credit officer, credit risk
officers, commercial lending manager, and commercial team leader. Additionally, loans with a risk rating of
substandard or worse, with balances of $2,000,000 or greater, must also be approved by the Management Loan
Committee. The Loan Committee of our Board of Directors meets at least quarterly to review the allowance
for credit losses, summary of loans reviewed by the Management Loan Committee, loan policy exceptions, and
various key credit metrics. The Bank’s legal lending limit was $15,946,000 at December 31, 2013. The internal
lending limit is $7,500,000 and represents the maximum lending limit to individual borrowers and related
entities. The Bank does not have significant loan concentrations to any individual customer, entity or group of
related entities.
The Bank’s underwriting policies focus on assessment of each borrower’s ability to service and repay the debt,
and the availability of collateral to secure the loan. Depending on the nature of the borrower and the purpose
and amount of the loan, the Bank’s loans may be secured by a variety of collateral, including real estate,
business assets, and personal assets. The value of our collateral is subject to change. See the discussion under
the subheading ‘‘Lending Activities — Classification of Loans’’ for additional
information regarding our
periodic evaluation of collateral values. Analysis of whether to make a loan to a particular borrower requires
consideration of (1) the borrower’s character, (2) the borrower’s financial condition as reflected in current
financial statements, (3) the borrower’s management capability, (4) the borrower’s industry, and (5) the
economic environment in which the loan will be repaid. Before closing a loan, the Bank’s loan documentation
files will include financial statements of the borrower, guarantors, endorsers and co-makers. We seek income
verification on loans other than homogenous non-real estate consumer loans. Tax returns are considered an
excellent source of financial information. Applicable credit reports (Dunn & Bradstreet, Equifax or credit
bureau reports) are also required on all loans. Financial statements reviewed by third party accountants are
required for commercial loans between $3 million and $5 million. Audited financial statements are required on
commercial credits of $5 million or more. In addition, in instances where a borrower or guarantor maintains
liquidity that is a material factor in loan approval, verification of that liquidity is sought.
4
The Bank generally requires guarantor support on commercial real estate loans, commercial and industrial
loans to entities, where applicable, and certain consumer loans. Loans to closely held corporations will
normally be guaranteed by the major stockholders. On occasion, we may choose to make exceptions to this
policy for long-standing customers and others. However, we seek to keep these exceptions to the minimum
necessary to retain good customers, and exceptions must be approved by credit administration. In addition, as a
policy, loans that are to legal entities formed for the limited purpose of the business or project being financed
require personal guarantees in support of the loan. Similarly,
to engage in
non-recourse financing on commercial and commercial real estate loans. Before extending credit to a business,
the Bank looks closely at its evaluation of the borrower’s management ability, financial history, including cash
flow of the borrower and all guarantors (referred to as ‘‘global cash flow’’ in our industry), and the liquidation
value of the collateral. Emphasis is placed on having a comprehensive understanding of the borrower’s and
guarantors’ cash flow and on financial due diligence.
the Bank’s policy is not
The Company’s loan portfolio does not include permanent residential mortgage loans originated as subprime
loans, ‘‘Alt-A’’ loans, or no documentation, interest only or option adjustable rate loans.
some of which may be partially guaranteed by the Small Business Administration or
Commercial Lending. The Bank’s commercial and agricultural loans consist primarily of secured revolving
operating lines of credit, equipment financing, accounts receivable and inventory financing and business term
loans,
the
U.S. Department of Agriculture. The Company’s credit policies determine advance rates against the different
forms of collateral that can be pledged against commercial loans. Typically, the majority of loans will be
limited to a percentage of the underlying collateral values such as equipment, eligible accounts receivable and
finished inventory. Individual advance rates may be higher or lower depending upon the financial strength of
the borrower, quality of the collateral and/or term of the loan.
The Bank provides secured and unsecured loans to commercial borrowers. Unsecured loans totaled $3,015,000
at December 31, 2013, or 0.6% of total loans as of that date.
Commercial Real Estate. The Bank originates commercial real estate and multifamily loans within its primary
market areas. Owner-occupied commercial real estate loans are preferred. Underwriting standards require that
commercial and multifamily real estate loans not exceed 65 − 80% of the lower of appraised value at
origination or cost of the underlying collateral, depending upon specific property type. The cash flow coverage
to debt servicing requirement is generally that annual cash flow be a minimum of between 1.25 − 1.35 times
debt service for commercial real estate loans and 1.25 times debt service for multifamily loans. Cash flow
coverage is calculated using a market interest rate.
Commercial real estate and multifamily loans typically involve a greater degree of risk than single-family
residential mortgage loans. Payments on loans secured by multifamily and commercial real estate properties
are dependent on successful operation and management of the properties and repayment of these loans is
affected by adverse conditions in the real estate market or the economy. The Bank seeks to minimize these
risks by scrutinizing the financial condition of the borrower, the quality and value of the collateral, and the
management of the property securing the loan. In addition, the Bank reviews the commercial real estate loan
portfolio annually to evaluate the performance of individual loans greater than $500,000 and for potential
changes in interest rates, occupancy, and collateral values.
5
Non-owner occupied commercial real estate loans are loans in which less than 50% of the property is occupied
by the owner and include loans such as apartment complexes, hotels and motels, retail centers and mini-storage
facilities. Repayment of non-owner occupied commercial real estate loans is dependent upon the lease or resale
of the subject property. Loan amortizations range from 10 to 30 years, although terms typically do not exceed
10 years. Interest rates can be either floating or fixed. Floating rates are typically indexed to the prime rate or
Federal Home Loan Bank advance rates plus a defined margin. Fixed rates are generally set for periods of
three to five years with either a rate reset provision or a payment due at maturity. Prepayment penalties are
sought on term commercial real estate loans. The penalties are designed to protect the Bank from refinancing
of the loan during the early years of the transaction.
Construction Loans. The Bank originates single-family residential construction loans for custom homes where
the home buyer is the borrower. It has also provided financing to builders for the construction of pre-sold
homes and, in selected cases, to builders for the construction of speculative residential property. Because of the
higher risks involved in the residential construction industry in today’s economic climate, the Bank is not
currently engaging in new land acquisition and site development financing.
The Bank endeavors to limit construction lending risks through adherence to specific underwriting guidelines
and procedures. Repayment of construction loans is dependent upon the sale of individual homes to consumers
or in some cases to other developers. Terms on construction loans are generally short-term in nature and most
loans mature in one to three years. Interest rates are usually floating and fully indexed to a short-term rate
index. The Bank’s credit policies address maximum loan to value, cash equity requirements,
inspection
requirements, and overall credit strength.
Single-Family Residential Real Estate Lending. The majority of our one-to-four family residential loans are
secured by single-family residences located in our primary market areas. Our underwriting standards require
that single-family portfolio loans are generally owner-occupied and do not exceed 80% of the lower of
appraised value at origination or cost of the underlying collateral. Terms typically range from 15 to 30 years.
Repayment of these loans comes from the borrower’s personal cash flows and liquidity, and collateral values
are a function of residential real estate values in the markets we serve. These loans include primary residences,
second homes, rental homes and home equity loans and home equity lines of credit.
Origination and Sales of Residential Mortgage Loans. The Bank also originates mortgage loans for sale into
the secondary market. Commitments to sell mortgage loans are generally made during the period between the
loan application and the closing of the mortgage loan. Most of these sale commitments are made on a ‘‘best
efforts’’ basis whereby the Bank is only obligated to sell the mortgage if the mortgage loan is approved and
closed. As a result, management believes that market risk is minimal. When we sell mortgage loans, we sell
the rights to service the loans as well (i.e., collection of principal and interest payments). Mortgage loans
the loan purchaser, as a result,
originated for sale are underwritten in accordance with standards of
underwriting standards vary. The Bank’s loans held for sale portfolio does not
include mortgage loans
originated as subprime loans, ‘‘Alt-A’’ loans, or no documentation or option adjustable rate loans.
Consumer. Consumer installment loans and other loans represent a small percentage of total outstanding loans
and include new and used auto loans, boat loans, and personal lines of credit.
6
Classification of Loans. Federal regulations require that the Bank periodically evaluate the risks inherent in its
loan portfolios. In addition, the Washington Division and the FDIC have authority to identify classified or
problem loans and, if appropriate, require them to be reclassified. There are three classifications for classified
loans: Substandard, Doubtful, and Loss. Substandard loans have one or more defined weaknesses and are
characterized by the distinct possibility that 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. A loan classified as Loss is 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 loans as Pass or Other Loans Especially Mentioned (‘‘OLEM’’).
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;
however within the Pass classification certain loans are Watch rated because they have elements of risk that
require more monitoring than other performing loans. Some loans within the Pass category are to 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 are assets that continue
to perform but have shown deterioration in credit quality and require closer monitoring.
terms and covenant
requirements in order
income is subsequently recognized only to the extent
On an ongoing basis, the Bank reviews borrower financial results, collateral values, and compliance with
payment
to identify problems in loan relationships. When
management believes that the collection of all or a portion of principal and interest is no longer probable, the
loan is placed on ‘‘non-accrual’’ status, accrual of interest is suspended, previously accrued interest is reversed,
and interest payments are applied to principal until the Company determines that all remaining principal and
interest can be recovered. This may occur at any time regardless of delinquency, however it is the policy of the
Bank that a loan past due 90 days or more and not in the process of collection be placed on non-accrual status.
Interest
in
management’s judgment, the borrower has the ability to make contractual interest and principal payments, in
which case the loan is returned to accrual status. When all or a portion of the contractual cash flows are not
expected to be collected, the loan is considered impaired. Impairment is measured on a loan by loan basis for
commercial, construction and real estate loans by either the present value of the expected future cash flows
discounted at the loan’s effective interest rate, or the fair value of the collateral less estimated selling costs if
the loan is collateral dependent. The Company estimates and records impairment based on the estimated net
realizable value of the collateral on collateral dependent loans. Large groups of small balance homogeneous
loans are collectively evaluated for impairment. The Company does not make additional loans to a borrower or
any related interest of the borrower when a loan is past due in principal or interest more than 90 days.
that cash payments are received until,
The Company reviews the net realizable values of the underlying collateral for collateral dependent impaired
loans on at
least a quarterly basis. To determine the collateral value, management utilizes independent
appraisals and internal evaluations. These valuations are reviewed to determine whether an additional discount
should be applied given the age of market information or other factors such as costs to carry and sell an asset.
Currently it is our practice to obtain new appraisals on non-performing collateral dependent loans and/or other
real estate owned (‘‘OREO’’) semi-annually for land and every nine months on improved property. Based upon
the appraisal, the Company will, if an appraisal suggests a reduced value, adjust the recorded loan balance to
the lower of cost or market value (less costs to sell) and record a charge-off to the allowance for credit losses
or designate a specific reserve within the allowance per accounting principles generally accepted in the United
States. Generally, the Company will record the charge-off rather than designate a specific reserve.
OREO. OREO is classified as other real estate owned until it is sold. When property is acquired, it is
recorded at the estimated fair value (less costs to sell) at the date of acquisition and any resulting write-down is
charged to the allowance for credit losses. Subsequent write-downs based upon re-evaluation of the property
are charged to non-interest expense. Upon acquisition of a particular property, all costs incurred in maintaining
the property are expensed. Costs relating to the development and improvement of the property, however, are
capitalized to the extent they do not result in the recorded amount exceeding the property’s net realizable
value. Net charge-offs to the allowance for credit losses on OREO properties totaled $64,000 and $212,000, for
the years ended December 31, 2013 and 2012, respectively. In addition, the Company recorded OREO write-
downs in non-interest expense in the income statement based upon subsequent
re-evaluations totaling
$946,000, $1,314,000, and $1,049,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
7
Troubled Debt Restructures. 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
the loan and circumstances are considered. Additional collateral, a
significant when all elements of
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 for the loan. 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.
When the Company makes a decision to grant an extension or renew a loan,
it does so based on the
information available with respect to the borrower’s ability to repay the loan. Such extensions are made only
after renewed credit analysis and with the approval of the appropriate credit administration personnel who must
be independent of the lending officer/relationship manager in a particular loan. The Company may renew a
loan or grant an extension when the maturity date is imminent and the borrower may be experiencing some
level of financial stress but it is not evident at the time of the extension that the loan or a portion of the loan is
not collectible.
TDRs are considered impaired and are reported as impaired loans. Additionally, loans modified in a TDR are
typically already on non-accrual status and partial charge-offs have in some cases already been taken against
the outstanding loan balance. 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 at approximate
six month intervals for land and nine months for improved properties.
TDRs totaled $4,088,000 and $4,374,000 at December 31, 2013 and 2012, respectively. See Note 4 —
‘‘Loans’’ in the audited consolidated financial statements included under Item 15 of this report for more
information on TDRs as of December 31, 2013 and 2012.
PFC Statutory Trusts I and II
PFC Statutory Trust I and II are wholly owned subsidiary trusts of the Company formed to facilitate the
issuance of trust preferred securities (TRUPs). The trusts were organized in December 2005 and June 2006 in
connection with two offerings of trust preferred securities. During the year ended December 31, 2012, the
Company paid all interest that had accrued with respect to its TRUPs since the Company elected, in 2009, to
exercise its right to defer interest on its trust preferred debentures, as permitted by the terms thereof. The
Company is currently making regular interest payments when due. As of December 31, 2013 and 2012, interest
on TRUPs totaled $40,000 and $41,000 respectively, and is included in accrued interest payable on the balance
sheet. For more information regarding the Company’s issuance of trust preferred securities, see Note 10
‘‘Junior Subordinated Debentures’’ to the audited consolidated financial statements included under Item 15 of
this report.
8
Competition
to
Competition in the banking industry is significant. Banks face a number of competitors with respect
providing banking services and attracting deposits. Competition comes from both bank and non-bank sources
and from both large national and smaller local institutions. Many of these institutions, such as Wells Fargo
Bank, Bank of America, and Chase Bank, have significantly greater resources than the Company and the Bank.
As a result, competition for deposits, loan, and other products is significant and may continue to increase,
particularly in Pacific’s larger market in and around Bellingham, Washington.
The Bank competes in Grays Harbor County with well-established thrifts which are headquartered in the area
along with branches of large banks with headquarters outside the area. The Bank also competes with well-
thrifts and credit unions in Pacific and
established small community banks, branches of large banks,
Wahkiakum Counties in the state of Washington and Clatsop County in the state of Oregon. In Whatcom,
Clark, Thurston and Skagit Counties, Washington,
the Bank also competes with large regional and
super-regional financial institutions that do not have a significant presence in the Company’s historical market
areas. The Company believes Whatcom, Clark and Thurston Counties provides opportunities for expansion, but
in pursuing that expansion it faces greater competitive challenges than it faces in its historical market areas.
The adoption of the Gramm-Leach-Bliley Act of 1999 (the Financial Services Modernization Act) eliminated
many of the barriers to affiliation among providers of financial services and further opened the door to business
combinations involving banks, insurance companies, securities or brokerage firms, and others. This regulatory
change has led to further consolidation in the financial services industry and the creation of financial
conglomerates which frequently offer multiple financial services, including deposit services, brokerage and
others. When combined with technological developments such as the Internet that have reduced barriers to
entry faced by companies physically located outside the Company’s market area, changes in the market have
resulted in increased competition and can be expected to result in further increases in competition in the future.
Consolidation trends among financial institutions may continue. There may be opportunities for Pacific to
acquire customers, personnel, and perhaps assets or even branches. The ability to do so will depend on
Pacific’s financial condition, as well as on its ability to compete successfully with other financial institutions
when opportunities arise. Many competitive institutions have greater resources and better access to capital
markets than we do, which may make it difficult for us to compete successfully for growth opportunities in our
geographic area of operations.
The Company has been able to maintain a competitive advantage in its historical markets as a result of its
status as a local institution, offering products and services tailored to the needs of the community. Further,
because of
in its market area and the business contacts of
management and the Company’s directors, management believes the Company can continue to compete
effectively.
the extensive experience of management
According to the Market Share Report compiled by the FDIC, as of June 30, 2013, the Company held a
deposit market share of 41.3% in Pacific County, 56.8% in Wahkiakum County, 28.4% in Grays
Harbor County, 4.4% in Whatcom County, 1.3% in Skagit County and 7.1% in Clatsop County (Oregon).
9
Employees
As of December 31, 2013, the Bank employed 234 full time equivalent employees. We place a high priority on
staff development. New employees are selected based upon their technical skills and customer service
capabilities. None of our employees are covered by a collective bargaining agreement. We offer a variety of
employee benefits and management believes relations with its employees are good.
Supervision and Regulation
The following is a general description of certain significant statutes and regulations affecting the banking
industry. The laws and regulations applicable to the Company and its subsidiaries are primarily intended to
protect depositors and borrowers of the Bank and not stockholders of the Company. Various proposals to
change the laws and regulations governing the banking industry are pending in Congress, in state legislatures
and before the various bank regulatory agencies and new or amended proposals are expected. In the current
economic climate and regulatory environment, the likelihood of enactment of new banking legislation and
promulgation of new banking regulations is significantly greater than it has been in recent years. The potential
impact of new laws and regulations on the Company and its subsidiaries cannot be determined, but any such
laws and regulations may materially affect the business and prospects of the Company and its subsidiaries.
Violation of the laws and regulations applicable to the Company and its subsidiaries may result in assessment
the imposition of a cease and desist or similar order, and other
of substantial civil monetary penalties,
regulatory sanctions, as well as private litigation.
General
The Company
As a bank holding company, the Company is subject to the Bank Holding Company Act of 1956, as amended
(BHCA), which places the Company under the primary supervision of the Board of Governors of the Federal
Reserve System (the ‘‘Federal Reserve’’). The Company must file annual reports with the Federal Reserve and
the Federal Reserve
must provide it with such additional
periodically examines the Company and the Bank.
information as it may require. In addition,
Bank Holding Company Regulation
General. The BHCA restricts the direct and indirect activities of the Company to banking, managing or
controlling banks and other subsidiaries authorized under the BHCA, and activities that are closely related to
banking or managing or controlling banks. The Company must obtain approval of the Federal Reserve before
it: (1) acquires direct or indirect ownership or control of any voting shares of any bank or bank holding
company that results in total ownership or control, directly or indirectly, of more than 5% of the outstanding
shares of any class of voting securities of such bank or bank holding company; (2) merges or consolidates with
another bank holding company; or (3) acquires substantially all of the assets of another bank or bank holding
company. In acting on applications for such prior approval, the Federal Reserve considers various factors,
including, without limitation, the effect of the proposed transaction on competition in relevant geographic and
product markets, and each transaction party’s financial condition, managerial resources, and the convenience
and needs of the communities to be served,
including the performance record under the Community
Reinvestment Act.
Source of Strength. Under Federal Reserve policy, the Company must act as a source of financial and
managerial strength to the Bank. This means that the Company is required to commit, as necessary, resources
to support the Bank, and that under certain conditions, the Federal Reserve may conclude that certain actions
of Company, such as payment of cash dividends, would constitute unsafe and unsound banking practices.
10
Dodd-Frank Act.
In addition, under the Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (the ‘‘Dodd-Frank Act’’), the FDIC has back-up enforcement authority over a depository institution
holding company, such as the Company, if the conduct or threatened conduct of a holding company poses a
risk to the Deposit Insurance Fund, subject to certain limitations.
Effects of Government Monetary Policy
Banking is a business which depends on interest rate differentials. In general, the major portions of a bank’s
earnings derives from the differences between: (i) interest received by a bank on loans extended to its
customers and the yield on securities held in its investment portfolio; and (ii) the interest paid by a bank on its
deposits and its other borrowings (the bank’s ‘‘cost of funds’’). Thus, our earnings and growth are constantly
subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary,
fiscal and related policies of the United States and its agencies, particularly the Federal Reserve and the U.S.
Treasury. The nature and timing of changes in such policies and their impact cannot be predicted.
General
The Bank
The Bank, as an FDIC insured state-chartered bank, is subject to regulation and examination by the FDIC and
the Washington Division. The federal laws that apply to the Bank regulate, among other things, the scope of its
business activities, its investments, its reserves against deposits, the timing of the availability of deposited
funds and the nature and amount of and collateral for loans.
CRA. The Community Reinvestment Act (the CRA) requires that the FDIC evaluate the Bank’s record in
meeting the credit needs of its local community, including low and moderate income neighborhoods, consistent
with the safe and sound operation of those banks. These factors are also considered in evaluating mergers,
acquisitions, and applications to open a branch or facility. In connection with the FDIC’s assessment of the
record of financial institutions under the CRA, it assigns a rating of either, ‘‘outstanding,’’ ‘‘satisfactory,’’
‘‘needs to improve,’’ or ‘‘substantial noncompliance’’ following an examination. The Bank received a CRA
rating of ‘‘satisfactory’’ during its most recent examination.
Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act
on extensions of credit to executive officers, directors, principal shareholders, or any related interests of such
persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and
collateral, and follow credit underwriting procedures that are not less stringent than those prevailing at the time
for comparable transactions with persons not covered above and who are not employees and (ii) must not
involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject
to certain lending limits and restrictions on overdrafts to such persons.
FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), each federal
banking agency has prescribed, by regulation, noncapital safety and soundness standards for institutions under
its authority. These standards cover internal controls, information systems, and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such
other operational and managerial standards as the agency determines to be appropriate, and standards for asset
quality, earnings and stock valuation. An institution which fails to meet these standards must develop a plan
acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to
submit or implement such a plan may subject the institution to regulatory sanctions. Management believes that
the Bank meets all such standards and,
these regulatory standards will
materially affect the Company’s business or operations.
therefore, does not believe that
11
Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish
operational and managerial standards to promote the safety and soundness of federally insured depository
institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems,
loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits,
asset quality and earnings. In general, the safety and soundness guidelines prescribe the goals to be achieved in
each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an
institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal
regulator may require the institution to submit a plan for achieving and maintaining compliance. If an
institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a
compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an
order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured,
the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict
the rates the institution pays on deposits or require the institution to take any action the regulator deems
appropriate under
the circumstances. Noncompliance with the standards established by the safety and
soundness guidelines may also constitute grounds for other enforcement action by the federal banking
regulators, including cease and desist orders and civil money penalty assessments. Management of the Bank is
not aware of any conditions relating to these safety and soundness standards which would require submission
of a plan of compliance.
Dodd-Frank Act
On July 21, 2010, the Dodd-Frank Act was signed into law and implements far-reaching changes across the
financial regulatory landscape, including provisions that, among other things, will:
•
•
•
•
Centralize responsibility for consumer financial protection by creating a new agency within the
Federal Reserve, the Bureau of Consumer Financial Protection, with broad rule making, supervision
and enforcement authority for a wide range of consumer protection laws that would apply to all
banks and thrifts. Smaller financial institutions, including the Bank, will be subject to the supervision
and enforcement of their primary federal banking regulator with respect to the federal consumer
financial protection laws.
Require the federal banking regulators to promulgate new capital regulations and seek to make their
capital requirements countercyclical, so that capital requirements increase in times of economic
expansion and decrease in times of economic contraction.
Provide for new disclosures and other requirements relating to executive compensation and corporate
governance.
Change the assessment base for federal deposit insurance from deposits to average total assets minus
tangible equity.
Many aspects of the Dodd-Frank Act are subject to ongoing rule-making. These rules are expected to increase
regulation of the financial services industry and impose restrictions on the ability of firms within the industry
to conduct business consistent with historical practices. These rules will, as examples, impact the ability of
financial institutions to charge certain banking and other fees, allow interest to be paid on demand deposits,
impose new restrictions on lending practices and require depository institution holding companies to maintain
capital levels at levels not less than the levels required for insured depository institutions. Compliance with
such legislation or regulation may, among other effects, significantly increase our costs, limit our product
offerings and operating flexibility, decrease our revenue opportunities, require significant adjustments in our
internal business processes, and possibly require us to maintain our regulatory capital at levels above historical
levels.
12
Jumpstart Our Business Startups (‘‘JOBS’’) Act
On April 5, 2012, the JOBS Act was signed into law. Among other things, the JOBS act contains provisions
that reduce certain reporting requirements for qualifying public companies. The JOBS Act also allows banks
and bank holding companies to terminate the registration of a class of securities under Section 12(g) and
Section 12(b) of the Exchange Act if such class is held of record by less than 1,200 persons, an increase from
the prior 300 person threshold. Although the Company has considered the possible benefits of deregistering its
common stock under the JOBS Act, it has not made any determination to do so.
The Volcker Rule
The Dodd-Frank Act implements the ‘‘Volcker Rule,’’ which prohibits banking entities such as the Company
and the Bank from engaging in certain short-term proprietary trading activities and investments. Transactions
in certain instruments, including obligations of the U.S. Government or U.S. Government agency, government-
sponsored enterprises, and state and local governments will be exempt from the prohibitions. The Volcker Rule
also prohibits the Company and the Bank from owning, sponsoring, or having certain relationships with any
hedge funds or private equity funds subject to certain exemptions. The prohibitions and restrictions of the
Volcker Rule will not take effect until after publication of final interagency rules implementing the Volcker
Rule. Upon effectiveness of the final interagency rules, the Company and the Bank will be afforded a two-year
conformance period during which they can wind down, sell, or otherwise conform their respective activities,
investments and relationships to the requirements of the Volcker Rule. The Volcker Rule is scheduled to be
effective April 1, 2014. As finalized, the Company and the Bank do not believe the final interagency rules will
have a material impact on its investment activities since it does not engage in the transactions covered by the
regulation.
Deposit Insurance
The deposits of the Bank are insured to a maximum of $250,000 per depositor through the Deposit Insurance
Fund administered by the FDIC. All insured banks are required to pay semi-annual deposit insurance premium
assessments to the FDIC. A bank’s assessment is calculated by multiplying its assessment rate (see below) by
its assessment base. A bank’s assessment base is its average consolidated total assets minus its average tangible
equity.
The FDIC currently assesses deposit insurance premiums on each FDIC-insured institution quarterly based on
annualized rates for one of four risk categories applied to its deposits, subject to certain adjustments. Each
institution is assigned to one of four risk categories based on its capital, supervisory ratings and other factors.
Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk
Category I. Risk Categories II, III and IV present progressively greater perceived risks to the DIF. Under
FDIC’s current risk-based assessment rules for institutions with less than $10 billion in assets, the initial base
assessment rates prior to adjustments range from 5 to 9 basis points for Risk Category I, 14 basis points for
Risk Category II, 23 basis points for Risk Category III, and 35 basis points for Risk Category IV.
Initial base assessment rates are subject to adjustments based on an institution’s unsecured debt and brokered
deposits, such that the total base assessment rates after adjustments range from 2.5 to 9 basis points for Risk
Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45
basis points for Risk Category IV. The FDIC’s regulations include authority to increase or decrease total base
assessment rates in the future by as much as three basis points without a formal rulemaking proceeding.
13
The FDIC may make special assessments on insured depository institutions in amounts determined by the
income to repay amounts borrowed from the
FDIC to be necessary to give it adequate assessment
U.S. Treasury and other sources, or for any other purpose the FDIC deems necessary.
Dividends
Dividends from the Bank constitute the major source of liquidity for the Company, from which the Company
may cover its expenses, pay interest on its obligations, including its debentures issued in connection with trust
preferred securities, and declare and pay dividends to shareholders. The amount of dividends payable by the
Bank to the Company depends on the Bank’s earnings and capital position, and is limited by federal and state
laws, regulations and policies.
Electronic Funds Transfer Act.
The electronic Funds Transfer Act (the EFTA) provides a basic framework for establishing the rights,
liabilities, and responsibilities of participants in electronic funds transfer (EFT) systems. The EFTA is
implemented by the Federal Reserve’s Regulation E which governs transfers initiated through ATMs, point-of-
sale terminals, payroll cards, automated clearinghouse (ACH) transactions, telephone bill-payment plans, or
remote banking services. Regulation E was amended to require bank customers in 2010 to opt in (affirmatively
consent) to participation in overdraft service programs for ATM and one-time debit card transactions before
overdraft fees may be assessed on the customer’s account and provides an ongoing right to revoke consent to
participation. For customers who do not affirmatively consent to overdraft service for ATM and one-time debit
card transactions, a bank must provide those customers with the same account terms, conditions, and features
that it provides to consumers who do affirmatively consent, except for the overdraft service.
Real Estate Concentration Guidance
Banks are subject to real estate concentration guidelines issued by federal banking agencies regarding sound
risk management practices for concentrations in commercial real estate lending. The particular focus is on
exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as
collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed to
real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of
the guidance is not to limit a bank’s commercial real estate lending but to guide banks in developing risk
management practices and capital levels commensurate with the level and nature of real estate concentrations.
Real estate concentration guidelines are as follows:
•
•
Total reported loans for construction, land development and other land representing 100% or more of
the bank’s capital; or
Total commercial real estate loans representing 300% or more of the bank’s total capital.
The strength of an institution’s lending and risk management practices with respect to such concentrations will
be taken into account in supervisory evaluation of capital adequacy. At December 31, 2013 and 2012, the Bank
was under the guidelines described above.
Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank
holding companies and banks. If capital falls below minimum levels, the bank holding company or bank may
be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities.
Capital Adequacy
14
The FDIC and Federal Reserve use risk-based capital guidelines for banks and bank holding companies. Risk-
based guidelines are designed to make capital requirements more sensitive to differences in risk profiles among
banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for
holding liquid low-risk assets. Assets and off-balance sheet items are assigned to broad risk categories, each
with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted
assets and off-balance sheet items. The guidelines are minimums and the FDIC or the Federal Reserve may
require that a holding company or bank, as applicable, maintain ratios in excess of the minimums, particularly
organizations contemplating significant expansion. Current guidelines require all bank holding companies and
federally-regulated banks to maintain a minimum total risk-based capital ratio equal to 8%, of which at least
4% must be Tier I capital. Tier I capital for bank holding companies includes common shareholders’ equity,
certain qualifying preferred stock and minority interests in equity accounts of consolidated subsidiaries, minus
certain deductions, including, without limitation, goodwill, other identifiable intangible assets, and certain
deferred tax assets.
The FDIC or the Federal Reserve also employ a leverage ratio, calculated as Tier I capital as a percentage of
total assets minus certain deductions, including, without limitation, goodwill, mortgage servicing assets, other
identifiable intangible assets, and certain deferred tax assets,
to risk-based
guidelines. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank
holding company may leverage its equity capital base. The Company and the Bank must maintain a minimum
leverage ratio of 3%.
to be used as a supplement
Under regulations adopted by the Federal Reserve and the FDIC, each bank holding company and bank is
assigned to one of five capital categories depending on, among other things, its total risk-based capital ratio,
Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. Institutions which are
deemed to be undercapitalized depending on the category to which they are assigned are subject to certain
mandatory supervisory corrective actions. Under these guidelines,
the Company and the Bank are each
considered well capitalized as of the end of the fiscal year.
Effective in 2015 (with some changes generally transitioned into full effectiveness over two to four years), the
Bank will be subject to new capital requirements adopted by the FDIC. These new requirements create a new
required ratio for common equity Tier 1 (‘‘CET1’’) capital, increases the leverage and Tier 1 capital ratios,
changes the risk-weights of certain assets for purposes of the risk-based capital ratios, creates an additional
capital conservation buffer over the required capital ratios and changes what qualifies as capital for purposes of
meeting these various capital requirements. Beginning in 2016, failure to maintain the required capital
conservation buffer will limit the ability of the Bank to pay dividends, repurchase shares or pay discretionary
bonuses.
When these new requirements to be considered well-capitalized become effective in 2015, the Bank’s leverage
ratio of 4% of adjusted total assets and total capital ratio of 8% of risk-weighted assets will remain the same;
however, the Tier 1 capital ratio requirement will increase from 4.0% to 6.0% of risk-weighted assets. In
addition, the Bank will have to meet the new CET1 capital ratio of 4.5% of risk-weighted assets, with CET1
consisting of qualifying Tier 1 capital less all capital components that are not considered common equity.
For all of these capital requirements, there are a number of changes in what constitutes regulatory capital,
some of which are subject to a two-year transition period. These changes include the phasing-out of certain
instruments as qualifying capital. The Bank does not have any of these instruments. Under the new
requirements for total capital, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in
total capital.
15
Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over
designated percentages of common stock will be deducted from capital, subject to a two-year transition period.
In addition, Tier 1 capital will include accumulated other comprehensive income (loss), which includes all
unrealized gains and losses on available for sale debt and equity securities, subject to a two-year transition
period. Because of its asset size, the Bank has the one-time option of deciding in the first quarter of 2015
whether to permanently opt-out of the inclusion of accumulated other comprehensive income (loss) in its
capital calculations. The Bank is considering whether to take advantage of this opt-out to reduce the impact of
market volatility on its regulatory capital levels.
The new requirements also include changes in the risk-weights of assets to better reflect credit risk and other
risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real
estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days
past due or otherwise on non-accrual status; a 20% (up from 0%) credit conversion factor for the unused
portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable
(currently set at 0%); a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets
that are not deducted from capital; and increased risk-weights (0% to 600%) for equity exposures.
In addition to the minimum CET1, Tier 1 and total capital ratios, the Bank will have to maintain a capital
conservation buffer consisting of additional CET1 capital equal to 2.5% of risk-weighted assets above the
required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and
paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such
actions. This new capital conservation buffer requirement is be phased in beginning in January 2016 at 0.625%
of risk-weighted assets and increasing each year until fully implemented at 2.5% in January 2019.
The FDIC’s prompt corrective action standards will change when these new capital ratios become effective.
Under the new standards, in order to be considered well-capitalized, the Bank would be required to have a
CET1 ratio of 6.5% (new), a Tier 1 ratio of 8% (increased from 6%), a total capital ratio of 10% (unchanged)
and a leverage ratio of 5% (unchanged). The Bank has conducted a pro forma analysis of the application of the
the Bank meets all new
new capital requirements as of September 30, 2013. We have determined that
requirements and would remain well-capitalized, even if these new requirements had been effect on that date.
Pacific has also conducted a pro forma analysis of the application of these new capital requirements as of
December 31, 2013. We have determined that the Company meets all new requirements and would remain
well-capitalized, even if these new requirements had been in effect on that date.
The application of these stringent capital requirements could, among other things, result in lower returns on
invested capital, over time require the raising of additional capital, and result in regulatory actions if we were
to be unable to comply with such requirements. Implementation of changes to asset risk weightings for risk
based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital
conservation buffers could result in management modifying its business strategy and could limit our ability to
make distributions, including paying out dividends or repurchasing shares. Furthermore, the imposition of
liquidity requirements in connection with the implementation of Basel III could result
in our having to
lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets.
Any additional changes in our regulation and oversight, in the form of new laws, rules and regulations could
make compliance more difficult or expensive or otherwise materially adversely affect our business, financial
condition or prospects.
16
ITEM 1A. Risk Factors
The following are material risks that management believes are specific to our business. This should not be
viewed as an all-inclusive list or in any particular order.
Weak economic conditions in the market areas we serve may adversely impact our earnings and could
increase the credit risk associated with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon. A
decline in the economies of our local market areas could have a material adverse effect on our business,
financial condition, results of operations and prospects. In particular, in recent years Washington and Oregon
experienced substantial home price declines and increased foreclosures and above average unemployment rates,
as discussed further under ‘‘Business Overview’’ in Item 7 of this report.
Although conditions have improved, any economic deterioration that affects household and or business
incomes in the markets in which we do business could have one or more of the following adverse effects on
our business:
•
•
•
•
An increase in loan delinquencies, problem assets and foreclosures;
A decrease in the demand for loans and other fee-based products and services;
An increase or decrease in the usage of unfunded commitments; or
A decrease in the value of loan collateral, especially real estate, which in turn may reduce a
customer’s borrowing power and significantly increase our exposure to particular loans.
A large percentage of our loan portfolio is secured by real estate, in particular commercial real estate,
and as a result, we are susceptible to deterioration in the real estate market in our local areas. If this
were to occur, it would lead to increased delinquencies and related losses in our loan portfolio, which
could have a material adverse effect on our business, financial condition and results of operations.
Our current business strategy is heavily focused on commercial real estate lending, which is already a
significant portion of our loans. This type of lending activity is generally more sensitive to regional and local
economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement
analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an
ongoing basis. Further downturns in the real estate market, could increase loan delinquencies, defaults and
foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon
foreclosure.
As of December 31, 2013, we had $222.9 million of commercial real estate loans, representing 51.2% of total
loans, an increase of $10.1 million, or 4.0%, from December 31, 2012. These types of loans typically involve
higher principal amounts than other types of loans, and repayment is dependent upon income generated, or
expected to be generated, by the property securing the loan, which may be adversely affected by changes in the
economy or local market conditions. Commercial real estate loans also expose a lender to greater credit risk
than loans secured by residential real estate because the collateral securing these loans typically cannot be sold
as easily as residential real estate. In addition, many of our commercial real estate loans are not fully
amortizing and may require balloon payments upon maturity. Such balloon payments may force the borrower
to either sell or refinance the underlying property in order to make the payment, which may increase the risk of
default.
A secondary market for most types of commercial real estate loans is not readily liquid, so we have less
opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these
characteristics, if we foreclose on a commercial real estate loan, our holding period of the collateral typically is
longer than for residential mortgage loans. Accordingly, charge-offs on commercial real estate loans may be
larger as a percentage of the total principal outstanding than those incurred with our residential or consumer
loan portfolios.
17
Future credit losses may exceed our allowance for credit losses.
We are subject to credit risk, which is the risk of losing principal or interest due to borrowers’ failure to repay
loans in accordance with their terms. A continued or sustained downturn in the economy or the real estate
market in our market areas or a rapid change in interest rates would have a negative effect on borrowers’
ability to repay loans and on collateral values. This deterioration could result in losses to the Company in
excess of the allowance for credit losses. To the extent loans are not paid timely by borrowers, the loans are
placed on non-accrual status,
income or even requiring reversals of previously
recorded income. To the extent loan charge-offs exceed our financial models, increased amounts will be
charged to the provision for credit losses, which would further reduce income.
thereby reducing interest
Our provision for credit losses remains volatile and we may be required to increase our provision for
credit losses and charge-off additional loans in the future, which could adversely affect our financial
condition and results of operations.
For the year ended December 31, 2013, we recorded a provision for (recapture of) credit losses of $(450,000),
compared to ($1,110,000) for the year ended December 31, 2012. We also recorded net loan charge-offs of
$549,000 for the year ended December 31, 2013, compared to $669,000 for the year ended December 31,
2012. Past due loans represented 1.4% and 2.4% of total loans outstanding at December 31, 2013 and 2012,
respectively.
While current economic conditions have improved modestly, we may experience higher than normal volatility
in delinquencies and credit losses if these improvements falter. As a result, we may experience additional
provision for credit losses and charge offs, which could have a material adverse effect on our financial
condition and results of operations. Further, our portfolio contains construction and land loans and commercial
and commercial real estate loans, all of which have a higher risk of loss than residential real estate loans.
See ‘‘Business Overview’’ in Part II, Item 7 of this report for further discussion of real estate values.
We hold and acquire other real estate owned (‘‘OREO’’) properties as part of our business, which can
lead to increased operating expenses and vulnerability to additional declines in the market value of real
estate in our areas of operations.
We foreclose on and take title to the real estate serving as collateral for many of our loans as part of our
business. During 2013, we continued to acquire OREO and at December 31, 2013, the Bank had 17 OREO
properties with an aggregate book value of $2,771,000, as compared to 26 OREO properties with an aggregate
book value of $4,679,000 at December 31, 2012. OREO balances have led to increased expenses, as we have
incurred costs to manage, maintain, improve in some cases, and dispose of our OREO properties. We expect
that our earnings in 2014 will continue to be negatively affected, albeit to a lesser extent, by various expenses
associated with OREO, including personnel costs, insurance and taxes, completion and repair costs, valuation
adjustments, and other expenses associated with property ownership. Also, at the time that we foreclose on a
loan and take possession of a property we estimate the value of that property using third party appraisals and
opinions and internal judgments. OREO property is valued on our books at the estimated market value of the
property, less the estimated costs to sell (or ‘‘fair value’’). Upon foreclosure, a charge-off to the allowance for
credit losses is recorded for any excess between the value of the asset on our books over its fair value.
Thereafter, we periodically reassess our judgment of fair value based on updated appraisals or other factors,
including, at times, at the request of our regulators. Any further declines in our estimate of fair value for
OREO will result in additional charges, with a corresponding expense in our statements of income that is
recorded under the line item for ‘‘OREO Write-downs.’’ As such, our results of operations are vulnerable to
declines in the market for residential and commercial real estate in the areas in which we operate. The
expenses associated with OREO and any further property write downs could have a material adverse effect on
our results of operations and financial condition. We currently have $7,243,000 in nonaccrual loans, which may
lead to increases in our OREO balance in the future, if not resolved.
18
We face liquidity risks in the operation of our business and our funding sources may prove insufficient to
support growth opportunities or satisfy our liabilities.
Liquidity is crucial to the operation of the Company and the Bank. Liquidity risk is the potential that we will
be unable to fund increases in assets or meet payment obligations, including obligations to depositors, as they
become due because of an inability to obtain adequate funding or liquidate assets. For example, funding
illiquidity may arise if we are unable to attract core deposits or are unable to renew at acceptable pricing
long-term or short-term borrowings. Illiquidity may also arise if our regulatory capital levels decrease, our
lenders require additional collateral to secure our repayment obligations, or a large amount of our deposits are
withdrawn.
We rely on customer deposits and advances from the FHLB of Seattle and other borrowings to fund our
operations. Although we have historically been able to replace maturing deposits and advances if desired, we
may not be able to replace such funds in the future if our financial condition or the financial condition of the
FHLB of Seattle or market conditions were to change. If we are required to rely more heavily on more
expensive funding sources to support operations, our revenues may not increase proportionately to cover our
costs. In this case, our net interest margin would be adversely affected, making it even more difficult for our
businesses to operate profitably.
Rapidly changing interest rate environments could reduce our net interest margin, net interest income,
fee income and net income.
Interest and fees on loans and securities, net of interest paid on deposits and borrowings, are a large part of our
net income. Interest rates are key drivers of our net interest margin and subject to many factors beyond the
control of management. As interest rates change, net interest income is affected. Rapid increases in interest
rates in the future could result in interest expense increasing faster than interest income because of mismatches
in financial instrument maturities, which would result in reduced spreads between the interest rates earned on
assets and the rates of interest paid on liabilities. Further, substantially higher interest rates generally reduce
loan demand and may hinder loan growth, particularly in commercial real estate lending, an important factor in
the Company’s revenue over the past two years.
19
Gain on sale of loans held for sale represents a significant source of our non-interest income and may be
adversely affected by any changes in the programs offered by secondary market investors or our ability
to qualify for such programs, as well as by any increases in market interest rates.
The sale of residential mortgage loans classified as loans held for sale provides a significant portion of our
non-interest income. Changes in programs applicable to the resale of residential mortgages or our eligibility to
participate in such programs could materially adversely affect our results of operations. Further, in a rising
interest rate environment, our originations of mortgage loans held for sale may decrease, resulting in fewer
loans that are available to be sold. This would result in a decrease in gain on sale of loans sold and a
corresponding decrease in non-interest
income. During periods of reduced loan demand, our results of
operations may be further adversely affected if we are unable to reduce our expenses proportionately to the
decline in the volume of loan originations and sales. For 2014, we expect residential mortgage loan demand to
continue to decline to the extent that interest rates stay above prior record lows.
We may elect or be required to seek additional capital in the future, but that capital may not be
available when it is needed.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our
operations. In addition, we may elect to raise capital to support our business or to finance acquisitions, if any.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic
conditions and a number of other factors, many of which are outside our control, and on our financial
performance. Accordingly, we cannot assure you of our ability to raise additional capital on terms acceptable to
us, or at all. If we do raise capital, equity financing may be dilutive to existing shareholders and any debt
financing may include covenants or other restrictions that limit our operating flexibility. If we cannot raise
additional capital when needed on favorable terms, it may have a material adverse effect on our financial
condition, results of operations and prospects.
We operate in a highly regulated environment and changes of or increases in, or supervisory
enforcement of, banking or other laws and regulations could adversely affect us.
As discussed more fully in the section entitled ‘‘Supervision and Regulation’’ in Item 1 above, we are subject
to extensive regulation, supervision and examination by federal and state banking authorities. Additional
legislation and regulations that could significantly affect our powers, authority and operations may be enacted
or adopted in the future. Further, regulators have significant discretion and authority to prevent or remedy
unsafe or unsound practices or violations of laws or regulations in the performance of their supervisory and
enforcement duties. Any failure to comply with laws, regulations or interpretations could result in sanctions by
regulatory agencies or damage to our reputation. Any changes in applicable regulations or federal, state or
in regulatory policies or interpretations, or in regulatory approaches to compliance and
local
enforcement could have a substantial impact on our financial condition and our result of operations, for
example, by leading to additional fees or taxes or restrictions on our operations.
legislation,
Recent legislation has impacted our operations, and additional legislation and rulemaking could have an
adverse impact on our business.
The Dodd-Frank Act has significantly changed the current bank regulatory structure and will affect the lending,
deposit, investment, trading and operating activities of financial institutions and their holding companies.
Among other things, the Dodd-Frank Act:
20
•
•
•
•
•
establishes the Bureau of Consumer Financial Protection with broad authority to administer and
enforce a new federal regulatory framework of consumer financial regulation;
changes the base for deposit insurance assessments;
introduces regulatory rate-setting for
transactions;
interchange fees charged to merchants for debit card
enhances the regulation of consumer mortgage banking; and
changes the methods and standards for resolution of troubled institutions.
Many of the provisions of the Dodd-Frank Act have extended implementation periods and delayed effective
dates and will require additional rulemaking by various regulatory agencies, and many could have far reaching
implications on our operations. Accordingly, we expect that the legislation may have a detrimental impact on
revenues and expenses, require the Company to change certain of its business practices, increase capital levels
and have other adverse effects on our business. Moreover, compliance obligations will expose us to additional
reputational risk in the event of noncompliance and could divert management’s focus from the business of
banking.
The short-term and long-term impact of the changing regulatory capital requirements and anticipated
new capital rules is uncertain.
As mentioned under the heading ‘‘Supervision and Regulation’’ in Item 1 above, effective January 1, 2015, the
Company and the Bank will each be subject to new capital requirements under regulations adopted by the
federal banking regulators to implement the Basel III regulatory capital reforms and changes required by the
Dodd-Frank Act. We have conducted a pro forma analysis of these new requirements as of December 31, 2013
and concluded on a preliminary basis that if these requirements had been in effect as of that date, Pacific and
the Bank would be considered well-capitalized, although there is no assurance that each will continue to do so.
in regulatory actions if we were unable to comply with such requirements. Furthermore,
in the current economic and regulatory environment, regulators of banks and bank holding
In addition,
companies have become more likely to impose capital requirements that are more stringent than those required
by existing regulations. The application of more stringent capital requirements for the Company and the Bank
could, among other things, result in lower returns on invested capital, require the raising of additional capital,
the
and result
imposition of liquidity requirements in connection with Basel III could result in our having to lengthen the
terms of our
liquid assets.
Implementation of changes to asset risk weightings for risk based capital calculations, and/or additional capital
conservation buffers could result in management modifying its business strategy and could limit our ability to
make distributions, including paying dividends or buying back shares. Any additional changes in our regulation
and oversight, in the form of new laws, rules and regulations could make compliance more difficult or
expensive or otherwise materially adversely affect our business, financial condition or prospects.
restructure our business models, and/or
increase our holdings of
funding,
We rely on dividends from subsidiaries for substantially all of our liquidity.
The Company is a separate and distinct legal entity from the Bank. The Company receives substantially all of
its liquidity from dividends from the Bank. These dividends are the principal source of funds to pay interest
and principal on our debt, other expenses, or dividends on our common stock, if any. Various federal and state
laws and regulations limit the amount of dividends that the Bank may pay to the Company, as may the actions
of regulators. If the Bank is unable to pay dividends to the Company, it may not be able to service debt, pay
any other obligations or pay dividends on common stock. The Company paid a cash dividend of $0.20 per
share for both 2013 and 2012, respectively.
21
The financial services industry is very competitive.
institutions such as credit unions, government-sponsored enterprises, mutual
We face competition in attracting and retaining deposits, making loans, and providing other financial services.
larger banking institutions, and a wide range of other
Our competitors include other community banks,
financial
fund companies,
insurance companies and other non-bank businesses. Many of these competitors have substantially greater
resources than we have. For a more complete discussion of our competitive environment, see ‘‘Business–
Competition’’ in Item 1 above. If we are unable to compete effectively, we will lose market share, including
deposits, and face a reduction in our income from our lending activities.
If there is unauthorized disclosure of sensitive or confidential client, customer or employee information,
whether through a breach of our computer systems or otherwise, it could harm our business.
As part of our business, we collect, process and retain sensitive and confidential client, customer and employee
information. Despite the various security measures we have in place, our facilities and systems may be
vulnerable to security breaches, computer viruses, data retention failures, human errors, or other similar events.
In particular, any security breach involving the misappropriation, loss or other unauthorized disclosure of
confidential customer information could expose us to the risk of private litigation or regulatory actions, damage
our reputation, and disrupt our operations, resulting in a material adverse effect on our results of operations.
We may experience difficulties in managing our growth and our growth strategy involves risks that may
negatively impact our net income.
As part of our general growth strategy, we may acquire branches, banks and establish new branches that we
believe provide a strategic and geographic fit with our business. We cannot predict the number, size or timing
of growth opportunities. To the extent that we grow through acquisitions, we cannot assure you that we will be
able to adequately and profitably integrate these new assets and manage this growth. Acquiring other branches
and businesses will involve risks commonly associated with acquisitions, including:
22
•
•
•
•
•
•
•
Potential exposure to unknown or contingent liabilities we acquire;
Exposure to potential asset quality issues;
Difficulty and expense of integrating the operations and personnel of banks and businesses we
acquire;
Potential disruption to our business;
Potential restrictions on our business resulting from the regulatory approval process;
Potential diversion of our management’s time and attention; and
The possible loss of key employees and customers of the bank and businesses we acquire.
In addition to acquisitions, we may expand into additional communities or attempt to strengthen our position in
our current markets by undertaking additional de novo bank formations or branch openings. Based on our
experience, we believe that it generally takes three years or more for new banking facilities to first achieve
operational profitability, due to the impact of organization and overhead expenses and the start-up phase of
generating loans and deposits. To the extent that we undertake additional branching and de novo bank and
business formations, we are likely to continue to experience the effects of higher operating expenses relative to
operating income from the new operations, which may have an adverse effect on our levels of reported net
income, return on average equity and return on average assets.
Impairment of investment securities, goodwill, other intangible assets, or deferred tax assets could
require charges to earnings, which could result in a negative impact on our results of operations.
The Bank has $101.3 million, or 14.4% of assets, in investments and FHLB stock at December 31, 2013, and
must periodically test our investment securities for impairment in value. In assessing whether the impairment
of investment securities is other-than-temporary, we consider the length of time and extent to which the fair
value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and
ability to retain our investment in the security for a period of time sufficient to allow for any anticipated
recovery in fair value in the near term. Under current accounting standards, goodwill is not amortized but,
instead, is subject to impairment tests on at least an annual basis or more frequently if an event occurs or
circumstances change that reduce the fair value of a reporting unit below its carrying amount. Although we do
not presently anticipate goodwill impairment charges, if we conclude that our goodwill may be impaired, a
non-cash charge for the amount of such impairment would be recorded against earnings. Such a charge would
have no impact on tangible capital. A decline in our stock price or occurrence of a triggering event could,
under certain circumstances, cause us to perform a goodwill impairment test and result in an impairment
charge being recorded for that period. At December 31, 2013, we had goodwill of $12.2 million, representing
approximately 18.1% of shareholders’ equity.
Further, our balance sheet reflects approximately $4.6 million of net deferred tax assets at December 31, 2013,
recorded in other assets on the balance sheet, which represents differences in the timing of the benefit of
deductions, credits and other items for accounting purposes and the benefit for tax purposes. To the extent we
conclude that the value of this asset is not more likely than not to be realized, we would be obligated to record
a valuation allowance against the asset, impacting our earnings during the period in which the valuation
allowance is recorded. Assessing the need for, or the sufficiency of, a valuation allowance requires management
to evaluate all available evidence, both negative and positive. If the positive evidence is not sufficient to
exceed the negative evidence, a valuation allowance for deferred tax assets is established. The impact of each
of these impairment matters could have a material adverse effect on our business, results of operations, and
financial condition.
23
We may be subject to environmental and other liability risks associated with lending activities.
We foreclose on and take title to real estate in the regular course of our business. Property ownership increases
our expenses due to the costs of managing and disposing of properties. Although environmental site
assessments are completed on properties that are considered an environment risk before such properties are
accepted as collateral, there remains a risk that hazardous or toxic substances will be found on properties, in
which case we may be liable for remediation costs and related personal injury and property damage and the
value of the property may be materially reduced. The costs and financial liabilities associated with property
ownership could have a material adverse effect on our results of operations and financial condition.
Our common stock is not listed on a securities exchange and trading in our stock on the OTC Bulletin
Board is limited, making it difficult for shareholders to sell shares in open-market transactions and may
cause our stock price to be volatile.
Our common stock trades in very low trading volumes on the OTC Bulletin Board under the trading symbol
‘‘PFLC.OB.’’ As a result, it may be difficult to liquidate your investment in our shares and can cause wide
fluctuations in our stock price. Also, because of this lack of liquidity in the market for our common stock, the
quoted price of our common stock from time to time may not reflect its fair value as would be determined in
an active trading market.
Our directors and executive officers own a significant percentage of our common stock and this
concentration of ownership could adversely affect our other shareholders.
Our directors and executive officers beneficially own approximately 13.2% of our common stock. As a result,
these individuals could, as a group, exert a significant degree of influence over our management and affairs and
over matters requiring shareholder approval, in addition to the influence they already have as directors and
executive officers. This concentration of ownership may limit the ability of other shareholders to influence
corporate matters and, as a result, we may take actions that our other shareholders do not view as beneficial.
For example, this concentration of ownership could have the effect of delaying or preventing a change in
control or otherwise discouraging a potential acquirer from attempting to obtain control of our company, which
could limit your ability to sell your shares at a premium in connection with a merger or other transaction
resulting in a change in control of our company.
We depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by
or on behalf of customers and counterparties, including financial statements, credit reports, and other financial
information. We may also rely on representations of those customers, counterparties, or other third parties, such
as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or
misleading financial statements, credit reports, or other financial information could cause us to enter into
unfavorable transactions, which could have a material adverse effect on our financial condition and results of
operations.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections,
network access and core application processing. While we have selected these third party vendors carefully, we
do not control their actions. Any problems caused by these third parties, including as a result of their not
providing us their services for any reason or their performing their services poorly, could adversely affect our
ability to deliver products and services to our customers and otherwise to conduct our business. Replacing
these third party vendors could also entail significant delay and expense.
ITEM 1.B. Unresolved Staff Comments
None.
24
ITEM 2.
Properties
The Company’s administrative offices are located in Aberdeen, Washington. The building located at 300 East
Market Street is owned by the Bank and houses the main branch. The administrative offices of the Bank and
the Company, which are leased from an unaffiliated third party, are located at 1101 S. Boone Street.
Pacific owns the land and buildings occupied by its sixteen branches in Grays Harbor, Pacific, Skagit,
Whatcom and Wahkiakum Counties in Washington as well as Clatsop County in Oregon. The remaining
locations operate in leased facilities, which are leased from unaffiliated third parties, except for one building
leased from a limited liability company in which Lori Reece, a director appointed in February 2014, is a
member. The aggregate monthly lease payment for all leased space is approximately $48,000.
In addition to the land and buildings owned by Pacific, it also owns all of its furniture, fixtures and equipment,
including data processing equipment. The net book value of the Company’s premises and equipment was
$16,790,000 at December 31, 2013.
Management believes that
appropriately insured and are adequately equipped for carrying on the business of the Bank.
the facilities are of sound construction and in good operating condition, are
ITEM 3. Legal Proceedings
The Company and the Bank from time to time are party to various legal proceedings arising in the ordinary
course of business. Management believes that there are no threatened or pending proceedings against the
Company or the Bank that will have a material adverse effect on its business, financial condition or results of
operations.
ITEM 4. Mine Safety Disclosures
None.
25
PART II
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases
of Equity Securities
The Company’s common stock is presently traded on the OTC Bulletin BoardTM under the trading symbol
PFLC.OB. Historically, trading in our stock has been very limited and the trades that have occurred cannot be
characterized as amounting to an established public trading market. As a result, the trading prices of our
common stock may not reflect the price that would result if our stock was actively traded at high volumes.
The following are high and low bid prices quoted on the OTC Bulletin Board during the periods indicated. The
quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent
actual transactions:
First Quarter
. . . . . . . . . . . . . .
Second Quarter . . . . . . . . . . . . .
Third Quarter . . . . . . . . . . . . . .
Fourth Quarter . . . . . . . . . . . . .
Estimated No.
Shares Traded
131,400
92,300
124,600
83,900
2013
High
$5.50
$6.50
$6.99
$6.75
Low
$4.56
$5.42
$5.59
$6.40
Estimated No.
Shares Traded
108,700
188,600
134,200
102,500
2012
High
$5.88
$4.75
$5.67
$4.25
Low
$4.50
$4.13
$4.01
$3.69
As of December 31, 2013, there were approximately 1,041 shareholders of record of the Company’s common
stock. Computershare serves as the transfer agent for our common stock.
The Company’s Board of Directors declared dividends on its common stock in December 2013 and 2012 in the
amount of $0.20 per share. The Board of Directors has adopted a dividend policy which is reviewed annually.
There can be no assurance as to whether or when the Company will pay cash dividends again in the future.
Under federal banking law, the payment of dividends by the Company and the Bank is subject to capital
adequacy requirements established by the Federal Reserve and the FDIC. In addition, payment of dividends by
either entity is subject to regulatory limitations. Under Washington general corporate law as it applies to the
Company, no cash dividend may be declared or paid if, after giving effect to the dividend, the Company would
not be able to pay its liabilities as they become due or its liabilities exceed its assets. Payment of dividends on
the Common Stock is also affected by statutory limitations, which restrict the ability of the Bank to pay
upstream dividends to the Company. Under Washington banking law as it applies to the Bank, no dividend
may be declared or paid in amount greater than net profits then available, and after a portion of such net profits
have been added to the surplus funds of the Bank.
Issuer Purchases of Equity Securities
In September 2012, the Company’s board of directors approved a share repurchase program authorizing the
purchase of up to 250,000 shares of its common stock. There were no purchases of common stock by the
Company during the year ended December 31, 2013. The maximum number of shares that may yet be
purchased under the plan is 250,000 at December 31, 2013.
26
ITEM 6.
Selected Financial Data
The following selected consolidated five year financial data should be read in conjunction with the Company’s
audited consolidated financial statements and the accompanying notes presented in this report. Dollars are in
thousands, except per share data.
Operations Data
Net interest income . . . . . . . . . . . . . . . .
Provision (recapture) for credit losses . . . .
Non-interest income . . . . . . . . . . . . . . . .
Non-interest expense . . . . . . . . . . . . . . .
Provision (benefit) for income taxes . . . . .
Net income (loss)
. . . . . . . . . . . . . . . . .
Net income (loss) per share:
Basic(1) . . . . . . . . . . . . . . . . . . . . . . .
Diluted(1)
. . . . . . . . . . . . . . . . . . . . .
Dividends declared . . . . . . . . . . . . . . . .
Dividends declared per share(1)
. . . . . . . .
Dividend payout ratio . . . . . . . . . . . . . . .
Performance Ratios
Interest rate spread . . . . . . . . . . . . . . . . .
Net interest margin(2)
. . . . . . . . . . . . . . .
Efficiency ratio(3) . . . . . . . . . . . . . . . . . .
Return on average assets . . . . . . . . . . . . .
Return on average equity . . . . . . . . . . . .
Balance Sheet Data
Total assets . . . . . . . . . . . . . . . . . . . . . .
Loans, net
. . . . . . . . . . . . . . . . . . . . . .
Total deposits . . . . . . . . . . . . . . . . . . . .
Total borrowings . . . . . . . . . . . . . . . . . .
Shareholders’ equity . . . . . . . . . . . . . . . .
Book value per share(1)(4)
. . . . . . . . . . . .
Tangible book value per share(1)(5)
. . . . . .
Equity to assets ratio . . . . . . . . . . . . . . .
Asset Quality Ratios
Nonperforming loans to total loans . . . . . .
Allowance for credit losses to total loans . .
Allowance for credit losses to
nonperforming loans . . . . . . . . . . . . . .
Nonperforming assets to total assets . . . . .
2013
$ 23,800
(450)
9,955
29,502
972
3,731
$
As of and For the Year Ended December 31,
2011
2012
2010
$ 24,011
(1,100)
9,391
28,417
1,300
4,785
$
$ 23,685
2,500
7,614
25,648
333
2,818
$
$ 22,879
3,600
8,451
26,400
(304)
1,634
$
$
$
0.37
0.37
2,036
0.20
$
0.47
0.47
2,024
0.20
55%
42%
0.28
0.28
—
—
—
$
0.16
0.16
—
—
—
2009
$ 21,753
9,944
7,025
29,691
(4,519)
$ (6,338)
$
(0.74)
(0.74)
—
—
3.88%
4.00%
87.40%
0.55%
5.48%
4.20%
4.34%
85.08%
0.75%
7.28%
4.03%
4.22%
81.95%
0.44%
4.55%
3.88%
4.10%
84.26%
0.25%
2.77%
3.50%
3.76%
103.17%
(0.96)%
(11.63)%
$705,039
496,307
607,347
23,403
67,137
6.63
5.31
9.52%
$643,594
438,838
548,243
23,903
66,721
6.59
5.35
10.37%
$641,254
463,766
548,050
24,644
63,270
6.25
5.01
9.87%
$644,403
455,064
544,954
35,328
59,769
5.90
4.66
9.28%
$668,626
471,154
567,695
39,880
57,649
5.70
4.44
8.62%
1.98%
1.65%
3.37%
2.09%
2.96%
2.34%
2.15%
2.28%
115.40%
1.42%
61.92%
3.08%
79.28%
3.39%
106.18%
2.57%
3.36%
2.30%
68.49%
3.42%
(1) Retroactively adjusted for a 1.1 to 1 stock split effective January 13, 2009.
(2) Net interest income divided by average earning assets.
(3) Non-interest expense divided by the sum of net interest income and non-interest income.
(4) Shareholder equity divided by shares outstanding.
(5) Shareholder equity less intangibles divided by shares outstanding.
27
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with Pacific’s audited consolidated
financial statements and related notes appearing elsewhere in this report. In addition, please refer to Pacific’s
forward-looking statement disclosure included in Part I of this report.
Pacific is a bank holding company providing full-service community banking through 16 branches in
Washington and one in Oregon. In addition, Pacific has three loan production offices in Washington and a
residential real estate mortgage department. The principal business of the Bank consists of making loans to and
accepting deposits from businesses and individuals. Our Bank provides full service commercial and retail
banking, primarily in its branch communities. Both our loans and our deposits are generated primarily through
strong banking and community relationships, and through management that is locally active. Our lending and
investment activities are funded primarily by core deposits. This stable source of funding is achieved by
developing strong banking relationships with customers through value-added product offerings, market pricing,
convenience and high-touch service.
Our results of operations depend primarily on net interest income, which is the difference between interest
income from interest earning assets and interest expense on interest bearing liabilities. Noninterest income,
which includes service charges and fees, gain on sale of loans, securities gains and income from bank owned
life insurance, also provides a significant contribution to our results of operations. Our principal operating
expenses, aside from interest expense, consist of salaries and employee benefits, occupancy and equipment
costs, professional fees, data processing, FDIC insurance premiums and the provision for credit losses.
EXECUTIVE OVERVIEW
The following are important factors in understanding the Company financial condition and liquidity:
•
•
•
•
Total assets at December 31, 2013, increased by $61,445,000, or 9.6%, to $705,039,000 compared to
$643,594,000 at the end of 2012. Increases in investments and loans were the primary contributors to
overall asset growth, which were partially offset by decreases in interest bearing deposits in banks
and loans held for sale. Total loans of $504,666,000 at December 31, 2013, increased $56,470,000, or
12.6%, compared to year-end 2012.
The Bank remains well capitalized with a total risk-based capital ratio of 14.03% at December 31,
2013, compared to 16.22% at December 31, 2012. Tier one leverage ratio was 9.77% at
December 31, 2013, compared to 10.69% at December 31, 2012. The asset growth mentioned above
outpaced the growth in retained earnings during 2013, resulting in the decline in capital ratios.
Non-performing assets (‘‘NPAs’’) totaled $10,014,000 at December 31, 2013, which represents
1.42% of total assets, a decrease from $19,791,000 at December 31, 2012. The decrease is largely
due to our continued focus on improving asset quality through proactive management of problem
assets, which contributed to the decline in non-performing loans and OREO during the year. NPAs
are concentrated in commercial real estate loans and related OREO, which total $6,003,000, or
59.9%, of our NPAs.
Demand deposits, savings, money market and certificates of deposits less than $100,000, increased
during 2013 by $69,831,000, or 15.2%, to $530,719,000 and comprise 87.4% of total deposits at
year-end, driven by the Sterling branch acquisition,
in addition to organic deposit growth. The
organic increase in core deposits was mostly in commercial demand and money market accounts,
coupled with an increase in public NOW accounts.
28
•
As a result of core deposit growth, lower borrowings and increased interest bearing deposits with
banks, the Company’s liquidity ratio increased to 41% at December 31, 2013, which translates into
over $288 million available to fund general operations and meet fluctuations in loans and deposits.
The following are significant components of the Company’s results of operations for 2013 as compared to
2012.
•
•
•
•
•
•
•
income for 2013 was $3,731,000, or $0.37 per diluted share, compared to net
Net
$4,785,000, or $0.47 per diluted share, in 2012.
income of
In 2013, return on average assets (‘‘ROAA’’) and return on average equity (‘‘ROAE’’) decreased to
0.55% and 5.48%, respectively, compared to 0.75% and 7.28%, respectively, in 2012. The reductions
in ROAA and ROAE were primarily driven by a decrease in recapture of provision for credit losses,
a decrease in net interest income and an increase in non-interest expense.
Net interest income decreased to $23,800,000 compared to $24,011,000 in 2012. The Company
experienced growth in loans and investments during the period. However, lower yields earned on
these assets, due to competition and decreased reinvestment rates on securities, resulted in a decline
in net interest income. Consequently, net interest margin for 2013 decreased 34 basis points to
4.00%, as compared to 4.34% in 2012.
Provision for (recapture of) credit losses was ($450,000) for 2013, compared to ($1,100,000) for
2012. The recapture of prior provision in the current year is primarily the result of the continued
overall improvement in credit quality, as evidenced by decreases in net charge-offs, non-performing
loans and performing loans classified as substandard or worse. During 2012, the recapture was
mostly due to the elimination of a $1.7 million specific impairment reserve.
Net charge-offs totaled $549,000 during 2013 compared to $669,000 in 2012. Loans classified as
substandard or worse totaled $12,763,000 at December 31, 2013, a decrease of $8,931,000, or 41.2%,
compared to $21,694,000 one year ago.
Non-interest income increased $564,000, or 6.0%, to $9,955,000 for 2013 primarily due to increases
in gains on sale of loans, ATM/debit card fees and annuity commission income. While gains on sale
of loans grew by $113,000, or 2.2%, to $5,171,000, this revenue source moderated during the latter
portion of the period as increases in mortgage rates slowed refinance activity. ATM/debit card fees
grew by $113,000, or 24.2%,
to $581,000, due to growth in deposit account relationships and
increased usage of this payment method by existing customers. Annuity commission revenue
increased to $303,000, up from $17,000. The current year was the first full year these products were
sold, having been introduced in late 2012.
Non-interest expense increased $1,085,000, or 3.8%,
to $29,502,000 for 2013. The increase is
primarily attributable to increases in salaries and employee benefits and data processing and
occupancy and equipment expenses associated with the acquisition of Sterling Bank branches in
Oregon and Washington, the denovo opening of the Warrenton, Oregon branch and opening of loan
production offices in Clark and Thurston Counties.
29
BUSINESS OVERVIEW
The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on
and repay principal of outstanding loans and the value of collateral securing those loans, is highly dependent
on the economy in our markets. Although economic conditions in general appear to be stabilizing,
the
Company’s future operating results and financial performance may be significantly affected by a return of
recessionary economic conditions in the Company’s market area.
According to the U.S. Bureau of Labor Statistics,
the unemployment rate in Washington was 6.6% at
December 31, 2013, compared to 7.6% in 2012 and 8.5% in 2011, and in Oregon the unemployment rate was
7.0% for 2013, compared to 8.4% in 2012 and 8.9% in 2011. These rates compare to the national
unemployment rate of 6.7% at December 31, 2013. According to the Washington State Employment Security
Department and the Oregon Employment Department, unemployment rates over the last three years in the
principal counties in which we operate were as follows:
Unemployment Rate at December 31,
County
Clatsop . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Grays Harbor . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Skagit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Wahkiakum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Whatcom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
6.1%
11.6%
10.5%
8.1%
10.4%
6.4%
2012
7.6%
12.4%
11.8%
9.1%
12.2%
6.9%
2011
7.8%
13.5%
11.9%
10.2%
11.9%
8.1%
Excluding Whatcom County, all Washington counties in which the Company operates have unemployment
rates greater than the state and national rates. In addition, the unemployment rate in Clatsop County is below
the Oregon state and national rate. Overall, the unemployment rate in all our markets has steadily improved
over the last three years.
Closed sales activity for single-family homes and condominiums had been on a declining trend in recent years;
however, sales activity began to rebound in 2011 and continued to increase in 2012 in selective counties within
our geographic footprint. Year over year changes in closed sales activity in Grays Harbor, Skagit and Whatcom
counties were 15.2%, 26.6%, and 14.8% (Gardner Rpt), respectively, during 2013. However, home prices
declined during 2013 in Grays Harbor and Whatcom counties by -10.9% and -5.1%% (Gardner Rpt),
respectively. We believe the decline was due primarily to the rise in mortgage interest rates experienced during
2013, impacting the prices buyers were willing to pay for housing in these markets. Home price growth
continued in Skagit County, up 26.9%, due to differences in housing supply and demand within that market.
Limited data is available on sales activity and sales prices for Pacific, Wahkiakum and Clatsop counties.
OPERATING STRATEGY
The Company’s vision is to achieve and maintain balanced growth in loans and deposits while maintaining top
peer group financial performance; to consistently exceed all internal and external customer expectations by
listening, understanding and identifying customers’ needs; to provide timely products and services through a
cost effective delivery system while maintaining customer value expectations; and positively impacting our
community through our passion and being a model corporate citizen.
30
In order to achieve long-term growth and accomplish our long-term financial objectives, the Company seeks to
successfully execute its long-term strategies. Operating strategies for 2014 are as follows:
•
•
•
•
•
Grow loans and increase core deposits organically by increasing our customer base in the markets we
serve and in markets adjacent
to our current footprint. We will seek to capture more of each
customer’s banking relationship by cross selling our loan and deposit products to our customers and
emphasizing our local ownership and decision making authority.
Focus on improving profitability with asset growth and reductions in net overhead and controllable
operating expenses through fiscal restraint and increased emphasis on non-interest
income and
efficiencies.
Limit exposure to increasing interest rates. The majority of our loans are relatively short term in
nature with interest rates tied to a market index such as the prime rate. The substantial majority of
the fixed rate residential mortgage loans we originate are sold in the secondary market which reduces
the interest rate and credit risk associated with fixed rate residential lending. The investment portfolio
is made up of fixed and adjustable rate securities with duration less than five years.
Continue to improve asset quality through proactive management of problem loans, monitoring
existing performing loans, and selling of OREO properties.
Successfully expand on the opportunities available to garner additional profitable banking
relationships thorough our branches and loan production offices in Skagit, Thurston and Clark
Counties due to continued merger-related market disruption in these markets. We will also look to
grow our banking relationships in Oregon, capitalizing on our acquisition of two branches from
Sterling Savings Bank and our newly opened branch in Warrenton, Oregon.
The degree to which we will be able to execute on these strategies will depend to a large degree on the local
and national economy, improvement in the local markets for residential real estate, limited deterioration in the
credit quality of our commercial real estate loans, and satisfaction of all conditions to our current expansion
initiatives, including receipt of any required regulatory approvals.
RESULTS OF OPERATIONS
Years ended December 31, 2013, 2012, and 2011
General. The following table presents condensed consolidated statements of income for the Company for
each of the years in the three-year period ended December 31, 2013.
(dollars in thousands)
Interest and dividend income . . . .
Interest expense . . . . . . . . . . . . .
Net interest income . . . . . . . . . . .
Provision for (recapture of) credit
losses
. . . . . . . . . . . . . . . . . .
Net interest income after provision
for credit losses . . . . . . . . . . . .
Other operating income . . . . . . . .
Other operating expense . . . . . . . .
Income before income taxes . . . . .
Income taxes . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . .
Increase
(Decrease)
Amount
$(1,205)
(994)
(211)
2013
$26,290
2,490
23,800
%
(4.4)
(28.3)
(0.9)
2012
$27,495
3,484
24,011
Increase
(Decrease)
Amount
$(1,823)
(2,149)
326
%
(6.2)
(38.2)
1.4
2011
$29,318
5,633
23,685
(450)
(650)
(59.1)
(1,100)
(3,600)
(144.0)
2,500
24,250
9,955
29,502
4,703
972
$ 3,731
(861)
564
1,085
(1,382)
(328)
$(1,054)
(3.4)
6.0
3.8
(22.7)
(25.2)
(22.0)
25,111
9,391
28,417
6,085
1,300
$ 4,785
3,926
1,777
2,769
2,934
967
$ 1,967
18.5
23.3
10.8
93.1
290.4
69.8
21,185
7,614
25,648
3,151
333
$ 2,818
31
Net income. For the year ended December 31, 2013, net income was $3,731,000 compared to $4,785,000 in
2012. The decrease in net income for 2013 was primarily related to an increase in noninterest expenses
associated with the expansion of loan production offices and assimilation of branches purchased from Sterling
Savings Bank, which was offset partially by an increase in non-interest income from ATM/Debit card and
annuity commission fee income. Net income was also impacted by a reduction in recapture of provision for
loan losses as compared to the prior period. Net income of $4,785,000 for 2012 was up from net income of
$2,818,000 for the year ended December 31, 2011. The improvement in net income for 2012 was primarily
related to an increase in net interest income, a substantial decrease in provision for credit losses, and an
increase in gain on sale of loans, which were partially offset by an increase in commissions paid on loans sold.
Net Interest Income. The Company derives the majority of its earnings from net interest income, which is
the difference between interest income earned on interest earning assets and interest expense incurred on
interest bearing liabilities. The Company’s net interest income is affected by the change in the level and mix of
interest-earning assets and interest-bearing liabilities, referred to as volume changes. The Company’s net
interest income is also affected by changes in the yields earned on assets and rates paid on liabilities, referred
to as rate changes. Interest rates charged on loans are affected principally by the demand for such loans, the
supply of money available for lending purposes and competitive factors. Those factors are, in turn, affected by
general economic conditions and other factors beyond the Company’s control, such as federal economic
policies, legislative tax policies and actions by the Federal Open Market Committee of the Federal Reserve
(‘‘FOMC’’). Interest rates on deposits are affected primarily by rates charged by competitors and actions by the
FOMC.
The FOMC heavily influences market interest rates, including deposit and loan rates offered by many financial
institutions. Also, as rates near zero, it becomes more difficult to match decreases in rates on interest earning
assets with decreases in rates paid on interest bearing liabilities. Approximately 78% of the Company’s loan
portfolio is tied to short-term rates, and therefore, re-price immediately when interest rate changes occur. The
Company’s funding sources also re-price when rates change; however, there is a meaningful lag in the timing
of the re-pricing of deposits as compared to loans and decreases in interest rates become less easily matched
by decreases in deposit rates as rates approach zero. Because of its focus on commercial lending, the Company
will continue to have a high percentage of floating rate loans. Because deposit rates are near the bottom, and
because the reinvestment rates on maturing securities have fallen dramatically and loan rates are impacted by
competition for new loans, the Company anticipates that the prolonged low rate environment will continue to
impact net interest margin in 2014.
32
The following table sets 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.
(dollars in thousands)
Assets
2013
Interest
Income
(Expense)
Avg
Rate
Average
Balance
Year Ended December 31,
2012
Interest
Income
(Expense)
Avg
Rate
Average
Balance
2011
Interest
Income
(Expense)
Average
Balance
Avg
Rate
Earning assets:
Loans(1)
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
$485,623
$24,614
5.07%
$479,036
$25,953
5.42%
$483,974
$27,481
5.68%
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Investment securities:
.
.
Taxable .
.
Tax-Exempt(1)
.
.
.
.
.
.
Total investment securities
.
.
.
Federal Home Loan Bank Stock .
Federal funds sold and deposits in banks
.
.
.
.
.
.
.
Total earnings assets/interest income .
.
.
.
.
.
.
Cash and due from banks .
.
Premises and equipment (net) .
.
.
Other real estate owned .
.
Other assets
.
.
.
.
Allowance for credit losses .
Total assets
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
. .
.
.
.
.
Liabilities and Shareholders’ Equity
Interest bearing liabilities:
Deposits:
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
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.
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.
Savings and interest-bearing demand .
.
.
.
.
Time certificates
Total deposits .
.
.
.
.
.
.
.
Short-term borrowings
.
.
Long-term borrowings
.
.
Secured borrowings .
.
Junior subordinated debentures .
Total borrowings .
.
.
.
.
.
.
.
.
.
Total interest-bearing liabilities/Interest
.
.
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.
.
.
.
Demand deposits .
.
Other liabilities .
.
.
Shareholders’ equity .
.
Total liabilities and shareholders’ equity .
Net interest income/spread(1) .
expense
.
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.
.
.
.
.
.
Net interest income as a percentage of average
earning assets
.
.
.
.
.
Interest income .
.
Interest expense
Net interest margin(2)
.
.
.
Tax equivalent adjustment(1)
.
.
.
.
.
.
.
.
.
.
.
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.
778
1,508
2,286
2
114
$27,016
$ (699)
(1,321)
(2,020)
(9)
(214)
—
(247)
(470)
$ (2,490)
53,505
32,650
86,155
3,078
38,848
$613,705
11,636
15,831
4,030
40,909
(9,065)
$677,046
$316,184
135,447
451,631
304
9,745
—
13,403
23,452
$475,083
129,218
4,688
68,057
$677,046
1,042
1,512
2,554
—
92
$30,127
3.49
6.14
4.69
—
0.24
5.19%
770
1,525
2,295
—
84
$28,332
29,993
1.45
27,590
4.62
57,583
2.65
3,173
0.06
0.29
32,089
4.40% $571,881
10,751
14,753
6,880
42,427
(11,022)
$635,670
29,844
2.57
24,613
5.53
54,457
3.99
3,183
—
0.26
38,535
4.95% $580,149
10,280
15,065
7,579
41,845
(11,028)
$643,890
$ (1,084)
(1,798)
(2,882)
(79)
(217)
(20)
(286)
(602)
$ (3,484)
0.22%
0.98
0.45
2.96
2.20
—
1.84
2.00
$288,984
144,486
433,470
2,697
7,803
448
13,403
24,351
0.52% $457,821
107,048
5,058
65,743
$635,670
0.38%
1.24
0.66
2.93
2.78
4.46
2.13
2.47
$275,630
176,631
452,261
6,885
10,500
777
13,403
31,565
0.76% $483,826
93,413
4,709
61,942
$643,890
$ (1,612)
(3,031)
(4,643)
(264)
(333)
(41)
(352)
(990)
0.58%
1.72
1.03
3.84
3.17
5.28
2.63
3.14
$ (5,633)
1.16%
$24,526
3.88%
$24,848
4.20%
$24,494
4.03%
4.40%
0.40%
4.00%
4.95%
0.61%
4.34%
5.19%
0.97%
4.22%
$
726
$
837
$
809
Interest earned on tax-exempt loans and securities has been computed on a 34% tax equivalent basis.
(1)
(2) Net interest income divided by average interest earning assets.
For purposes of computing the average rate, the Company used historical cost balances which do not give
effect to changes in fair value that are reflected as a component of shareholders’ equity. Nonaccrual loans and
loans held for sale are included in ‘‘loans.’’ Interest income on loans includes loan fees of $547,000, $569,000,
and $480,000 in 2013, 2012, and 2011, respectively.
33
The net interest margin decreased to 4.00% for the year ended December 31, 2013, down from 4.34% in the
prior year. Net interest income for the year ended December 31, 2013 decreased $211,000, or 0.9%, While the
Company generated an increase in the volume of both loans and investment securities, the yields earned on
these assets declined as compared to 2012. Competitive demand for credit worthy borrowers, along with
Federal Reserve Bank’s continued effort to keep interest rates low, negatively impact yields in the current
period. This was partially offset by an improvement in funding costs, a change in the mix of deposits with a
greater concentration in demand and savings accounts than higher cost certificates of deposits. The average
cost of funds decreased to 0.52% at December 31, 2013 from 0.76% one year ago, which was only partially
offset by a decline in the Company’s average yield earned on assets from 4.95% for year ended December 31,
2012 to 4.40% for the current year. In 2012, decreasing levels of nonperforming loans placed on nonaccrual
status positively affected our net interest margin which improved to 4.34% from 4.22% in 2011.
Net interest income on a tax equivalent basis totaled $24,526,000 for the year ended December 31, 2013, a
decrease of $322,000, or 1.3%, compared to 2012. Net interest income on a tax equivalent basis increased
1.4% to $24,848,000 in 2012 compared to 2011. The Company’s tax equivalent interest income decreased
4.6% to $27,016,000 in 2013, from $28,332,000 in 2012 and $30,127,000 in 2011. The decline from 2012 is
associated with competitive loan environment and general
interest rate conditions mentioned above. The
increase in net interest income in 2012 and 2011 was primarily due to the decline in yield earned on our loan
and investment portfolios; however, this decline was more than offset by decreases in interest expense during
these years.
Average interest earning balances with banks at December 31, 2013, increased to $38.8 million with an
average yield of 0.29% compared to $32.1 million with an average yield of 0.26% for the same period in 2012.
Net interest margin continued to be negatively affected in 2013 and 2012 by the relatively low yields earned by
balances used to support the bank’s short-term liquidity needs. The average yield in both periods is comparable
to the federal funds target rate of 0.25% set by the Federal Open Market Committee of the Federal Reserve.
The Company’s average loan portfolio increased $6,587,000, or 1.4%, from year end 2012 to year end 2013,
and decreased $4,938,000, or 1.0%, from 2011 to 2012. Current period growth was generated primarily in the
commercial and industrial and commercial real estate sectors, as well as one-to-four-unit residential investment
properties. The decrease in 2012 is due to decreases in construction and land development
loans and
commercial real estate loans. Overall, loan demand is beginning to increase as the economy slowly improves
and consolidations in the industry have provided opportunities to garner additional business from larger
financial institutions.
The Company’s average investment portfolio increased $28,572,000, or 49.6%, from 2012 to 2013, and
increased $3,126,000, or 5.7%, from 2011 to 2012. Interest and dividend income on investment securities for
the year ended December 31, 2013, on a tax-equivalent basis, decreased $55,000, or 5.2%, compared to the
same period in 2012. The average tax equivalent yield on investment securities decreased to 2.65% at
December 31, 2013, from 3.99% at December 31, 2012 and 4.69% at year-end 2011. The decrease in 2013 and
2012 is attributable to the reduction in yield from accelerated prepayments on mortgage-backed securities and
the maturity and sale of higher yielding securities that cannot be replaced in the current low rate environment.
Additionally, new securities purchases during 2013 are at substantially lower yields than existing bonds in the
portfolio.
The Company’s average interest-bearing deposits increased $18,161,000, or 4.2%, from 2012 to 2013, and
decreased $18,791,000, or 4.2%, in 2012 from 2011. The Company attributes the increase in 2013 primarily to
the acquisition of branches from Sterling Savings Bank, which was offset by planned runoff of higher cost
certificates of deposits. The Company attributes the decrease in 2012 to the planned runoff of higher cost
certificates of deposits, partially offset by growth in all other deposit categories. Additionally, fewer retail
customers have been willing to lock in low interest rates on certificates of deposits for an extended period of
time. Average borrowings decreased during 2013 by $899,000, or 3.7%, and decreased by $7,214,000, or
22.9%, during 2012. The decrease in average borrowing balances outstanding in 2012 was primarily due to the
maturity of $10,500,000 in FHLB advances in the latter part of 2011. The pay down in borrowings was funded
by growth in lower cost demand deposits, which contributed to the increase in interest margin during 2012.
34
Interest expense for the year ended December 31, 2013, decreased $994,000, or 28.5%, compared to the same
period in 2012. During 2012, interest expense declined $2,149,000, or 38.2%, compared to 2011. While
interest rates paid on our deposits decreased significantly during 2012, the decline in rates paid in 2013
moderated as opportunities to reduce deposit rates diminished due to fewer opportunities to reprice higher cost
certificates of deposits. Additionally, average balances of higher cost certificates and other borrowings
decreased during both periods. The average rate paid on deposits declined to 0.45% in 2013 compared to
0.66% in 2012 and 1.03% in 2011. The opportunity for continued downward repricing of maturing certificates
of deposits has diminished. For the next twelve months, the amount of certificates maturing is $65,367,000 at a
weighted average rate of 0.59%. Additionally, we believe that rates currently paid on non-maturity deposits are
effectively near the floor and that we will have less flexibility to pay lower rates on these deposits in the future.
The Company’s overall cost of interest-bearing liabilities decreased to 0.52% in 2013 from 0.76% and 1.16%
in 2012 and 2011, respectively.
The following table presents changes in net interest income, on a tax-equivalent basis, attributable to changes
in volume or rate. Changes not solely due to volume or rate are allocated to volume and rate based on the
absolute values of each.
(dollars in thousands)
Interest earned on:
2013 compared to 2012
Increase (decrease) due to
Rate
Net
Volume
2012 compared to 2011
Increase (decrease) due to
Rate
Net
Volume
Loans
. . . . . . . . . . . . . . . . . . . . .
$ 353
$(1,692)
$(1,339)
$(278)
$(1,250)
$(1,528)
Securities:
Taxable . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . .
Tax-exempt
. . . . . . . . . . . . .
Total securities
435
255
911
(427)
(272)
(920)
8
(17)
(9)
Fed funds sold and interest bearing
deposits in other banks . . . . . . . . . .
Total interest earning assets . . . . . . .
19
1,062
11
(2,380)
30
(1,318)
5
173
178
(16)
(116)
(277)
(160)
(437)
(272)
13
(259)
8
(1,679)
(8)
(1,795)
Interest paid on:
Savings and interest bearing demand
deposits . . . . . . . . . . . . . . . . . . . .
Time deposits . . . . . . . . . . . . . . . . . .
Total borrowings
. . . . . . . . . . . . . . .
Total interest bearing liabilities
. . . .
Change in net interest income . . . . .
(94)
107
22
34
$1,097
479
370
110
960
$(1,421)
385
477
132
994
$ (324)
75
(491)
(201)
(617)
$ 501
(603)
(742)
(187)
(1,532)
$ (147)
(528)
(1,233)
(388)
(2,149)
354
$
Non-Interest Income. Non-interest income was $9,955,000 for 2013, an increase of $564,000, or 6.0%, from
2012 when it totaled $9,391,000. Categories contributing to the increase during 2013 compared to 2012 were
increases in non-interest income from ATM/Debit card and annuity commission fee income and a reduction in
OTTI losses, which were partially offset by a decrease in gain on sale of OREO. Non-interest income was
$9,391,000 during 2012, an increase of $1,777,000, or 23.3%, compared to the 2011 total of $7,614,000 due to
increases in gains on sale of loans and OREO.
35
The following table represents the principal categories of non-interest income for each of the years in the
three-year period ended December 31, 2013.
(dollars in thousands)
Service charges on deposit Accounts . . $1,731
Net gain (loss) on sale of other real
2013
estate owned . . . . . . . . . . . . . . . .
Net gains on sales of loans . . . . . . . .
Net gain (loss) on sales of Securities . .
Net OTTI losses . . . . . . . . . . . . . . .
Earnings on bank owned life
40
5,171
405
(37)
452
Insurance . . . . . . . . . . . . . . . . . .
2,193
Other operating income . . . . . . . . . .
Total non-interest income . . . . . . . . $9,955
Increase
(Decrease)
Amount
$ 45
%
2.7
2012
$1,686
Increase
(Decrease)
Amount
$ (113)
%
(6.3)
2011
$1,799
(291)
113
102
296
(58)
357
$ 564
(87.9)
2.23
33.7
(88.9)
(11.4)
19.4
6.0
331
5,058
303
(333)
414
1,465
(395)
(3)
498.8
40.8
(56.6)
(0.9)
(83)
3,593
698
(330)
510
1,836
$9,391
(17)
426
$1,777
(3.2)
30.2
23.3
527
1,410
$7,614
Service charges on deposits increased $45,000, or 2.7%, during 2013 due to growth in core deposits, primarily
due to the acquisition of the Sterling Savings Bank branches. Service charges on deposits decreased $113,000,
or 6.3%, during 2012 due to a decline in overdraft revenue as a result of regulatory opt-in requirements that
affect the Bank’s ability to charge overdraft fees for ATM withdrawals and debit card transactions. The
Company continues to emphasize the importance of exceptional customer service and believes this emphasis
will contribute to an increase in service charge revenue in 2014.
The Company sells long-term fixed and adjustable rate residential real estate loans into the secondary market,
which is an important source of non-interest income. Gain on sales of loans, the largest component of non-
interest income, totaled $5,171,000 for the year ended December 31, 2013, compared to $5,058,000 for the
same period in 2012. This increase in income during the current year was due to increased mortgage
refinancing activity driven by the low rate environment and recovering housing market, particularly earlier in
the year. Originations of loans held for sale were $225,068,000 for the year ended December 31, 2013,
compared to $251,435,000 for the same period in 2012. Also contributing to the growth in volume was the
addition of origination staff during 2012. However, management expects gain on sale of loans to decline in
2014 due to its expectation that the low interest rates experienced prior to the latter part of 2013, which had
spurred an increase in refinance activity, will not return, and is making adjustments to its operations
accordingly.
The Bank continues to have success in liquidating OREO properties. As a result, net gain on sale of OREO
totaled $40,000 on twenty-one properties sold during 2013 compared to a net gain on sale of OREO of
$331,000 for the year ended December 31, 2012.
The Bank recorded net gains on sale of securities available-for-sale of $405,000, $303,000 and $698,000, for
the years ended December 31, 2013, 2012 and 2011, respectively. During each of these years, one non-agency
mortgage-backed security was determined to be other-than-temporarily-impaired resulting in the Company
recording $37,000, $333,000, and $330,000, respectively, in impairment charges related to credit losses through
earnings. There were no additional OTTI securities at December 31, 2013 or December 31, 2012.
Other operating income totaled $2,193,000 in 2013, an increase of $357,000 from 2012, or 19.4%, due
primarily to increases in wire fees, check cashing fees, debit card interchange revenue, and annuity commission
revenue. Other operating income grew to $1,836,000 in 2012, an increase of $426,000 from the previous year,
due primarily to growth in gains on sale of OREO and residential mortgage loans, offset by a decrease in gains
on sale of securities.
36
Non-Interest Expense. Total non-interest expense in 2013 was $29,502,000, an increase of $1,085,000, or
3.8%, compared to $28,417,000 in 2012. Contributing to this increase in non-interest expense were costs
associated with integration of the three coastal branches acquired from Sterling Savings Bank early in 2013.
The effect of these increases was partially mitigated by decreases in FDIC insurance assessments, expenses
related to other-real-estate-owned and other related costs. In 2012, non-interest expense increased $2,769,000,
or 10.8%, compared to $25,648,000 in 2011. The increase in 2012 was mostly related to increases in salaries
and employee benefits (including commissions), OREO expenses, and data processing expenses. The effect of
these increases was partially mitigated by decreases in FDIC insurance assessments, marketing costs and
occupancy expenses.
The following table shows the principal categories of non-interest expense for each of the years in the three-
year period ended December 31, 2013.
2013
(dollars in thousands)
. . . $17,013
Salaries and employee benefits
2,699
Occupancy and equipment
. . . . . .
458
State taxes . . . . . . . . . . . . . . . . .
2,268
Data processing . . . . . . . . . . . . . .
935
. . . . . . . . . .
Professional services
535
FDIC and state assessments
. . . . .
946
OREO write-downs . . . . . . . . . . .
408
. . . . . .
OREO operating expenses
393
Marketing and advertising . . . . . . .
Other expense . . . . . . . . . . . . . . .
3,847
Total non-interest expense . . . . . . $29,502
Increase
(Decrease)
Amount
$ 798
225
(60)
661
185
(75)
(368)
(142)
(48)
(91)
$1,085
%
4.9
9.1
(11.6)
41.1
24.7
(12.3)
(28.0)
(25.8)
(10.9)
(2.3)
3.8
2012
$16,215
2,474
518
1,607
750
610
1,314
550
441
3,938
$28,417
Increase
(Decrease)
Amount
$2,492
(60)
45
192
11
(328)
265
100
(82)
134
$2,769
%
18.2
(2.4)
9.5
13.6
1.5
(35.0)
25.3
22.2
15.7
3.5
10.8
2011
$13,723
2,534
473
1,415
739
938
1,049
450
523
3,804
$25,648
Salary and employee benefits costs, which are the largest component of non-interest expense, increased by
$798,000, or 4.9%, in 2013 to $17,013,000 and increased by $2,492,000, or 18.2%, in 2012 compared to 2011.
The increase in 2013 is largely attributable to increases in commissions paid on the sale of loans held for sale
as part of increased residential mortgage loan production during the first part of the year, and increases in loan
production personnel which tend to be more highly compensated. Additionally, annual performance and merit
increases coupled with a 3.0% increase in medical insurance premiums also contributed to the increase in
salaries and benefits for 2013. Employees hired for the loan production offices and acquired branches were
more than offset by reductions in other positions throughout the Company. The increase in 2012 is largely
attributable to increases in salaries and employee benefits related to an increase in commissions paid on the
sale of loans held for sale. Additionally, increases in incentive compensation and an 11.0% increase in medical
insurance also contributed to the increase in salaries and benefits for 2012. Full time equivalent employees at
December 31, 2013, were 234, a decrease from 237 at December 31, 2012, and an increase from 213 at
December 31, 2011. Also included in salaries and benefits for 2013 and 2012 was stock compensation expense
of $117,000 and $24,000, respectively. For more information regarding stock options, see Note 16 — ‘‘Stock
Based Compensation’’ to the Company’s audited consolidated financial statements included in Item 15 of this
report.
Occupancy and equipment expenses increased/(decreased) $225,000 and $(60,000)
to $2,699,000 and
$2,474,000, respectively, in 2013 and 2012 compared with $2,534,000 for 2011. The increase in 2013 was
associated primarily with the branch acquisitions noted above. The decline in 2012 was due primarily to
reductions in depreciation expense, building repair and maintenance, and annual equipment hardware
maintenance.
37
Data processing expense increased $661,000, or 41.1%, in 2013 compared to 2012 due mostly to the one-time
conversion expenses and increased account processing costs associated with the aforementioned branch
acquisitions. Data processing expense increased $192,000, or 13.6%, in 2012 compared to 2011. The increase
in 2012 was due mostly to the investment in technology for mobile apps, contact management software,
compliance management software and enhanced financial monitoring tools. The Company expects to continue
in new technology when appropriate to support future growth and address changing customer
to invest
preferences.
FDIC assessment expense totaled $535,000 in 2013 compared with $610,000 in 2012 and $938,000 in 2011.
The decreases in 2013 and 2012 is mostly attributable to a decrease in assessment rates effective April 2011
due to changes implemented by the FDIC under the Dodd-Frank Act to assess premiums based on average
assets rather than on domestic deposits. This change had a favorable impact on community banks, including
Bank of the Pacific.
OREO write-downs and operating costs decreased $510,000, or 27.4%, during 2013 compared to 2012 due to a
decrease in the number of OREO properties held during the year. OREO write-downs and operating costs
increased in 2012 by $365,000 which was due to an increase in the number of OREO properties held during
the year and valuation adjustments arising out of decreases in land and commercial real estate values.
Marketing and advertising expense decreased by $48,000, or 10.9%, in 2013 compared to $441,000 in 2012.
The decrease was due to reductions in corporate donations and print advertising, which was partially offset by
promotional expenses associated with our branch expansion. Marketing and advertising expense decreased by
15.7% to $441,000 in 2012 compared with $523,000 in 2011 due reduction in the number of sponsorships,
coupled with better allocation of marketing dollars dedicated to print and radio advertising. The Company
anticipates the marketing and advertising expense will increase in 2014 as the Company promotes heightened
brand awareness particularly in its new markets in Vancouver and DuPont, Washington, and Astoria and
Seaside, Oregon.
Other operating expense decreased 2.3% to $3,847,000 in 2013 compared with $3,938,000 for 2012, primarily
due to small decreases in a broad range of categories with the most notable in credit card expenses and
education and training. Other operating expense increased 3.5% to $3,938,000 in 2012 compared with
$3,804,000 in 2011, primarily due small increases in a broad range of categories with the most notable in
credit reports and loan origination expense associated with the ramp up of mortgage origination operations.
Income Taxes. For the years ended December 31, 2013, 2012, and 2011, income taxes totaled $972,000,
$1,300,000 and $333,000,
representing effective tax rates of 20.7%, 21.4% and 10.6%,
respectively. The effective tax rate differs from the statutory rate of 34.6% due to tax exempt income from
investments in municipal securities and loans, income earned on BOLI, and tax credits received on investments
in low income housing partnerships.
respectively,
Deferred income tax assets or liabilities reflect the estimated future tax effects attributable to differences as to
when certain items of income or expense are reported in the financial statements versus when they are reported
in the tax returns. At December 31, 2013 and 2012, the Company had a net deferred tax asset of $4,546,000
and $4,013,000, respectively.
See ‘‘Critical Accounting Policies’’ in this section below.
38
FINANCIAL CONDITION
At December 31, 2013 and 2012
Total assets were $705,039,000 at December 31, 2013, an increase of $61,445,000, or 9.6%, over year-end
2012. Increases in investment securities and loans were the primary contributors to overall asset growth, which
were partially offset by a decrease in cash and cash equivalents, loans held for sale and OREO.
Cash and Cash Equivalents
Total cash and cash equivalents decreased to $38,675,000 at December 31, 2013, from $59,840,000 at
December 31, 2012, due to increased lending through new loan production offices and deployment of excess
cash balances into higher yielding investments.
Investment Portfolio
The composition of our investment portfolio is managed to maximize total return on the portfolio while
considering the impact it has on asset/liability position and liquidity needs. The majority of securities are
classified as available-for-sale and carried at fair value with a small amount classified as held-to-maturity and
carried at amortized cost. The Company regularly reviews its portfolio in conjunction with overall balance
sheet management strategies. From time to time securities may be sold to reposition the portfolio in response
to strategies developed by the Company’s asset liability committee or to realize gains within the portfolio. The
Company’s investment securities portfolio increased $30,232,000, or 44.4%, during 2013 to $98,276,000 due
to investment in municipal, government agency and mortgage-backed securities from proceeds received from
the Sterling branch acquisition. The Company’s investment securities portfolio increased $13,366,000, or
24.4%, during 2012 to $68,043,000 due to investment in municipal, government agency and mortgage-backed
securities as an alternative to cash.
The Company regularly reviews its investment portfolio to determine whether any of its securities are other
than temporarily impaired. In addition to accounting and regulatory guidance,
in determining whether a
security is other than temporarily impaired, the Company considers whether it intends to sell the security and if
it does not intend to sell the security, whether it is more likely than not it will be required to sell the security
before recovery of its amortized cost basis. The Company also considers cash flow analysis for mortgage-
backed securities under various prepayment, default, and loss severity scenarios in determining whether a
mortgage-backed security is other than temporarily impaired. At December 31, 2013, the Company owned 20
securities in a continuous unrealized loss position for twelve months or longer, with an amortized cost of
$13,219,000 and fair value of $12,348,000. These securities that have been in a continuous unrealized loss
position for twelve months or longer at December 31, 2013, had investment grade ratings upon purchase.
Following its evaluation of factors deemed relevant, management determined, in part 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, which may be at maturity, the Company does not have any other than
temporarily impaired securities at December 31, 2013. For more information regarding our investment
securities and analysis of the value of securities in our investment portfolio, see Note 3 — ‘‘Securities’’ and
Note 18 — ‘‘Fair Value of Financial Instruments’’ to the Company’s audited consolidated financial statements
included in Item 15 of this report.
39
The carrying values of investment securities at December 31 in each of the last three years are as follows:
(dollars in thousands)
Held to Maturity
State and municipal securities
Mortgage-backed securities
Total
. . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Available For Sale
U.S. Government agency securities . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . .
State and municipal securities
Mortgage-backed securities
. . . . . . . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$1,973
159
$2,132
2013
$ 8,811
32,160
54,191
982
$96,144
2012
$6,716
221
$6,937
2012
$ 5,952
26,906
24,703
3,545
$61,106
2011
$6,732
293
$7,025
2011
$
84
22,859
22,797
1,912
$47,652
The following table presents the maturities of investment securities at December 31, 2013. Taxable equivalent
values are used in calculating yields assuming a tax rate of 34%.
(dollars in thousands)
Held To Maturity
State and municipal securities . . . .
Weighted average yield . . . . . . .
Mortgage-backed securities . . . . . .
Weighted average yield . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Total
Available For Sale
U.S. Agency securities . . . . . . . . .
Weighted average yield . . . . . . .
State and municipal securities . . . .
Weighted average yield . . . . . . .
Mortgage-backed securities . . . . . .
Weighted average yield . . . . . . .
. . . . . . . . . . . . .
Weighted average yield . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Corporate bonds
Total
Due in
one year
or less
$ 190
6.02%
—
—
$ 190
Due in
one year
or less
$1,021
0.33%
462
5.43%
—
—
—
—
$1,483
Due after
one through
five years
$—
—
—
—
$—
Due after
one through
five years
$ 6,690
1.14%
5,768
2.74%
1,940
1.76%
982
1.00%
$15,380
Due after
five through
ten years
$ 914
6.36%
113
5.22%
Due after
ten years
$ 869
6.57%
46
6.17%
$1,027
$ 915
Due after
five through
ten years
61
$
8.16%
8,821
3.92%
11,220
1.98%
—
—
$20,102
Due after
ten years
$ 1,039
2.80%
17,109
4.57%
41,031
1.95%
—
—
$59,179
Total
$1,973
159
—
$2,132
Total
$ 8,811
32,160
54,191
982
—
$96,144
40
Loan Portfolio
General. Total loans were $512,431,000 at December 31, 2013, an increase of $51,285,000, or 11.1%,
compared to December 31, 2012. The increase in total loans was driven primarily by growth in several loan
categories, notably commercial and agricultural, multi-family, commercial real estate and installment loans.
While competition for commercial loans in the markets we serve is strong, loan demand is beginning to grow.
In addition, recent merger and acquisition activity in our market area by larger institutions has enabled the
Bank to acquire commercial relationships that desire to deal with a local community bank. Management
expects the loan portfolio will continue to grow in 2014, although it believes the uncertainty surrounding
various aspects of the economy is causing many customers to wait for even more clarity before borrowing
additional funds to expand their businesses or purchase assets.
The following table sets forth the composition of the Company’s loan portfolio (including loans held for sale)
at December 31 in each of the past five years.
(dollars in thousands)
Commercial and agricultural . . . . . . . .
Construction, land development and
other land loans
. . . . . . . . . . . . . .
Residential real estate 1 − 4 family . . .
Multi-family . . . . . . . . . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . .
Commercial real estate . . . . . . . . . . .
Installment . . . . . . . . . . . . . . . . . . . .
Credit cards and overdrafts . . . . . . . . .
Less unearned income . . . . . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . .
2013
$104,111
2012
$ 87,278
2011
$ 90,731
2010
$ 84,575
2009
$ 93,125
29,096
95,527
17,520
23,698
222,888
18,160
2,568
(1,137)
$512,431
31,411
90,447
7,744
24,544
212,797
5,465
2,317
(857)
$461,146
47,156
90,552
7,682
23,752
221,474
6,772
2,156
(841)
$489,434
46,256
89,212
9,113
22,354
216,015
7,029
2,099
(828)
$475,825
64,812
91,821
8,605
22,824
205,184
7,216
1,929
(881)
$494,635
The Company’s strategy is to originate loans primarily in its local markets. Depending on the purpose of a
loan, loans may be secured by a variety of collateral, including real estate, business assets, and personal assets.
Loans, including loans held for sale, represent 73% and 72% of total assets as of December 31, 2013 and
2012, respectively. The majority of the Company’s loan portfolio is comprised of commercial and agricultural
loans (commercial loans) and real estate loans. The commercial and agricultural loans are a diverse group of
loans to small, medium, and large businesses for purposes ranging from working capital needs to term
financing of equipment.
The commercial and commercial real estate loan categories continue to be the primary focus for the Bank. Our
commercial real estate portfolio generally consists of a wide cross-section of retail, small office, warehouse,
and industrial type properties. Loan to value ratios for the Company’s commercial real estate loans generally
did not exceed 75% at origination and debt service ratios were generally 125% or better. While we have
significant balances within this lending category, we believe that our lending policies and underwriting
standards are sufficient to reduce risk even in a downturn in the commercial real estate market. Additionally,
this is a sector in which we have significant and long-term management experience. It is our strategic plan to
seek growth in commercial and small business loans where available and owner occupied commercial real
estate loans.
We remain conservative in underwriting while active in managing our existing construction loan and land
development portfolios. While these segments have historically played a significant role in our loan portfolio,
balances have declined over the last three years. Construction and land development loans represented 5.7%
and 6.8% of total loans outstanding at December 31, 2013 and 2012, respectively. We believe this segment will
remain challenged into 2014, although to a lesser extent than in previous years.
41
It is the Company’s strategic objective to maintain concentrations in land and residential construction and total
commercial real estate below the regulatory guidelines of 100% and 300% of risk based capital, respectively.
As of December 31, 2013, concentration in land and residential construction as a percentage of risk based
capital was 40.1% and total concentration in non-owner occupied commercial real estate plus land and
residential construction as a percentage of risk-based capital stood at 230.7%.
Loan Maturities and Sensitivity in Interest Rates. The following table presents information related to
maturity distribution and interest rate sensitivity of loans outstanding (excluding residential mortgages held for
sale), based on scheduled repayments at December 31, 2013.
(dollars in thousands)
Commercial
Construction, land development and other land
. . . . . . . . . . . . . . . . . . . . . . . . . .
loans
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate 1 − 4 family . . . . . . . . . . .
Multi-family . . . . . . . . . . . . . . . . . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial real estate . . . . . . . . . . . . . . . . . . .
Installment
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit cards and overdrafts . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less unearned income . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . .
Total loans
Due in
one year
or less
$ 55,033
18,201
47,564
717
9,489
97,824
3,435
2,396
$234,659
Due after
one through
five years
$ 22,814
16,264
41,436
6,105
8,254
134,693
7,881
—
$237,447
Due after
five years
$ 8,368
77
7,001
10,698
251
758
6,549
—
$33,702
Total
$ 86,215
34,542
96,001
17,520
17,994
233,275
17,865
2,236
$505,808
(1,137)
$504,671
Total loans maturing after one year with
Predetermined interest rates (fixed) . . . . . . . . .
. . . . . . .
Floating or adjustable rates (variable)
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 55,100
182,347
$237,447
$20,230
13,675
$33,702
$ 75,330
196,022
$271,149
At December 31, 2013, 46.8% of the total loan portfolio was due in one year or less, up from 40.9% at
December 31, 2012. This increase is part of management’s efforts to mitigate the Company’s interest rate risk
in the near term.
Nonperforming Assets. Nonperforming assets are defined as loans on non-accrual status, loans past due
ninety days or more and still accruing interest, and OREO. The Company’s policy for placing loans on non-
accrual status is based upon management’s evaluation of the ability of the borrower to meet both principal and
interest payments as they become due. Generally, loans with interest or principal payments which are ninety or
more days past due are placed on non-accrual (unless they are well-secured and in the process of collection)
and previously accrued interest is reversed against income.
Non-performing assets totaled $10,014,000 at December 31, 2013. This represents 1.42% of total assets,
compared to $19,791,000, or 3.08%, at December 31, 2012, and $21,760,000, or 3.39%, at December 31,
2011. Commercial real estate loans are the primary component of non-performing assets, representing
$6,003,000, or 59.9%, of non-performing assets.
42
The following table presents information related to the Company’s non-accrual loans and other non-performing
assets at December 31 in each of the last five years.
(dollars in thousands)
Accruing loans past due 90 days or more . . . . . . . . .
2013
2012
2011
2010
2009
$ — $ — $
299
$ — $
547
Non-accrual loans:
Construction, land development and other land
loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate 1-4 family . . . . . . . . . . . . .
Multi-family real estate . . . . . . . . . . . . . . . . . . .
Commercial real estate(4)
. . . . . . . . . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Installment . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total non-accrual loans(1) . . . . . . . . . . . . . . . .
Total non-performing loans . . . . . . . . . . . . . . . .
OREO:
Construction, land development and other land
loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate 1 − 4 family . . . . . . . . . . . .
Commercial real estate . . . . . . . . . . . . . . . . . . . .
Total OREO . . . . . . . . . . . . . . . . . . . . . . . . .
Total non-performing assets(2) . . . . . . . . . . . . . .
Troubled debt restructured loans on accrual status . . .
. . . . . . . . . . . . . . . . . .
Allowance for credit losses
Allowance to non-performing loans . . . . . . . . . . . . .
. . . . . . . . . . . .
Allowance to non-performing assets
Non-performing loans to total loans(3)
. . . . . . . . . . .
Non-performing assets to total assets . . . . . . . . . . . .
1,408
400
—
4,141
955
286
53
7,243
7,243
1,792
800
—
9,642
976
1,901
1
15,112
15,112
5,510
528
—
7,168
—
530
—
13,736
14,035
5,529
2,246
—
803
170
1,251
—
9,999
9,999
9,886
1,323
353
2,949
87
1,049
—
15,647
16,194
237
672
1,862
2,771
$10,014
$ 2,680
$ 8,359
1,860
507
2,312
4,679
$19,791
$
444
$ 9,358
4,150
1,427
2,148
7,725
$21,760
$
398
$11,127
4,043
540
1,997
6,580
$16,579
4,850
220
1,595
6,665
$22,859
$ — $ —
$11.092
$10,617
115.41% 61.92% 79.28% 106.18%
83.47% 47.28% 51.14% 64.04%
2.15%
1.44%
2.57%
1.42%
3.37%
3.08%
2.96%
3.39%
68.49%
48.52%
3.36%
3.42%
(1)
Includes $1,408,000, $3,930,000, $7,734,000 and $932,000 in non-accrual troubled debt restructured loans
(‘‘TDRs’’) as of December 31, 2013, 2012, 2011 and 2010, respectively, which are also considered
impaired loans. There were no TDRs as of December 31, 2009.
(2) Does not include TDRs on accrual status.
(3) Excludes loans held for sale
(4)
Includes one loan totaling $1,831,000 at December 31, 2013 of which $1,465,000 is guaranteed by the
United States Department of Agriculture.
Non-performing loans decreased $7,869,000, or 52.1%, from the balance at December 31, 2012 due to
decreases in all non-accrual loan categories except installment. The decline in non-accrual commercial real
estate is primarily the result of partial or full payoffs totaling $3,389,000 from six borrowing relationships. The
decrease in non-accrual commercial is made up primarily of a partial payoff of one loan relationship totaling
$1,446,000. The level of non-performing loans reflects recent improvements in the real estate market and
economy in our region. OREO decreased by $1,908,000, or 40.8%, from the balance at December 31, 2012.
Six properties, primarily residential real estate totaling $1,756,000, were taken into OREO during the year.
However, twenty properties totaling $2,753,000 were liquidated in the period, most of which were commercial
real estate.
43
Non-performing loans at December 31, 2012 increased 1,077,000, or 7.7%, from the balance at December 31,
2011 due to increases in non-accrual commercial and commercial real estate loans that were only partially
offset by a significant decrease in construction, land development and other land loans. The increase in non-
accrual commercial in 2012 was made up primarily of one loan totaling $1,587,000.
The Company continues to aggressively identify and monitor non-performing assets and take action based
upon available information. The balance of non-performing loans at year end 2013 is equal to 1.44% of total
loans, excluding loans held for sale, compared to 3.37% at December 31, 2012. The totals are net of charge-
offs based on the difference between carrying value on our books and management’s estimate of fair market
value after taking into account the result of appraisals and other factors. Delinquencies continue to be well-
managed and no significant adverse trends have been identified. Past due loans represented 1.4% and 2.4% of
total loans outstanding at December 31, 2013 and 2012, respectively.
The Company had troubled debt restructures totaling $4,088,000, $4,374,000, and $8,132,000 at December 31,
2013, 2012 and 2011, respectively, which were on non-accrual status. A TDR is a loan for which the terms
have been modified in order to grant a concession to a borrower that is experiencing financial difficulty.
Troubled debt restructurings are considered impaired loans and reported as such. For more information
regarding TDRs, see Note 4 — ‘‘Loans’’ to the Company’s audited financial statements included in Item 15 of
this report.
Interest income on non-accrual loans that would have been recorded had those loans performed in accordance
with their initial terms was $1,130,000, $1,213,000 and $752,000 for 2013, 2012, and 2011, respectively.
Interest income recognized on impaired loans was $177,000, $226,000 and $255,000 for 2013, 2012, and 2011,
respectively.
Currently, it is our practice to obtain new appraisals on non-performing collateral dependent loans and/or
OREO semi-annually on land and every nine months on improved properties. Based upon the appraisal review
for non-performing loans, the Company will record the loan at the lower of carrying value or fair value of
collateral (less costs to sell) by recording a charge-off to the allowance for credit losses or by designating a
specific reserve. Generally, the Company will record the charge-off rather than designate a specific reserve.
During 2013 and 2012, as a result of these appraisals and other factors, the Company recorded OREO write-
downs of $946,000 and $1,314,000, respectively. The Company will continue to reevaluate non-performing
assets over the coming months as market conditions change.
OREO at December 31, 2013 totaled $2,771,000 and includes: five land or land development properties
totaling $237,000; eight commercial
real estate properties totaling $1,862,000; and four single family
residences collectively valued at $672,000. The balances are recorded at the estimated net realizable value less
the assets held in OREO. Management
selling costs. Liquidation strategies have been identified for all
continues to market these properties through an orderly liquidation process rather than engaging in immediate
liquidation that it believes would result in discounts greater than the projected carrying costs.
Loan Concentrations. The Company has credit risk exposure related to real estate loans. The Company
makes loans for acquisition, construction and other purposes that are secured by real estate. At December 31,
2013, loans secured by real estate totaled $380,964,000, which represents 75.5% of the total loan portfolio.
Real estate construction loans comprised $29,096,000 of that amount, while real estate loans secured by
residential properties totaled $87,762,000. As a result of these concentrations of loans, the loan portfolio is
susceptible to deteriorating economic and market conditions in the Company’s market areas. The Company
generally requires collateral on all real estate exposures and typically originates loans at loan-to-value ratios at
loan origination of no greater than 80%. See ‘‘Risk Factors’’ under Item 1A of this report.
44
Allowance and Provision for Credit Losses. The allowance for credit losses reflects management’s current
estimate of the amount required to absorb probable losses on loans in its loan portfolio based on factors
present as of the end of the period. Loans deemed uncollectible are charged against and reduce the allowance.
Periodic provisions for credit losses are charged to current expense to replenish the allowance for credit losses
in order to maintain the allowance at a level that management considers adequate. The amount of provision is
based on an analysis of various factors including historical loss experience based on volumes and types of
loans, volumes and trends in delinquencies and non-accrual loans, trends in portfolio volume, results of internal
and independent external credit reviews, and anticipated economic conditions. Estimated loss factors used in
the allowance for credit loss analysis are established based in part on historic charge-off data by loan category,
portfolio migration analysis, economic conditions and other qualitative factors. During the year ended
December 31, 2013, based upon charge-off experience and other factors considered by management, the loss
factors used in the allowance for credit losses were updated from 0.50% to 0.40% on pass rated commercial
loans, from 0.50% to 0.40% on non owner-occupied commercial real estate loans, and from 0.60% to 0.55%
on owner-occupied commercial real estate. Loss factors for land and land development loans, speculative
residential construction, residential real estate, personal lines of credit and other consumer loans remained
unchanged. As a result, the estimate for the allowance for credit losses decreased. See ‘‘Critical Accounting
Policies’’ in this section below, as well as ‘‘Risk Factors’’ under Item 1A. above.
Transactions in the allowance for credit losses for the years ended December 31 are as follows:
(dollars in thousands)
Balance at beginning of year . . . . . . . . . . . . . . .
2013
$9,358
2012
$11,127
2011
$10,617
2010
$11,092
2009
$ 7,623
Charge-offs:
Construction and land development . . . . . . . . .
Residential real estate 1-4 family . . . . . . . . . .
Commercial real estate . . . . . . . . . . . . . . . . .
Commercial . . . . . . . . . . . . . . . . . . . . . . . . .
Credit card . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
Installment
Total charge-offs . . . . . . . . . . . . . . . . . . .
26
453
64
131
80
74
828
348
576
479
67
17
292
1,779
790
665
1,215
161
38
55
2,924
Recoveries:
Construction and land development . . . . . . . . .
Residential real estate 1 − 4 family . . . . . . . . .
Commercial real estate . . . . . . . . . . . . . . . . .
Commercial . . . . . . . . . . . . . . . . . . . . . . . . .
Credit card . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
Installment
Total recoveries . . . . . . . . . . . . . . . . . . . .
Net charge-offs . . . . . . . . . . . . . . . . . . . . . . . .
Provision for (recapture of) credit losses . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . .
Ratio of net charge-offs to average loans
7
14
219
36
0
3
279
549
(450)
$8,359
896
162
21
23
5
3
1,110
669
(1,100)
$ 9,358
630
107
120
69
3
5
934
1,990
2,500
$11,127
1,891
1,518
164
469
38
81
4,161
2
48
17
13
3
3
86
4,075
3,600
$10,617
4,687
940
505
238
80
74
6,524
—
2
17
17
4
9
49
6,475
9,944
$11,092
outstanding . . . . . . . . . . . . . . . . . . . . . . . . .
0.11%
0.14%
0.41%
0.84%
1.29%
45
During the year ended December 31, 2013, provision for (recapture of) credit
losses totaled ($450,000)
compared to ($1,100,000) and $2,500,000 for the same periods in 2012 and 2011, respectively. The recapture
of prior provision in the current year is primarily the result of the continued overall improvement in credit
quality, as evidenced by decreases in net charge-offs, non-performing loans and performing loans classified as
substandard or worse. During 2012,
the recapture of provision was mostly due to the elimination of a
$1.7 million specific impairment reserve as a result of a favorable ruling with respect to a government
guaranty. Net charge-offs totaled $549,000 for the twelve months ended December 31, 2013, compared to
$669,000 for the same period in 2012, and loans classified as substandard decreased $8,655,000, or 40.4%,
from year end 2012 to $12,763,000 at December 31, 2013.
The decrease in provision for credit losses in 2011 was due to improving credit quality as evidenced by
decreases in net charge-offs, substandard loans, and impaired loans. Loans classified as substandard decreased
$5,285,000 to $34,570,000 at December 31, 2011. Impaired loans decreased $241,000 to $14,432,000 at
December 31, 2011. The provision reflects management’s continuing evaluation of the loan portfolio’s credit
quality, which is affected by a broad range of economic metrics.
The allowance for credit
losses was $8,359,000 at December 31, 2013, compared with $9,358,000 at
December 31, 2012, a decrease of $999,000, or 10.7%. The decrease in 2013 is due to a decrease in classified
loans and estimated loss factors used in determining the allowance for credit losses due to improving credit
losses decreased to
quality metrics and economic conditions discussed above. The allowance for credit
$9,358,000 at year-end 2012 compared to $11,127,000 at year-end 2011. The decrease in 2012 is due to the
elimination of a $1.7 impairment reserve discussed above and a decrease in estimated loss factors used in
determining the allowance for credit losses also discussed above.
The ratio of the allowance for credit losses to total loans outstanding (excluding loans held for sale) was
1.66%, 2.09% and 2.34% at December 31, 2013, 2012 and 2011, respectively. The Company’s loan portfolio
contains a significant portion of government guaranteed loans which are fully guaranteed by the United States
Government. Government guaranteed loans were $37,823,000 and $49,966,000 at December 31, 2013 and
loans outstanding excluding the
2012, respectively. The ratio of the allowance for credit
government guaranteed loans was 1.76% and 2.35%, respectively.
losses to total
There is no precise method of predicting specific credit losses or amounts that ultimately may be charged off.
The determination that a loan may become uncollectible, in whole or in part, is a matter of significant
management judgment. Similarly, the adequacy of the allowance for credit losses is a matter of judgment that
requires consideration of many factors, including (a) economic conditions and the effect on particular industries
and specific borrowers; (b) a review of borrowers’ financial data, together with industry data, the competitive
situation, the borrowers’ management capabilities and other factors; (c) a continuing evaluation of the loan
portfolio, including monitoring by lending officers and staff credit personnel of all loans which are identified as
being of less than acceptable quality; (d) an in-depth review, at a minimum of quarterly or more frequently as
considered necessary, of all loans judged to present a possibility of loss (if, as a result of such quarterly review,
the loan is judged to be not fully collectible, the carrying value of the loan is reduced to that portion
considered collectible); and (e) an evaluation of the underlying collateral for secured lending, including the use
of independent appraisals of real estate properties securing loans. An analysis of the adequacy of the allowance
is conducted by management quarterly and is reviewed by the Board of Directors. Based on this analysis and
applicable accounting standards, management considers the allowance for credit losses of $8,359,000 to be
adequate at December 31, 2013.
46
The Financial Accounting Standards Board (FASB) has issued accounting guidance relating to 1) accounting
by creditors for impairment of a loan and 2) accounting by creditors for impairment of a loan for income
recognition disclosures. The Company measures impaired loans based on the present value of expected future
cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable
market price or the fair market value of the collateral if the loan is collateral dependent. The Company
excludes loans that are currently measured at fair value or at the lower of cost or fair value, and certain large
groups of smaller balance homogeneous loans that are collectively measured for impairment.
The following table summarizes the Bank’s impaired loans at December 31:
(dollars in thousands)
Total impaired loans . . . . . . . . . . . . . . . . . . . . .
Total impaired loans with valuation allowance . . .
. . .
Valuation allowance related to impaired loans
2013
$9,922
—
—
2012
$14,784
—
—
2011
$14,432
4,498
2,032
2010
$14,673
508
142
2009
$25,738
2,962
638
No valuation allowance was considered necessary for the remaining impaired loans. The balance of the
allowance for credit losses in excess of these specific reserves is available to absorb losses from all non-
impaired loans.
It is the Company’s policy to charge-off any loan or portion of a loan that is deemed uncollectible in the
ordinary course of business. The entire allowance for credit losses is available to absorb such charge-offs.
The Company allocates its allowance for credit losses among major loan categories primarily on the basis of
historical data. Based on certain characteristics of the portfolio and management’s analysis, losses can be
estimated for major loan categories. The following table presents the allocation of the allowance for credit
losses among the major loan categories based primarily on historical net charge-off experience and other
considerations at December 31 in each of the last five years.
2013
(dollars in thousands)
Reserve
Commercial loans . . . . . . . . . . . $ 775
4,181
Real estate loans
. . . . . . . . . . .
Consumer loans . . . . . . . . . . . .
744
2,659
Unallocated . . . . . . . . . . . . . . .
Total allowance . . . . . . . . . . . . $8,359
Ratio of allowance for credit
losses to loans outstanding at
end of year
. . . . . . . . . . . . .
% of
Total
Loans*
2012
Reserve
19% $ 923
79% 4,927
2%
531
2,977
—
100% $9,358
% of
Total
Loans*
2011
Reserve
19% $ 1,012
7,849
79%
642
2%
1,624
100% $11,127
—
% of
Total
Loans*
18% $
80%
2%
2010
Reserve
816
7,139
690
1,972
100% $10,617
—
% of
Total
Loans*
2009
Reserve
18% $ 1,308
8,341
80%
260
2%
1,183
100% $11,092
—
% of
Total
Loans*
19%
79%
2%
—
100%
1.66%
2.09%
2.34%
2.28%
2.30%
*
Represents the total of all outstanding loans in each category as a percent of total loans outstanding.
The table indicates decreases of $148,000 and $746,000 during 2013 in the portion of the allowance related to
commercial and real estate loans, respectively, which were partially offset by an increase in the portion related
to consumer loans. The significant decline in 2013 in the commercial, real estate and unallocated portions of
the reserve is due to the reduction in loss factors associated with these loan categories and the overall
improvement in credit quality as previously mentioned. The increase in the allowance related to consumer
loans resulted from a growth in loans in this sector during 2013. The significant decline in 2012 in the real
estate portion of the reserve is due to the elimination of a $1.7 million impairment reserve.
47
Deposits
The Company’s primary source of funds has historically been customer deposits. A variety of deposit products
are offered to attract customer deposits. These products include non-interest bearing demand accounts, NOW
accounts, savings accounts, and time deposits. Interest-bearing accounts earn interest at rates established by
management based on competitive market factors and the need to increase or decrease certain types or
maturities of deposits. The Company has succeeded in growing its deposit base over the last three years despite
increasing competition for deposits in our markets. The Company believes that it has benefited from its local
identity and superior customer service. Attracting deposits remains integral to the Company’s business as it is
the primary source of funds for loans and a major decline in deposits or failure to attract deposits in the future
could have an adverse effect on results of operations and financial condition. The Company’s strategic plan
contemplates and focuses on continued growth in non-interest bearing accounts, which contribute to higher
levels of non-interest income and net interest margin, through increased sales efforts and continued focus on
customer service and emphasis on our expanded electronic services. We expect significant competition for
deposits of this nature to continue for the foreseeable future as loan demand improves within our markets.
Deposit detail by category as of December 31, 2013, 2012 and 2011, respectively, follows:
(dollars in thousands)
Demand, non-interest bearing . . . . . . . . . . . . . . . . . .
Interest bearing demand (NOW) . . . . . . . . . . . . . . . .
Money market deposits . . . . . . . . . . . . . . . . . . . . . .
Savings deposits . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . .
Time, interest bearing (CDs)
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$145,028
144,221
118,627
73,412
126,059
$607,347
2012
$115,138
125,758
106,849
62,493
138,005
$548,243
2011
$108,899
122,160
99,031
65,451
152,509
$548,050
Total deposits increased to $607,347,000 at December 31, 2013 compared to 2012. Increases in demand and
money market accounts were offset by a similar decrease in time certificates of deposits (CDs). Non-interest
bearing demand deposits increased $29,890,000, or 26.0%, mostly in commercial and public demand accounts.
The increase in NOW accounts of $18,463,000 and money market accounts of $11,778,000 was attributable to
an increased emphasis on growing our customer base in non-maturity deposit products instead of higher cost
CDs. Growth in all categories was also the result of the acquisition of Sterling Savings Bank branches in
second quarter 2013, representing $37,636,000 in deposits. The Bank prices CDs competitively to retain
existing relationship-based customers, but not to retain CD-only customers or to attract new CD customers.
Additionally, due to the low interest rate environment, many CD customers opted to place their maturing
balances in checking or money market accounts while waiting for interest rates to improve. CDs decreased
$11,946,000, or 8.7%, to $126,059,000 at December 31, 2013.
Total deposits were flat at $548,243,000 at December 31, 2012 and 2011. Increases in demand and money
market accounts were offset by a similar decrease in time certificates of deposits (CDs). Non-interest bearing
demand deposits increased $6,239,000, or 5.7%, mostly in commercial and public demand accounts. The
increase in NOW accounts of $3,598,000 and money market accounts of $7,818,000 was again attributable to
an increased emphasis on growing our customer base in non-maturity deposit products. CDs decreased
$14,504,000, or 9.5%, to $138,005,000 at December 31, 2012.
48
Brokered deposits, excluding CDARS, totaled $17,788,000, $19,239,000 and $13,000,000 at December 31,
2013, 2012 and 2011, respectively. The Bank increased brokered deposits during 2013 and 2012 in order to
lock in a low-cost source of funds for an extended maturity to help insulate the Bank in a rising rate
environment. Longer term CDs are generally not available in the retail market as customers generally desire to
keep funds more liquid and accessible. The decrease in brokered deposits in 2011 was due to management’s
strategy to roll off brokered deposits as they came due during the year, of which $14.2 million matured in
2011. Changes in the market or new regulatory restrictions could limit our ability to maintain or acquire
brokered deposits in the future.
The ratio of non-interest bearing deposits to total deposits was 23.9%, 21.0% and 19.9% at December 31,
2013, 2012 and 2011, respectively.
The following table sets forth the average balances for each major category of deposits and the weighted
average interest rate paid for deposits for the periods indicated.
(dollars in thousands)
Non-interest bearing demand Deposits . . .
Interest bearing demand deposits . . . . . . .
Savings and money market deposits
. . . .
Time deposits . . . . . . . . . . . . . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . .
2013
2012
2011
Average
Deposits
$129,218
131,179
185,005
135,447
$580,849
Average
Rate
Deposits
0.00% $107,048
0.30% 120,472
0.27% 168,512
0.98% 144,486
0.35% $540,518
Average
Rate
Deposits
0.00% $ 93,413
0.48% 113,399
0.30% 162,231
1.24% 176,631
0.53% $545,674
Rate
0.00%
0.72%
0.49%
1.72%
0.85%
Maturities of time certificates of deposit as of December 31, 2013 are summarized as follows:
(dollars in thousands)
3 months or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Over 3 through 6 months . . . . . . . . . . . . . . . . . . . . . . . . . . .
Over 6 through 12 months . . . . . . . . . . . . . . . . . . . . . . . . . .
Over 12 months . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Under
$100,000
$11,616
8,681
10,488
18,664
$49,449
Over
$100,000
$ 9,145
7,858
17,578
42,029
$76,610
Total
$ 20,761
16,539
28,066
60,693
$126,059
Short-Term Borrowings
The following is
December 31, 2013, 2012 and 2011.
information regarding the Company’s
short-term borrowings
for
the years ended
(dollars in thousands)
Amount outstanding at end of period . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted average interest rate thereon . . . . . . . . . . . . . . . . . . . . . . . .
Maximum month-end balance during the year
. . . . . . . . . . . . . . . . . . .
Average balance during the year
. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average interest rate during the year . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$ —
2012
$3,000
2011
$ —
—%
3,000
303
2.94%
2.94%
3,000
2,697
2.94%
—%
10,500
6,885
3.84%
49
CONTRACTUAL OBLIGATIONS
The Company is party to many contractual financial obligations at December 31, 2013, including without
limitation, borrowings from the FHLB, junior subordinated debentures associated with trust preferred securities
and operating leases for branch locations. The following is information regarding the dates payments of such
obligations are due.
Contractual obligations
Operating leases
. . . . . . . . . . . . . . . . . .
Total deposits . . . . . . . . . . . . . . . . . . . .
Federal Home Loan Bank borrowings . . . .
Junior subordinated debentures
. . . . . . . .
Total long-term obligations . . . . . . . . . .
Less than
1 year
$
461
546,655
—
—
$547,116
Payments due by Period
3 − 5
years
1 − 3
years
$
785
45,846
10,000
—
$56,631
$
157
14,122
—
—
$14,279
More than
5 years
$ —
724
—
13,403
$14,127
$
Total
1,403
607,347
10,000
13,403
$632,153
COMMITMENTS AND CONTINGENCIES AND OFF-BALANCE SHEET ARRANGEMENTS
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
the Bank’s commitments at
December 31 is as follows:
instruments. A summary of
Commitments to extend credit
Standby letters of credit
. . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$106,017
1,733
2012
$84,493
1,975
KEY FINANCIAL RATIOS
Year ended December 31,
Return on average assets . . . . . . . . . . . . . . . . . .
Return on average equity . . . . . . . . . . . . . . . . .
Dividend payout ratio . . . . . . . . . . . . . . . . . . . .
2013
.55%
5.48%
55%
2012
.75%
7.28%
42%
2011
.44%
4.45%
—%
2010
.25%
2.77%
—%
2009
(.96)%
(11.63)%
—%
50
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The primary concern of depositors, creditors and regulators is the Company’s ability to have
sufficient funds readily available to repay liabilities as they mature. In order to evaluate whether adequate
funds are and will be available at all times, the Company monitors and projects the amount of funds required
on a daily basis. The Bank’s primary source of liquidity is deposits from its customer base, which has
historically provided a stable source of ‘‘core’’ demand and consumer deposits. Other sources of liquidity are
available, including borrowings from the FHLB, the Federal Reserve Bank, and from correspondent banks.
Liquidity requirements can also be met through disposition of short-term assets. In management’s opinion, the
Company maintains an adequate level of liquid assets for its known and reasonably foreseeable liquidity
requirements, consisting of cash and amounts due from banks, interest bearing deposits and federal funds sold
to support daily cash flow requirements.
Management expects to continue to rely on customer deposits as the primary source of liquidity, but may also
obtain liquidity from maturity of its investment securities, sale of securities currently available for sale, loan
sales, brokered deposits, government sponsored programs, loan repayments, net income, and other borrowings.
Although deposit balances have shown historical growth, deposit habits of customers may be influenced by
changes in the financial services industry, interest rates available on other investments, general economic
conditions, consumer confidence, changes to government insurance programs, and competition. Competition for
deposits is presently quite intense, even in our traditional markets of operations in Western Washington,
making deposit retention challenging and new deposit growth quite difficult. Any significant reduction in
deposits could adversely affect the Company’s financial condition, results of operations, and liquidity. See
‘‘Risk Factors’’ under Item 1A. above.
Borrowings may be used on a short-term basis to compensate for reductions in deposits, but are generally not
considered a long term solution to liquidity issues. Long-term borrowings at December 31, 2013 and 2012
represent advances from the FHLB of Seattle. Advances at December 31, 2013 bear interest at 0.47% to 2.94%
and mature in various years as follows: 2015 — $5,000,000, and 2016 — $5,000,000. The Bank has pledged
$168,136,000 of loans as collateral for these borrowings at December 31, 2013. Based on pledged collateral, at
December 31, 2013, the Bank had $113,849,000 of available borrowing capacity on its line at the FHLB,
although each advance is subject to prior consent. The Bank also has a borrowing facility of $53,187,000 at the
Federal Reserve Bank, of which none was used at December 31, 2013. The Bank has pledged $79,422,000 of
loans as collateral to the Federal Reserve Bank.
The holding company specifically relies on dividends from the Bank, proceeds from the exercise of stock
options, and proceeds from the issuance of trust preferred securities for its funds, which are used for various
corporate purposes. Dividends from the Bank are the holding company’s most important source of funds, and
are subject to regulatory restrictions and the capital needs of the Bank, which are always primary. Sales of trust
preferred securities (‘‘TRUPs’’) were also a historical source of liquidity for the holding company and capital
for both the holding company and the Bank; however, we have not issued TRUPs since 2006 and do not
anticipate TRUPs will be a source of liquidity in 2014 or beyond.
At December 31, 2013, two wholly-owned subsidiary grantor trusts established by the Company had issued and
outstanding $13,403,000 of trust preferred securities. During 2012,
the Company paid all accrued interest,
including deferred interest, which had accrued since the Company elected, in 2009, to exercise its right to defer
interest payments on trust preferred debentures, as permitted by the terms thereof. The Company is currently
making regular interest payments when due. As of December 31, 2013 and 2012, interest on TRUPs totaled
$40,000 and $41,000 respectively, and is included in accrued interest payable on the balance sheet. For more
information regarding the Company’s issuance of trust preferred securities, see Note 10 ‘‘Junior Subordinated
Debentures’’ to the audited consolidated financial statements included under Item 15 of this report.
Capital. The Company conducts its business through the Bank. Thus, the Company needs to be able to
provide capital and financing to the Bank should the need arise. The primary sources for obtaining capital are
additional stock sales and retained earnings. Total shareholders’ equity was $67,137,000 at December 31, 2013,
an increase of $416,000, or 0.6%, compared to December 31, 2012. The increase is largely attributable to
earnings retention. Total shareholders’ equity averaged $68,057,000 in 2013, which includes $12,168,000 of
goodwill. Shareholders’ equity averaged $65,743,000 in 2012, compared to $61,942,000 in 2011.
51
The Company’s Board of Directors considers financial results, growth plans, and anticipated capital needs in
formulating its dividend policy. The payment of dividends is subject to adequate financial resources at the
Bank, which depend in part on operating results and limitations imposed by law and governmental regulations
or actions of regulators.
The Federal Reserve has established guidelines for risk-based capital requirements for bank holding companies.
Under the guidelines, one of four risk weights is applied to balance sheet assets, each with different capital
requirements based on the credit risk of the asset. The Company’s capital ratios include the assets of the Bank
on a consolidated basis in accordance with the requirements of the Federal Reserve. The Company’s capital
ratios have exceeded the minimum required to be classified ‘‘well capitalized’’ during each of the past three
years.
The following table sets forth the minimum required capital ratios and actual ratios for December 31, 2013 and
2012.
(dollars in thousands)
December 31, 2013
Tier 1 capital (to average assets)
Actual
Amount
Requirements for
Well-Capitalized
Ratio
Amount
Ratio
Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$67,856
67,420
9.83% $27,604
27,591
9.77%
Tier 1 capital (to risk-weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total capital (to risk-weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
67,856
67,420
74,477
74,036
12,85%
12,78%
14,11%
14,03%
21,119
21,101
42,237
42,202
December 31, 2012
Tier 1 capital (to average assets)
Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$66,750
66,712
10.69% $24,975
24,966
10.69%
Tier 1 capital (to risk-weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total capital (to risk-weighted assets)
Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
66,750
66,712
72,376
72,334
14.95%
14.96%
16.21%
16.22%
17,855
17,842
35,710
35,685
4.00%
4.00%
4.00%
4.00%
8.00%
8.00%
4.00%
4.00%
4.00%
4.00%
8.00%
8.00%
is assigned to reporting units for purposes of impairment
Goodwill Valuation. Goodwill
testing. The
Company has one reporting unit, the Bank, for purposes of computing goodwill. The Company performs an
annual review in the second quarter of each fiscal year, or more frequently if indications of potential
impairment exist, to determine if the recorded goodwill is impaired. As of December 31, 2013, management
determined there were no events or circumstances which would more likely than not reduce the fair value of
its reporting unit below its carrying value.
52
A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such
indicators may include, among others: a significant decline in expected future cash flows; a sustained,
significant decline in our stock price and market capitalization; a significant adverse change in legal factors or
in the business climate; adverse assessment or action by a regulator; and unanticipated competition. Any
adverse change in these factors could have a significant impact on the recoverability of such assets and could
have a material impact on the Company’s Consolidated Financial Statements.
The goodwill impairment test involves a two-step process. The first step is a comparison of the reporting unit’s
fair value to its carrying value. If the reporting unit’s fair value is less than its carrying value, the Company is
required to progress to the second step. In the second step the Company calculates the implied fair value of its
reporting unit and, in accordance with applicable GAAP standards, compares the implied fair value of goodwill
to the carrying amount of goodwill on the Company’s balance sheet. If the carrying amount of the goodwill is
greater than the implied fair value of that goodwill, an impairment loss must be recognized in an amount equal
to that excess. The implied fair value of goodwill is determined in the same manner as goodwill recognized in
a business combination. The estimated fair value of the Company is allocated to all of the Company’s
individual assets and liabilities, including any unrecognized identifiable intangible assets, as if the Company
had been acquired in a business combination and the estimated fair value of the Company is the price paid to
acquire it. The allocation process is performed only for purposes of determining whether a goodwill
impairment exists and the amount of any such impairment. No assets or liabilities are written up or down, nor
are any additional unrecognized identifiable intangible assets recorded as a part of this process.
The Company estimates fair value using the best information available, including market information and a
discounted cash flow analysis, which is also referred to as the income approach. The income approach uses a
reporting unit’s projection of estimated operating results and cash flows that is discounted using a rate that
reflects current market conditions. The projection uses management’s best estimates of economic and market
conditions over the projected period including growth rates in loans and deposits, estimates of future expected
changes in net interest margins and cash expenditures. The market approach estimates fair value by applying
cash flow multiples to the reporting unit’s operating performance. The multiples are derived from comparable
publicly traded companies with similar operating and investment characteristics of the reporting unit. We
validate our estimated fair value by comparing the fair value estimates using the income approach to the fair
value estimates using the market approach.
As part of our process for performing the step one impairment test of goodwill, the Company estimated the fair
value of the reporting unit utilizing the income approach and the market approach in order to derive an
enterprise value of the Company. In determining the discount rate for the discounted cash flow model, the
Company used a modified capital asset pricing model that develops a rate of return utilizing a risk-free rate
and equity risk premium resulting in a discount rate of 14.0%. This approach also includes adjustments for the
industry the Company operates in and size of the Company. In addition, assumptions used by the Company in
its discounted cash flow model (income approach) included an average annual revenue growth rate that
approximated 2%; an asset growth of 4.5% in years one through six; net interest margin ranging from 3.88%
in the base year to 4.28% in year six; and a return on assets that ranged from 0.4% to 1.1%.
In applying the market approach method, the Company considered all banks acquired between January 1, 2012
and June 30, 2013, with total assets between $200 million and $2 billion, and non-performing assets to total
assets between 1% and 5%. This resulted in selecting 32 comparable institutions which were analyzed based
on a variety of financial metrics (tangible equity, return on assets, return on equity, net interest margin,
efficiency ratio, nonperforming assets, and reserves for loan losses). After selecting comparable institutions, the
Company derived the fair value of the reporting unit by completing a comparative analysis of the relationship
between their financial metrics listed above and their market values utilizing various market multiples. Focus
was placed on the price to tangible book value of equity multiple as this multiple generally reflects returns on
the capital employed within the industry and is generally correlated with the profitability of each individual
company.
53
The Company concluded its reporting unit had a fair value of $72.5 million, after giving similar consideration
to the values derived from 1) the income approach, which was $68.0 million weighted at 50%, and 2) the
market approach, which was $80.4 million and also weighted at 50%, compared to a carrying value of its
reporting unit of $66.8 million. Accordingly, following step one of the goodwill impairment test, the Company
concluded that its reporting unit’s fair value exceeded its carrying value and no goodwill impairment existed.
Even though the Company determined that there was no goodwill impairment, declines in the value of our
stock price as well as values of others in the financial industry, declines in revenue for the Bank or significant
adverse changes in the operating environment for the financial industry may result in a future impairment
charge. It is possible that changes in circumstances existing at the measurement date or at other times in the
future, or in the numerous estimates associated with management’s judgments, assumptions and estimates made
in assessing the fair value of our goodwill, could result in an impairment charge of a portion or all of our
goodwill. If the Company recorded an impairment charge, its financial position and results of operations would
be adversely affected, however, such an impairment charge would have no impact on our liquidity, operations
or regulatory capital.
New Accounting Pronouncements. For a discussion of new accounting pronouncements and their impact on
the Company, see Note 1 of the Notes to the audited consolidated financial statements included in Item 15 of
this report.
CRITICAL ACCOUNTING POLICIES
The Company’s consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America. The financial information contained within these statements
is, to a significant extent, financial information that is based on approximate measures of the financial effects of
transactions and events that have already occurred. Based on its evaluation of accounting policies that involve
the most complex and subjective decisions and assessments, management has identified the following as its
most critical accounting policies. This discussion and analysis should be read in conjunction with the
Company’s financial statements and the accompanying notes presented elsewhere herein, as well as the related
discussions of each topic in this Management’s Discussion and Analysis section above. See also ‘‘Risk
Factors’’ under Item 1A above for a discussion of certain risks faced by the Company.
Allowance for Credit Losses
in establishing an allowance for credit
The Company’s allowance for credit losses methodology incorporates a variety of risk considerations, both
quantitative and qualitative,
losses that management believes is
appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience,
delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors.
Quantitative factors also incorporate known information about
including borrowers’
sensitivity to interest rate movements. Qualitative factors include the general economic environment in the
Company’s markets, including economic conditions and, in particular, the state of certain industries. Size and
complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth
are other qualitative factors that are considered in the methodology. As the Company adds new products and
increases the complexity of its loan portfolio, it intends to enhance its methodology accordingly. A materially
different amount could be reported for the provision for credit losses in the statement of operations to change
the allowance for credit losses if management’s assessment of the above factors were different.
individual
loans,
54
Goodwill
Goodwill is initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value
of the net identified tangible and intangible assets acquired. Goodwill is presumed to have an indefinite useful
life and is tested for impairment no less than annually. The Company has one reporting unit, the Bank, for
purposes of computing goodwill. The Company performs an annual review each year, or more frequently if
indicators of potential impairment exist, to determine if the recorded goodwill is impaired. The analysis of
potential impairment of goodwill requires a two-step process. The first step is the estimation of fair value. If
step one indicates that impairment potentially exists, the second step is performed to measure the amount of
impairment, if any. Goodwill impairment exists when the estimated fair value of goodwill is less than its
carrying value. The results of the Company’s annual second quarter impairment test determined the reporting
unit’s fair value exceeds its carrying value on the Company’s balance sheet and no goodwill impairment
existed. As of December 31, 2013, management determined there were no events or circumstances which
would more likely than not reduce the fair value of its reporting unit below its carrying value. No assurance
can be given that the Company will not record an impairment loss on goodwill in the future.
Investment Valuation and Other-Than-Temporary-Impairment (‘‘OTTI’’)
The Company records investments in securities available-for-sale at fair value and securities held-to-maturity at
amortized cost. Fair value is determined based on 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. Declines in
fair value below amortized cost are reviewed to determine if they are other than temporary. If the decline in
fair value is judged to be other than temporary, the impairment loss is separated into a credit and noncredit
component. Noncredit losses are recorded in other comprehensive income (loss) when the Company a) does
not intend to sell the security or b) is not more likely than not it will be required to sell the security prior to
the security’s anticipated recovery. Credit component losses are reported in non-interest income. The Company
regularly reviews its investment portfolio to determine whether any of its securities are other-than-temporarily
impaired.
Valuation of OREO
Real estate properties acquired through foreclosure or by deed-in-lieu of foreclosure (OREO) are recorded at
fair value less estimated costs to sell. Fair value is generally determined by management based on a number of
factors, including third-party appraisals of fair value in an orderly sale. Accordingly, the valuation of OREO is
subject to significant external and internal judgment. Any differences between management’s assessment of fair
value, less estimated costs to sell, and the carrying value of the loan at the date a particular property is
transferred into OREO are charged to the allowance for credit losses. Management periodically reviews OREO
values to determine whether the property continues to be carried at the lower of its recorded book value or fair
value, net of estimated costs to sell. Any further decreases in the value of OREO are considered valuation
adjustments and trigger a corresponding charge to non-interest expense in the Consolidated Statements of
Income. Expenses from the maintenance and operations of OREO are included in other non-interest expense.
55
Income Taxes
Deferred tax assets and liabilities result from differences between the financial statement carrying amounts and
the tax basis of assets and liabilities, and are reflected at currently enacted income taxes rates applicable to the
period in which the deferred tax assets or liabilities are expected to be realized or settled.
The Company had net deferred tax assets (‘‘DTAs’’) of $4,546,000 at December 31, 2013, compared to
$4,013,000 at December 31, 2012. The most significant portions of the deductible temporary differences relate
to the allowance for credit losses, supplemental executive retirement plan, and fair value adjustments or
impairment write-downs related to OREO. As of December 31, 2013, the Company believes that it is more
likely than not that it will be able to fully realize its DTA and therefore has not recorded a valuation allowance.
Assessing the need for, and the amount of, a valuation allowance requires significant judgment and analysis of
both positive and negative evidence regarding realization of the DTA. The realization of the DTA is dependent
upon the Company generating a sufficient level of taxable income in future periods, which can be difficult to
predict. If future taxable income should prove non-existent or less than the amount of temporary differences
giving rise to the net DTAs within the tax years to which they may be applied, the assets will not be realized
and net income will be reduced. An extended period of losses could result in the Company establishing a
valuation allowance against its DTA. The establishment of a valuation allowance would be accounted for as a
charge against income and could have a material effect on our results of operations in a particular period.
ASSET AND LIABILITY MANAGEMENT
The largest component of the Company’s earnings is net interest income. Interest income and interest expense
are affected by general economic conditions, competition in the market place, market
interest rates and
repricing and maturity characteristics of the Company’s assets and liabilities. Exposure to interest rate risk is
primarily a function of differences between the maturity and repricing schedules of assets (principally loans
and investment securities) and liabilities (principally deposits). Assets and liabilities are described as interest
rate sensitive for a given period of time when they mature or can reprice within that period. The difference
between the amount of interest sensitive assets and interest sensitive liabilities is referred to as the interest
sensitivity ‘‘GAP’’ for any given period. The ‘‘GAP’’ may be either positive or negative. If positive, more
assets reprice than liabilities. If negative, the reverse is true.
Certain shortcomings are inherent in the interest sensitivity ‘‘GAP’’ method of analysis. Complexities such as
prepayment risk and customer responses to interest rate changes are not taken into account in the ‘‘GAP’’
analysis. Accordingly, management also utilizes a net interest income simulation model to measure interest rate
sensitivity. Simulation modeling gives a broader view of net interest income variability, by providing various
rate shock exposure estimates. Management regularly reviews the interest rate risk position and provides
measurement reports to the Board of Directors.
The following table shows the dollar amount of interest sensitive assets and interest sensitive liabilities at
December 31, 2013 and differences between them for the maturity or repricing periods indicated.
56
(dollars in thousands)
Interest earning assets
Loans, including loans held for sale . . . . . . . . . .
Investments and bank owned life insurance . . . . .
Fed Funds sold and interest bearing balances with
banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal Home Loan Bank stock . . . . . . . . . . . . .
Total interest earning assets . . . . . . . . . . . . .
Interest bearing liabilities
Interest bearing demand deposits . . . . . . . . . . . .
Savings and money market deposits . . . . . . . . . .
Time deposits . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . .
Secured borrowings . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . .
Junior subordinated debentures
. . . . . . . . . .
Net interest rate sensitivity GAP . . . . . . . . . . . .
Cumulative interest rate sensitivity GAP . . . . . . .
Cumulative interest rate sensitivity GAP as a % of
. . . . . . . . . . . . . . . . . . . . . . .
Total interest bearing liabilities
earning assets
Due in
one year
or less
Due after
one through
five years
Due after
five years
Total
$ 239,585
19,874
$251,299
11,036
$ 20,066
89,972
23,448
—
$ 285,956
—
—
$262,335
—
3,103
$110,038
$ 144,220
192,039
65,873
—
—
13,403
$ 415,535
$(129,579)
$
—
—
59,465
10,000
—
—
$ 69,465
$192,870
63,291
$
—
—
722
—
—
—
722
$
$109,316
172,607
9.6%
26.2%
$512,431
119,526
234,481
3,103
$658,418
$144,220
192,039
126,060
10,000
—
13,403
$485,722
$172,607
Effects of Changing Prices. The results of operations and financial condition presented in this report are
based on historical cost information, and are unadjusted for the effects of inflation. Since the assets and
liabilities of financial institutions are primarily monetary in nature, the performance of the Company is affected
more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation
increases, but the magnitude of the change in rates may not be the same.
The effects of inflation on financial institutions are normally not as significant as its influence on businesses
which have investments in plants and inventories. During periods of high inflation there are normally
corresponding increases in the money supply, and financial institutions will normally experience above-average
growth in assets, loans and deposits. Inflation does increase the price of goods and services, and therefore
operating expenses increase during inflationary periods.
ITEM 8.
Financial Statements and Supplementary Data
Information required for this item is included in Item 15 of this report.
ITEM 9. Changes in and disagreements with accountants on accounting and financial disclosure
None.
57
ITEM 9A. Controls and Procedures
Disclosure Controls and Procedures. Our management has evaluated, with the participation and under the
supervision of our chief executive officer (CEO) and chief financial officer (CFO), the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the
end of the period covered by this report. Based on this evaluation, our CEO and CFO have concluded that, as
of such date, the Company’s disclosure controls and procedures are effective in ensuring that information
relating to the Company, including its consolidated subsidiaries, required to be disclosed in reports that it files
under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our CEO
and CFO, as appropriate to allow timely decisions regarding required disclosures.
Management’s Report on Internal Control Over Financial Reporting. The Company’s management is
responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s
internal control system is designed to provide reasonable assurance to our management and the board of
directors regarding the preparation and fair presentation of published financial statements. Nonetheless, all
internal control systems, no matter how well designed, have inherent limitations. Because of these inherent
limitations,
including the possibility of collusion or improper management override of controls, material
misstatements due to error or fraud may occur and not be detected. Even systems determined to be effective as
of a particular date can provide only reasonable assurance with respect to financial statement preparation and
presentation and may not eliminate the need for restatements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated
Framework (1992). Based on our assessment, we believe that, as of December 31, 2013, the Company’s
internal control over financial reporting is effective based on those criteria.
Changes in Internal Control Over Financial Reporting. There have not been any changes in the
Company’s internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act, during the Company’s fiscal quarter ended December 31, 2013 that have materially
affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B. Other Information
None.
ITEM 10. Directors and Executive Officers of the Registrant
Part III
Information concerning directors and executive officers requested by this item is contained in the Company’s
its 2014 annual meeting of shareholders to be held on April 23, 2014 (2014
Proxy Statement
‘‘PROPOSAL
entitled ‘‘CURRENT EXECUTIVE OFFICERS,’’
Proxy Statement),
NO. 1 — ELECTION OF DIRECTORS,’’ and ‘‘SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE’’ and is incorporated into this report by reference.
sections
in the
for
The Board of Directors adopted a Code of Ethics for the Company’s executive officers that requires the
Company’s officers to maintain the highest standards of professional conduct. A copy of the Executive Officer
Code of Ethics is available on the Company’s Web site www.bankofthepacific.com under the link for Investor
Info and Governance Documents.
58
The Company has a separately designated Audit Committee established in accordance with Section 3(a)(58)(A)
of the Exchange Act. The committee is composed of Directors John Van Dijk, Gary C. Forcum, Randy Rust,
and Dwayne Carter. Messrs. Forcum, Rust and Carter are independent applying the definition of independence
for audit committee members found in the Nasdaq listing standards. Director John VanDijk is considered
independent per the Exchange Act rules, but he is not independent under the Nasdaq listing standards.
The Company’s Board of Directors has determined that Gary C. Forcum, Randy Rust and John Van Dijk are
audit committee financial experts as defined in Item 401(h) of the SEC’s Regulation S-K.
ITEM 11. Executive Compensation
Information concerning executive and director compensation and certain matters regarding participation in the
Company’s compensation committee required by this item is contained in the registrant’s 2014 Proxy
Statement
in the sections entitled ‘‘DIRECTOR COMPENSATION FOR 2013’’ and ‘‘EXECUTIVE
COMPENSATION,’’ and is incorporated into this report by reference.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Information concerning security ownership of certain beneficial owners and management requested by this item
is incorporated by reference to the material contained in the registrant’s 2014 Proxy Statement in the section
entitled ‘‘SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT’’ and
under
in the section entitled ‘‘EXECUTIVE
COMPENSATION.’’
the caption ‘‘Equity Compensation Plan Information’’
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
Information concerning certain relationships and related transactions requested by this item is contained in the
registrant’s 2014 Proxy Statement
in the section ‘‘RELATED PERSON TRANSACTIONS’’ and is
incorporated into this report by reference. The current members of the Compensation and Management
Development Committee, who were also members throughout 2013, are Douglas Schermer (Chair), John
VanDijk, Gary Forcum and Randy Rognlin.
Information concerning director independence requested by this item is contained in the registrant’s 2014
in the section entitled ‘‘PROPOSAL NO. 1 — ELECTION OF DIRECTORS’’ and is
Proxy Statement
incorporated into this report by reference.
ITEM 14. Principal Accountant Fees and Services
Information concerning fees paid to our independent public accountants required by this item is included under
the heading ‘‘AUDITORS — Fees Paid to Auditors’’ in the registrant’s 2014 Proxy Statement and is
incorporated into this report by reference.
59
ITEM 15. Exhibits and Financial Statement Schedules
(a)
(1) The following financial statements are filed below:
Part IV
Report of Independent Registered Public Accounting Firm — Deloitte & Touche LLP . .
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
F-1
F-2
F-3
F-5
F-6
F-8
(a)
(a)
(2) Schedules: None
(3) Exhibits: See Exhibit Index immediately following the signature page.
60
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Pacific Financial Corporation
Aberdeen, Washington
We have audited the accompanying consolidated balance sheets of Pacific Financial Corporation and subsidiary
(the ‘‘Company’’) as of December 31, 2013 and 2012, and the related consolidated statements of income,
comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2013. These financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. The Company is not required to have,
nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial
position of Pacific Financial Corporation and subsidiary as of December 31, 2013 and 2012, and the results of
their operations and their cash flows for each of the three years in the period ended December 31, 2013, in
conformity with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Portland, Oregon
March 21, 2014
F-1
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012
Consolidated Balance Sheets
(Dollars in Thousands, Except Per Share Amounts)
2013
2012
Assets
Cash and due from banks (See note 2)
. . . . . . . . . . . . . . . . . . . . . . . . . .
Interest bearing deposits in banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Certificates of deposits held for investment . . . . . . . . . . . . . . . . . . . . . . . .
Securities available for sale, at fair value (amortized cost of $97,536 and
$59,658)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Securities held to maturity (fair value of $2,158 and $6,985)
. . . . . . . . . . .
Federal Home Loan Bank stock, at cost . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for credit losses
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans − net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Premises and equipment
Other real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash surrender value of life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other intangible assets
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liabilities and Shareholders’ Equity
Liabilities
Deposits:
Demand, non-interest bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Savings and interest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . .
Time, interest-bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term borrowings
Long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Junior subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commitments and Contingencies (See note 14) . . . . . . . . . . . . . . . . . . . . .
Shareholders’ Equity
Common stock (par value $1); authorized: 25,000,000 shares; issued and
outstanding: 2013 − 10,182,083 and 2012 − 10,121,853 shares . . . . . . . . .
Additional paid-in capital
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . .
Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . .
$ 12,214
23,734
2,727
96,144
2,132
3,013
7,765
504,666
(8,359)
496,307
16,790
2,771
2,307
18,237
12,168
1,481
7,249
$705,039
$145,028
336,260
126,059
607,347
167
—
10,000
13,403
6,985
637,902
—
10,182
41,817
16,507
(1,369)
67,137
$705,039
$ 14,168
42,687
2,985
61,106
6,937
3,126
12,950
448,196
(9,358)
438,838
14,593
4,679
2,079
17,784
11,282
1,268
9,112
$643,594
$115,138
295,100
138,005
548,243
213
3,000
7,500
13,403
4,514
576,873
—
10,122
41,366
14,812
421
66,721
$643,594
See notes to consolidated financial statements.
F-2
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Income
(Dollars in Thousands, Except Per Share Amounts)
Interest and Dividend Income
Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Deposits in banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24,401 $
114
25,635
84
$
27,186
92
2013
2012
2011
Securities available for sale:
Taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax-exempt
Securities held to maturity:
Taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax-exempt
Total interest and dividend income . . . . . . . . . . . . . . . . . .
Interest Expense
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term borrowings
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Secured borrowings
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Junior subordinated debentures . . . . . . . . . . . . . . . . . . . . . .
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . .
Net interest income after provision for credit losses . . . . . .
Provision for (recapture of) credit losses
Non-Interest Income
Service charges on deposit accounts
. . . . . . . . . . . . . . . . . .
Net gains (loss) on sale of other real estate owned . . . . . . . .
Net gains from sales of loans . . . . . . . . . . . . . . . . . . . . . . .
Net gains on sales of securities available for sale . . . . . . . . .
Net other-than-temporary impairment (net of $3, $4 and $256
recognized in other comprehensive income before taxes) . . .
Earnings on bank owned life insurance . . . . . . . . . . . . . . . .
Other operating income . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total non-interest income
. . . . . . . . . . . . . . . . . . . . . . . .
Non-Interest Expense
Salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . .
Occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
State taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Data processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Professional services . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other real estate owned write-downs . . . . . . . . . . . . . . . . . .
Other real estate owned operating costs . . . . . . . . . . . . . . . .
FDIC assessments
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other
Total non-interest expense . . . . . . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
Provision for income taxes
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
769
798
10
198
26,290
2,020
9
214
—
247
2,490
23,800
(450)
24,250
1,731
40
5,171
405
(37)
452
2,193
9,955
17,013
1,839
860
458
2,268
935
946
408
535
4,240
29,502
4,703
972
3,731 $
756
711
14
295
27,495
2,882
79
217
20
286
3,484
24,011
(1,100)
25,111
1,686
331
5,058
303
(333)
510
1,836
9,391
16,215
1,673
801
518
1,607
750
1,314
550
610
4,379
28,417
6,085
1,300
4,785
Earnings Per Share
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
0.37 $
0.37 $
0.47
0.47
$
$
$
1,024
707
18
291
29,318
4,643
—
597
41
352
5,633
23,685
2,500
21,185
1,799
(83)
3,593
698
(330)
527
1,410
7,614
13,723
1,523
1,011
473
1,415
739
1,049
450
938
4,327
25,648
3,151
333
2,818
0.28
0.28
Weighted Average Shares Outstanding:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10,121,738
10,189,888
10,121,853
10,126,244
10,121,853
10,121,870
See notes to consolidated financial statements.
F-3
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Comprehensive Income
(Dollars in Thousands, Except Per Share Amounts)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income, net of tax:
Net unrealized (losses) gains on investment securities (net of
2013
$ 3,731
2012
$4,785
2011
$2,818
tax of $(966), $276, and $391, respectively)
. . . . . . . . . . .
(1,875)
536
758
Defined benefit plans (net of tax of $29, $44, and $34,
respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income . . . . . . . . . . . . . . . . . . . . . .
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . .
85
(1,790)
$ 1,941
130
666
$5,451
(101)
657
$3,475
See notes to consolidated financial statements.
F-4
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Shareholders’ Equity
(Dollars in Thousands, Except Per Share Amounts)
Shares of
Common
Stock
Common
Stock
Balance at January 1, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . 10,121,853 $10,122
Comprehensive income:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized holding gain on securities less reclassification
adjustment for net gains included in net income . . . . . . . .
Amortization of unrecognized prior service costs and net
—
—
—
—
gains/losses
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . .
Stock compensation expense . . . . . . . . . . . . . . . . . . . . . . . .
—
Balance at December 31, 2011 . . . . . . . . . . . . . . . . . . . . . . 10,121,853 $10,122
—
—
—
Comprehensive income:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized holding gain on securities less reclassification
adjustment for net gains included in net income . . . . . . . .
Amortization of unrecognized prior service costs and net
—
—
—
—
gains/losses
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . .
—
Dividend paid ($0.20 per share) . . . . . . . . . . . . . . . . . . . . . .
Stock compensation expense . . . . . . . . . . . . . . . . . . . . . . . .
—
Balance at December 31, 2012 . . . . . . . . . . . . . . . . . . . . . . 10,121,853 $10,122
—
—
—
—
Comprehensive income:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized holding gain on securities less reclassification
adjustment for net gains included in net income . . . . . . . .
Amortization of unrecognized prior service costs and net
—
—
—
—
gains/losses
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . .
Issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . .
60
Dividend declared ($0.20 per share)
. . . . . . . . . . . . . . . . . . .
—
—
Stock compensation expense . . . . . . . . . . . . . . . . . . . . . . . .
Balance at December 31, 2013 . . . . . . . . . . . . . . . . . . . . . . 10,182,083 $10,182
60,230
—
—
—
—
Additional
Paid-in
Capital
$41,316
Retained
Earnings
$ 9,233
Accumulated
Other
Comprehensive
Income (Loss)
$ (902)
—
—
—
2,818
—
—
—
758
(101)
26
$41,342
—
$12,051
—
$ (245)
—
—
—
4,785
—
—
— (2,024)
—
24
$14,812
$41,366
$
—
536
130
—
—
421
Total
$59,769
2,818
758
(101)
3,475
26
$63,270
4,785
536
130
5,451
(2,024)
24
$66,721
3,731
—
3,731
—
—
—
—
—
334
—
— (2,036)
—
117
$16,507
$41,817
(1,875)
(1,875)
85
—
—
—
$(1,369)
85
1,790
394
(2,036)
117
$67,137
See notes to consolidated financial statements.
F-5
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows
(Dollars in Thousands)
Cash Flows from Operating Activities
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
3,731
$
4,785
$
2,818
2013
2012
2011
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . .
Provision for (recapture of) credit losses . . . . . . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . .
Originations of loans held for sale . . . . . . . . . . . . . . . .
Proceeds from sales of loans held for sale . . . . . . . . . . .
Net gains on sales of loans . . . . . . . . . . . . . . . . . . . . .
Net gain on sales of securities available for sale . . . . . . .
Net OTTI recognized in earnings . . . . . . . . . . . . . . . . .
(Gain) loss on sales of other real estate owned . . . . . . . .
(Gain) loss on sale of premises and equipment . . . . . . . .
Earnings on bank owned life insurance . . . . . . . . . . . . .
(Increase) decrease in accrued interest receivable . . . . . .
Increase (decrease) in accrued interest payable . . . . . . . .
Other real estate owned write-downs
. . . . . . . . . . . . . .
Additions to other real estate owned . . . . . . . . . . . . . . .
Proceeds from Internal Revenue Service tax refund . . . . .
Decrease in prepaid expenses
. . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other − net
Net cash provided by operating activities . . . . . . . . . . . . . . .
Cash Flows from Investing Activities
2,328
(450)
386
(225,068)
234,194
(5,171)
(405)
37
(40)
36
(452)
(228)
(48)
946
—
—
2,157
1,003
12,956
1,491
(1,100)
63
(251,435)
256,720
(5,058)
(303)
333
(331)
(6)
(510)
77
(1,277)
1,314
(185)
—
374
288
5,240
1,428
2,500
(815)
(172,274)
170,797
(3,593)
(698)
330
83
23
(527)
178
110
1,049
(260)
1,876
801
1,869
5,695
Net (increase) decrease in interest bearing deposits in banks . .
. .
Purchase of certificates of deposits held for investment, net
18,953
258
(14,162)
(2,985)
25,805
—
Activity in securities available for sale:
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Maturities, prepayments and calls
. . . . . . . . . . . . . . . . . .
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7,832
11,265
(57,521)
10,917
10,451
(34,194)
Activity in securities held to maturity:
Maturities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from sales of government loan pools . . . . . . . . . . .
(Increase) decrease in loans made to customers, net of
principal collections
. . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . .
Purchases of premises and equipment
Proceeds from sales of other real estate owned . . . . . . . . . . .
Cash received in acquisition, net of cash paid . . . . . . . . . . . .
Net cash provided by (used in) investing activities . . . . . . .
4,804
—
6,266
(60,004)
(2,728)
2,660
31,941
(36,274)
286
(200)
1,296
24,105
(844)
4,223
—
(1,107)
17,407
7,564
(29,553)
255
(828)
9,845
(23,505)
(1,019)
1,101
—
7,072
(continued)
See notes to consolidated financial statements.
F-6
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows
(concluded) (Dollars in Thousands)
2013
2012
2011
Cash Flows from Financing Activities
Net increase in deposits . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net decrease in short-term borrowings . . . . . . . . . . . . . . . . .
Decrease in secured borrowings . . . . . . . . . . . . . . . . . . . . .
Proceeds from issuance of long-term borrowings . . . . . . . . . .
Prepayments of long-term borrowings . . . . . . . . . . . . . . . . .
Common stock issued . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by (used in) financing activities . . . . . . .
Net change in cash and due from banks . . . . . . . . . . . . . .
$21,470
(3,000)
—
2,500
—
394
—
21,364
(1,954)
$
193
—
(741)
2,500
(2,500)
—
(2,024)
(2,572)
1,561
$ 3,096
(10,500)
(184)
7,500
(7,500)
—
—
(7,588)
5,179
Cash and Due from Banks
Beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
End of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14,168
$12,214
12,607
$14,168
7,428
$ 12,607
Supplemental Disclosures of Cash Flow Information
Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,536
690
$ 4,761
1,998
$ 5,523
332
Supplemental Disclosures of Non-Cash Investing Activities
Fair value adjustment of securities available for sale, net
of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transfer of loans held for sale to loans held for investment
. .
Other real estate owned acquired in settlement of loans . . . . .
Financed sale of other real estate owned . . . . . . . . . . . . . . .
Reclass of current portion of long-term borrowings to short-
$ (1,875)
986
(1,756)
98
$
536
1,295
(2,897)
922
$
758
300
(4,278)
1,160
term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
3,000
—
See notes to consolidated financial statements.
F-7
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 1 — Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Pacific Financial Corporation (the Company), and
its wholly owned subsidiary, Bank of the Pacific (the Bank), after elimination of intercompany transactions and
balances. The Company has two wholly owned subsidiaries, PFC Statutory Trust I and II (the Trusts), which
do not meet the criteria for consolidation, and therefore, are not consolidated in the Company’s financial
statements. The Company was incorporated in the State of Washington on February 12, 1997, pursuant to a
holding company reorganization of the Bank.
Nature of Operations
The Company is a holding company which operates primarily through its subsidiary bank. The Bank operates
16 branches located in communities in Grays Harbor, Pacific, Whatcom, Skagit and Wahkiakum counties in the
state of Washington and three in Clatsop County, Oregon. In addition, the Bank operates three loan production
real estate mortgage
offices in Burlington, DuPont and Vancouver, Washington and has a residential
department. The Bank provides loan and deposit services to customers, who are predominately small- and
middle-market businesses and middle-income individuals in western Washington and the north coast of
Oregon.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally
accepted in the United States of America (‘‘GAAP’’) and practices within the banking industry. The
preparation of consolidated financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, as of
the date of the balance sheet, and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are particularly susceptible to
significant change in the near term relate to the determination of the allowance for credit losses, the valuation
of deferred tax assets, the valuation of investments, the valuation of other real estate owned and the evaluation
of goodwill and investments for impairment.
Certain prior year disclosures have been reclassified to conform to the 2013 presentation with no change to net
income or shareholders’ equity as previously reported. Loans held for sale have been excluded from the loan
and credit quality tables in Note 4 — Loans.
Securities Available for Sale
Securities available for sale consist of debt securities that the Company intends to hold for an indefinite period,
but not necessarily to maturity. Securities available for sale are reported at fair value. Unrealized gains and
losses, net of the related deferred tax effect, are reported net as a separate component of shareholders’ equity
entitled ‘‘accumulated other comprehensive loss.’’ Realized gains and losses on securities available for sale,
determined using the specific identification method, are included in earnings. Amortization of premiums and
accretion of discounts are recognized in interest income over the period to maturity. For mortgage-backed
securities, actual maturity may differ from contractual maturity due to principal payments and amortization of
premiums and accretion of discounts may vary due to prepayment speed assumptions.
F-8
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 1 — Summary of Significant Accounting Policies − (continued)
Securities Held to Maturity
Debt securities for which the Company has the positive intent and ability to hold to maturity are reported at
cost, adjusted for amortization of premiums and accretion of discounts, which are recognized in interest
income over the period to maturity.
Declines in the fair value of individual securities held to maturity and available for sale that are deemed to be
other than temporary are reflected in earnings when identified. Management evaluates individual securities for
other than temporary impairment (‘‘OTTI’’) on a quarterly basis. OTTI is separated into a credit and noncredit
losses are recorded in other comprehensive income (loss) when the
component. Noncredit component
Company a) does not intend to sell the security or b) is not more likely than not it will be required to sell the
security prior to the security’s anticipated recovery. Credit component losses are reported in non-interest
income.
Federal Home Loan Bank Stock
The Company’s investment in Federal Home Loan Bank (‘‘FHLB’’) stock is carried at cost. The Company is
required to maintain a minimum level of investment in FHLB stock based on specific percentages of its
outstanding mortgages, total assets or FHLB advances.
The Company views its investment in the FHLB stock as a long-term investment. Based on the Company’s
evaluation of the underlying investment, including the long-term nature of the investment, the liquidity position
of the FHLB, the actions being taken by the FHLB to address its regulatory situation and the Company’s intent
and ability to hold the investment for a period of time sufficient to recover the par value, the Company does
not believe its investment with the FHLB is impaired. Even though the Company did not determine its
investment in the FHLB stock was impaired at December 31, 2013, future deterioration of the FHLB’s
financial condition may result in future impairment losses.
Loans Held for Sale
Mortgage loans originated for sale in the foreseeable future in the secondary market are carried at the lower of
aggregate cost or estimated fair value. Gains and losses on sales of loans are recognized at settlement date and
are determined by the difference between the sales proceeds and the carrying value of the loans. Net unrealized
losses are recognized through a valuation allowance established by charges to income. Loans held for sale that
are unable to be sold in the secondary market are transferred to loans receivable when identified.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity
or pay-off are reported at their outstanding principal balances adjusted for any charge-offs, the allowance for
credit losses, any deferred fees or costs on originated loans, and unamortized premiums or discounts on
purchased loans. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is
recognized as an adjustment of yield over the contractual life of the related loans using the effective interest
method.
Interest income on loans is accrued over the term of the loans based upon the principal outstanding. The
accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to
meet payments as they come due. When interest accrual is discontinued, all unpaid accrued interest is reversed
against interest income. Interest income is subsequently recognized only to the extent that cash payments are
received until, in management’s judgment, the borrower has the ability to make contractual interest and
principal payments, in which case the loan is returned to accrual status.
F-9
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 1 — Summary of Significant Accounting Policies − (continued)
Allowance for Credit Losses
The allowance for credit losses is established through a provision that is charged to earnings as probable losses
are incurred. Losses are charged against the allowance when management believes the collectability of a loan
balance is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance for credit
losses is evaluated on a regular basis by management and is based upon
management’s periodic review of the collectability of the loans in light of historical experience, the nature and
volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value
of underlying collateral and prevailing economic conditions. The evaluation is inherently subjective, as it
requires estimates that are susceptible to significant revision as more information becomes available. The
Company’s methodology for assessing the appropriateness of the allowance consists of several key elements,
which includes a general formulaic allowance and a specific allowance on impaired loans. The formulaic
portion of the general credit loss allowance is established by applying a loss percentage factor to the different
loan types based on historical loss experience adjusted for qualitative factors.
A loan is considered impaired when, based on current information and events, it is probable the Company will
be unable to collect principal and interest when due according to the contractual terms of the original loan
agreement. Factors considered by management in determining impairment include payment status, collateral
value, and the probability of collecting scheduled principal and interest payments when due. Loans that
experience insignificant payment delays and payment shortfalls are generally not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case-by-case basis,
taking into consideration all of the circumstances surrounding the loan and the borrowers, including the length
of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in
relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial,
construction and real estate loans by either the present value of the expected future cash flows discounted at
the loan’s effective interest rate, or the fair value of the collateral less estimated selling costs if the loan is
collateral dependent. When the net realizable value of an impaired loan is less than the book value of the loan,
impairment is recognized by adjusting the allowance for credit losses. Uncollected accrued interest is reversed
against interest income. If ultimate collection of principal is in doubt, all subsequent cash receipts including
interest payments on impaired loans are applied to reduce the principal balance.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation, which is computed on the straight-
line method over the estimated useful lives of the assets. Asset lives range from 3 to 39 years. Leasehold
improvements are amortized over the terms of the respective leases or the estimated useful lives of the
improvements, whichever is less. Gains or losses on dispositions are reflected in earnings.
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are initially recorded at the
fair value of the properties less estimated costs of disposal. Any write-down to fair value at the time of transfer
to other real estate owned (‘‘OREO’’) is charged to the allowance for credit losses. Properties are evaluated
regularly to ensure that the recorded amounts are supported by their current fair values, and that write-downs
to reduce the carrying amounts to fair value less estimated costs to dispose are recorded as necessary. Any
subsequent reductions in carrying values, and revenue and expense from the operations of properties, are
charged to operations.
F-10
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 1 — Summary of Significant Accounting Policies − (continued)
Goodwill and other intangible assets
At December 31, 2013 the Company had $13,649 in goodwill and other intangible assets. Goodwill is initially
recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified
tangible and intangible assets acquired. Goodwill is not amortized but is reviewed for potential impairment
during the second quarter on an annual basis or more frequently if events or circumstances indicate a potential
impairment, at the reporting unit level. The Company has one reporting unit, the Bank, for purposes of
computing goodwill. The analysis of potential impairment of goodwill requires a two-step process. The first
step is a comparison of the reporting unit’s fair value to its carrying value. If the reporting unit’s fair value is
less than its carrying value, the Company would be required to progress to the second step. In the second step
the Company calculates the implied fair value of its reporting unit. The Company compares the implied fair
value of goodwill to the carrying amount of goodwill on the Company’s balance sheet. If the carrying amount
of the goodwill is greater than the implied fair value of that goodwill, an impairment loss must be recognized
in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as
goodwill recognized in a business combination. The estimated fair value of the Company is allocated to all of
the Company’s individual assets and liabilities, including any unrecognized identifiable intangible assets, as if
the Company had been acquired in a business combination and the estimated fair value of the Company is the
price paid to acquire it. The allocation process is performed only for purposes of determining the amount of
goodwill impairment, as no assets or liabilities are written up or down, nor are any additional unrecognized
identifiable intangible assets recorded as a part of this process.
The results of the Company’s annual impairment test determined the reporting unit’s fair value exceeded its
carrying value and no goodwill impairment existed. As of December 31, 2013 management determined there
were no events or circumstances which would more likely than not reduce the fair value of its reporting unit
below its carrying value. No assurance can be given that the Company will not record an impairment loss on
goodwill in the future.
Core deposit intangibles are amortized to non-interest expenses using an accelerated method over ten years.
Net unamortized core deposit intangible totaled $213 at December 31, 2013. Amortization expense related to
core deposit intangible totaled $28 during the year ended December 31, 2013.
In 2006, the Bank completed a deposit transfer and assumption transaction with an Oregon-based bank for a
$1,268 premium. In connection with completion of the transaction, the Oregon Department of Consumer and
Business Services issued a Certificate of Authority to the Bank authorizing it to conduct a banking business in
the State of Oregon. The premium, and the resultant right to conduct business in Oregon, is recorded as an
indefinite-lived intangible asset.
Impairment of long-lived assets
Management periodically reviews the carrying value of its long-lived assets to determine if an impairment has
occurred or whether changes in circumstances have occurred that would require a revision to the remaining
useful
life, of which there have been none. In making such determination, management evaluates the
performance, on an undiscounted basis, of the underlying operations or assets which give rise to such amount.
Transfers of Financial Assets
Transfers of financial assets, including cash, investment securities, loans and loans held for sale, are accounted
for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free
of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets,
and (3) the Company does not maintain effective control over the transferred assets through either an
agreement to repurchase them before their maturity, or the ability to cause the buyer to return specific assets.
F-11
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 1 — Summary of Significant Accounting Policies − (continued)
Income Taxes
Deferred tax assets and liabilities result from differences between the financial statement carrying amounts and
the tax bases of assets and liabilities, and are reflected at currently enacted income tax rates applicable to the
period in which the deferred tax assets or liabilities are expected to be realized or settled. Deferred tax assets
are reduced by a valuation allowance when management determines that it is more likely than not that some
portion or all of the deferred tax assets will not be realized. As changes in tax laws or rates are enacted,
deferred tax assets and liabilities are adjusted through the provision for income taxes.
The Company files a consolidated federal income tax return. The Bank provides for income taxes separately
and remits to the Company amounts currently due in accordance with a tax allocation agreement between the
Company and the Bank.
As of December 31, 2013, the Company had no unrecognized tax benefits. The Company’s policy is to
recognize interest and penalties on unrecognized tax benefits in ‘‘Income Taxes’’ in the consolidated statements
of
the year ended
December 31, 2013. The tax years that remain subject to examination by federal and state taxing authorities
are the years ended December 31, 2012, 2011 and 2010.
income. There were no amounts related to interest and penalties recognized for
Stock-Based Compensation
Accounting guidance requires measurement of compensation cost for all stock based awards based on the grant
date fair value and recognition of compensation cost over the service period of stock based awards. The fair
value of stock options is determined using the Black-Scholes valuation model. The Company’s stock
compensation plans are described more fully in Note 16.
Cash Equivalents and Cash Flows
The Company considers all amounts included in the balance sheet caption ‘‘Cash and due from banks’’ to be
cash equivalents. Cash and cash equivalents have a maturity of 90 days or less at the time of purchase. Cash
flows from loans,
interest bearing deposits in banks, federal funds sold, short-term borrowings, secured
borrowings and deposits are reported net. The Company maintains balances in depository institution accounts
which, at times, may exceed federally insured limits. The Company has not experienced any losses in such
accounts.
Certificates of Deposit Held for Investment
Certificates of deposit held for investments include amounts invested with financial institutions for a stated
interest rate and maturity date. Early withdraw penalties apply, however the Company plans to hold these
investments to maturity.
Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing net income by the weighted average
number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur
if common shares were issued pursuant to the exercise of options under the Company’s stock option plans.
Stock options excluded from the calculation of diluted earnings per share because they are antidilutive, were
436,495, 532,106, and 581,448 in 2013, 2012 and 2011, respectively. Outstanding warrants also excluded were
638,920, 699,642, and 699,642 for the years ended 2013, 2012, and 2011, respectively.
F-12
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 1 — Summary of Significant Accounting Policies − (continued)
Comprehensive Income
Recognized revenue, expenses, gains and losses are included in net income. Certain changes in assets and
liabilities, such as prior service costs and amortization of prior service costs related to defined benefit plans and
unrealized gains and losses on securities available for sale, are reported within equity in other accumulated
comprehensive loss in the consolidated balance sheets. Such items, along with net income, are components of
comprehensive income. Gains and losses on securities available for sale are reclassified to net income as the
gains or losses are realized upon sale of the securities. Other-than-temporary impairment charges are
reclassified to net income at the time of the charge.
Business Segment
The Company operates a single business segment. The financial information that is used by the chief operating
decision maker in allocating resources and assessing performance is only provided for one reportable segment
as of December 31, 2013, 2012 and 2011.
Recent Accounting Pronouncements
In December 2011, FASB issued ASU No. 2011-11, ‘‘Disclosures about Offsetting Assets and Liabilities’’. This
ASU will require an entity to disclose information about offsetting and related arrangements to enable users of
its financial statements to understand the effect of those arrangements on its financial position. An entity is
required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and
interim periods within those annual periods. An entity should provide the disclosures required by those
amendments retrospectively for all comparative periods presented. The adoption of ASU No. 2011-11 did not
have a significant impact on the Company’s Consolidated Financial Statements at the date of adoption.
In February 2013, FASB issued ASU No. 2013-02, ‘‘Reporting of Amounts Reclassified Out of Accumulated
Other Comprehensive Income’’. This ASU requires an entity to provide information about
the amounts
reclassified out of accumulated other comprehensive income by component and to present either on the face of
the statement where net
income is presented, or in the notes, significant amounts reclassified out of
accumulated other comprehensive income by the respective line items of net income, but only if the amount
reclassified is required to be reclassified to net income in its entirety in the same reporting period. The
amendments are effective for annual and interim reporting periods beginning on or after December 15, 2012.
The disclosures required from adoption of this ASU have been included in these financial statements.
In July 2013, FASB issued ASU No. 2013-11, ‘‘Presentation of an Unrecognized Tax Benefit When a Net
Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.’’ The provisions of
ASU No. 2013-11 require an entity to present an unrecognized tax benefit, or portion thereof, in the statement
of financial position as a reduction to a deferred tax asset for a net operating loss carryforward or a tax credit
carryforward, with certain exceptions related to availability. ASU No. 2013-11 is effective for interim and
annual reporting periods beginning after December 15, 2013. The adoption of ASU No. 2013-11 is not
expected to have a material impact on the Company’s Consolidated Financial Statements.
Note 2 — Restricted Assets
Federal Reserve Board regulations require that the Bank maintain certain minimum reserve balances in cash on
hand and on deposit with the Federal Reserve Bank, based on a percentage of deposits. The average amount of
such balances for the years ended December 31, 2013 and 2012 was approximately $953 and $577,
respectively.
F-13
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 3 — Securities
instruments issued by the
Investment securities consist principally of short and intermediate term debt
U.S. Treasury, other U.S. government agencies, state and local governments, other corporations, and mortgaged
backed securities (‘‘MBS’’). Investment securities have been classified according to management’s intent. The
amortized cost of securities and their approximate fair value are as follows:
Securities Available for Sale
December 31, 2013
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
U.S. Government agency securities . . . . . . . . . . . . .
State and municipal securities
. . . . . . . . . . . . . . . .
Agency MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-agency MBS . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2012
U.S. Government agency securities . . . . . . . . . . . . .
State and municipal securities
. . . . . . . . . . . . . . . .
Agency MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-agency MBS . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 8,859
31,973
53,462
2,251
991
$97,536
$ 5,922
25,254
22,113
2,804
3,565
$59,658
$
34
774
267
3
—
$1,078
$
36
1,691
249
12
—
$1,988
$
82
587
1,549
243
9
$2,470
$
6
39
203
272
20
$ 540
Securities Held to Maturity
December 31, 2013
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
State and municipal securities
. . . . . . . . . . . . . . . .
Agency MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2012
State and municipal securities
. . . . . . . . . . . . . . . .
Agency MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,973
159
$2,132
$6,716
221
$6,937
$13
13
$26
$32
16
$48
$—
—
$—
$—
—
$—
Fair
Value
$ 8,811
32,160
52,180
2,011
982
$96,144
$ 5,952
26,906
22,159
2,544
3,545
$61,106
Fair
Value
$1,986
172
$2,158
$6,748
237
$6,985
F-14
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 3 — Securities − (continued)
individual
Unrealized losses and fair value, aggregated by investment category and length of time that
securities have been in continuous unrealized loss position, as of December 31, 2013 and 2012 are summarized
as follows:
December 31, 2013
Available for Sale
Less than 12 Months
More than 12 Months
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
U.S. Government agency securities . . $ 5,550
11,551
State and municipal securities . . . . .
28,795
Agency MBS . . . . . . . . . . . . . . . .
389
Non-agency MBS . . . . . . . . . . . . .
982
. . . . . . . . . . . . . .
Corporate bonds
. . . . . . . . . . . . . . . . . . . . $47,267
Total
$
82
485
996
27
9
$1,599
$ —
1,821
8,908
1,619
—
$12,348
$ —
102
553
216
—
$871
$ 5,550
13,372
37,703
2,008
982
$59,615
$
82
587
1,549
243
9
$2,470
December 31, 2012
Available for Sale
Less than 12 Months
More than 12 Months
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
U.S. Government agency securities . . $ 2,688
State and municipal securities . . . . .
1,896
11,890
Agency MBS . . . . . . . . . . . . . . . .
—
Non-agency MBS . . . . . . . . . . . . .
1,957
. . . . . . . . . . . . . .
Corporate bonds
. . . . . . . . . . . . . . . . . . . . $18,431
Total
$
6
39
198
—
20
$263
$ —
—
370
1,909
—
$2,279
$ —
—
5
272
—
$277
$ 2,688
1,896
12,260
1,909
1,957
$20,710
$
6
39
203
272
20
$540
At December 31, 2013, there were 81 investment securities in an unrealized loss position, of which 20 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, causing 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 December 31, 2013, except as described below with respect to one non-agency MBS.
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
losses (which considers current
the remaining contractual cash flows adjusted for future expected credit
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 year ended
December 31, 2013 and 2012, one non-agency MBS was determined to be other-than-temporarily impaired
resulting in the Company recording $37 and $333 in impairments related to credit losses through earnings.
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 have any investment
in, or exposure to, collateralized debt obligations, structured
investment vehicles or Euro zone sovereign debt.
F-15
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 3 — Securities − (continued)
The contractual maturities of investment securities held to maturity and available for sale at December 31,
2013 are shown below. Investments in mortgage-backed securities are shown separately as maturities may
differ from contractual maturities because borrowers have the right to call or prepay obligations, with or
without call or prepayment penalties.
Due in one year or less . . . . . . . . . . . . . . . . . . . . . . .
Due from one year to five years . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
Due from five to ten years
Due after ten years
. . . . . . . . . . . . . . . . . . . . . . . . .
Mortgage-backed securities . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total
Held to Maturity
Amortized
Cost
$ 190
—
915
868
159
$2,132
Fair
Value
$ 192
—
926
868
172
$2,158
Available for Sale
Fair
Value
$ 1,483
11,037
7,801
21,632
54,191
$96,144
Amortized
Cost
$ 1,481
11,108
7,810
21,424
55,713
$97,536
Gross gains realized on sales of securities were $448, $332 and $720 and gross losses realized were $43, $29
and $22 in 2013, 2012 and 2011, respectively.
Securities carried at approximately $57,418 at December 31, 2013 and $44,133 at December 31, 2012 were
pledged to secure public deposits and for other purposes required or permitted by law.
Note 4 — Loans
Loans and Leases
Loans at December 31 consist of the following:
Commercial and agricultural
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Real estate:
Construction and development
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Residential 1-4 family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Multi-family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial real estate − owner occupied . . . . . . . . . . . . . . . . . . . .
Commercial real estate − non owner occupied . . . . . . . . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less unearned income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total
2013
$104,111
2012
$ 87,278
29,096
87,762
17,520
105,594
117,294
23,698
20,728
505,803
(1,137)
$504,666
31,411
77,497
7,744
109,783
103,014
24,544
7,782
449,053
(857)
$448,196
F-16
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Allowance for Credit Losses
Changes in the allowance for credit losses for the years ended December 31, 2013, 2012 and 2011 are as
follows:
Allowance for Credit Losses:
Year ended December 31, 2013
Beginning balance . . . . . . . . . . . .
Charge-offs . . . . . . . . . . . . . . .
Recoveries . . . . . . . . . . . . . . .
Provision for (recapture of)
credit losses . . . . . . . . . . . . .
Ending balance . . . . . . . . . . . . .
Year ended December 31, 2012
Beginning balance . . . . . . . . . . . .
Charge-offs . . . . . . . . . . . . . . .
Recoveries . . . . . . . . . . . . . . .
Provision for (recapture of)
credit losses . . . . . . . . . . . . .
Ending balance . . . . . . . . . . . . .
Year ended December 31, 2011
Beginning balance . . . . . . . . . . . .
Charge-offs . . . . . . . . . . . . . . .
Recoveries . . . . . . . . . . . . . . .
Provision for (recapture of)
credit losses . . . . . . . . . . . . .
Ending balance . . . . . . . . . . . . .
Commercial
Commercial
Real Estate
(‘‘CRE’’)
Residential
Real Estate
Consumer
Unallocated
2013
Total
$ 923
(131)
36
$ 4,098
(90)
226
$ 829
(453)
14
(53)
$ 775
(728)
$ 3,506
285
$ 675
$1,012
(67)
23
$ 6,803
(827)
917
$1,046
(576)
162
(45)
$ 923
(2,795)
$ 4,098
197
$ 829
$ 816
(161)
69
$ 5,385
(2,005)
750
288
$1,012
2,673
$ 6,803
$1,754
(665)
107
(150)
$1,046
$ 531
(154)
3
364
$ 744
$ 642
(309)
8
190
$ 531
$ 690
(93)
8
37
$ 642
$2,977
—
—
$ 9,358
(828)
279
(318)
$2,659
(450)
$ 8,359
$1,624
—
—
1,353
$2,977
$1,972
—
—
$11,127
(1,779)
1,110
(1,100)
$ 9,358
$10,617
(2,924)
934
(348)
$1,624
2,500
$11,127
F-17
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Recorded investment in loans as of December 31, 2013 and 2012 are as follows:
December 31, 2013
Allowance for credit losses:
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
Commercial
Commercial
Real Estate
(‘‘CRE’’)
Residential
Real Estate
Consumer
Unallocated
Total
. . . . . $
— $
— $
— $ —
$ — $
—
. . . . .
775
3,506
675
744
2,659
8,359
Loans:
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
. . . . . $
587
$
8,656
$
626
$
53
$ — $
9,922
103,524
Ending Balance . . . . . . . . . . . . . $ 104,111
. . . . .
Less unearned income . . . . . . .
Ending balance total loans . . . . .
267,026
$275,682
104,656
$105,282
20,675
$20,728
—
495,881
$ — $505,803
(1,137)
$504,666
December 31, 2012
Allowance for credit losses:
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
Commercial
Commercial
Real Estate
(‘‘CRE’’)
Residential
Real Estate
Consumer
Unallocated
Total
. . . . .
$ — $
— $ —
$ —
$ — $
—
. . . . .
923
4,098
829
531
2,977
9,358
Loans:
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
. . . . .
Ending Balance . . . . . . . . . . . . .
Less unearned income . . . . . . .
Ending balance total loans . . . . .
. . . . .
$ 2,219
$ 11,697
$
868
$ —
$ — $ 14,784
85,059
$87,278
257,055
$268,752
84,373
$85,241
7,782
$7,782
—
434,269
$ — $449,053
(857)
$448,196
F-18
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Credit Quality Indicators
Federal regulations require that the Bank periodically evaluates the risks inherent in its loan portfolios. In
addition, the Washington Division of Banks and the 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.
loans classified as ‘‘Substandard’’, with additional
‘‘Doubtful’’ loans have the weaknesses of
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 the 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 that 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 close monitoring.
Loans by credit quality risk rating at December 31, 2013 are as follows:
Commercial . . . . . . . . . . . . . . . . . . . . . .
Real estate:
Construction and development . . . . . . . .
Residential 1 − 4 family . . . . . . . . . . . .
Multi-family . . . . . . . . . . . . . . . . . . . .
CRE – owner occupied . . . . . . . . . . . .
CRE – non owner occupied . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . .
Total real estate . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
Consumer
Subtotal
Less unearned income . . . . . . . . . . . . . . .
Total loans . . . . . . . . . . . . . . . . . . . . . .
Pass
$100,262
26,587
84,407
17,520
100,612
98,044
20,228
347,398
20,570
$468,230
Other Loans
Especially
Mentioned
$ 2,858
1,101
554
—
1,019
16,752
2,464
21,890
62
$24,810
Substandard
$
991
Doubtful
$—
Total
$104,111
1,408
2,801
—
3,963
2,498
1,006
11,676
96
$12,763
—
—
—
—
—
—
—
—
$—
29,096
87,762
17,520
105,594
117,294
23,698
380,964
20,728
$505,803
(1,137)
$504,666
F-19
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Loans by credit quality risk rating at December 31, 2012 are as follows:
Commercial . . . . . . . . . . . . . . . . . . . . . .
Real estate:
Construction and development . . . . . . . .
Residential 1 − 4 family . . . . . . . . . . . .
Multi-family . . . . . . . . . . . . . . . . . . . .
CRE − owner occupied . . . . . . . . . . . . .
CRE − non owner occupied . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . .
Total real estate . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
Less unearned income . . . . . . . . . . . . . . .
Total loans . . . . . . . . . . . . . . . . . . . . . .
Consumer
Subtotal
Pass
$ 82,899
27,209
72,414
7,744
103,444
84,610
23,511
318,932
7,740
$409,571
Other Loans
Especially
Mentioned
979
$
603
2,016
—
1,844
12,346
—
16,809
—
$17,788
Substandard
$ 3,368
Doubtful
$ 32
Total
$ 87,278
3,355
3,067
—
4,495
6,058
1,033
18,008
42
$21,418
244
—
—
—
—
—
244
—
$276
31,411
77,497
7,744
109,783
103,014
24,544
353,993
7,782
$449,053
(857)
$448,196
F-20
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Aging Analysis
The following table illustrates an age analysis of past due loans as of December 31, 2013.
Current
Commercial . . . . . . . . . . . . . . . . $103,811
30 − 59
Days
Past Due
14
$
60 − 89
Days
Past Due
$—
Greater
Than
90 Days
Past Due
and Still
Accruing
$—
Real estate:
Construction & development . . .
Residential 1 − 4 family . . . . . .
Multi-family . . . . . . . . . . . . . .
CRE − owner occupied . . . . . .
CRE − non-owner occupied . . .
Farmland . . . . . . . . . . . . . . . .
Total real estate . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . .
Less unearned income . . . . . . . . .
Total
27,688
87,029
17,520
103,935
114,812
21,868
372,852
20,507
(1,137)
. . . . . . . . . . . . . . . . . . . . $496,033
—
333
—
—
—
875
1,208
165
—
$1,387
—
—
—
—
—
—
—
3
—
$ 3
—
—
—
—
—
—
—
—
—
$—
Total
Past Due
14
$
—
333
—
—
—
875
1,208
168
—
$1,390
Non-
accrual
Loans
$ 286
1,408
400
—
1,659
2,482
955
6,904
53
—
$7,243
Total
Loans
$104,111
29,096
87,762
17,520
105,594
117,294
23,698
380,964
20,728
(1,137)
$504,666
The following table illustrates an age analysis of past due loans as of December 31, 2012.
30 − 59
Days
Past Due
60 − 89
Days
Past Due
Current
Greater
Than
90 Days
Past Due
and Still
Accruing
Total
Past Due
Non-
accrual
Loans
Total
Loans
Commercial . . . . . . . . . . . . . . . . $ 85,243
$ 107
$ 27
$—
$ 134
$ 1,901 $ 87,278
Real estate:
Construction & development . . .
Residential 1 − 4 family . . . . . .
Multi-family . . . . . . . . . . . . . .
CRE − owner occupied . . . . . .
CRE − non-owner occupied . . .
Farmland . . . . . . . . . . . . . . . .
Total real estate . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . .
Less unearned income . . . . . . . . .
Total
29,619
75,102
7,744
105,936
96,567
23,435
338,403
7,773
(857)
. . . . . . . . . . . . . . . . . . . . $430,562
—
1,505
—
—
652
133
2,290
8
—
$2,405
—
90
—
—
—
—
90
—
—
$117
—
—
—
—
—
—
—
—
—
$—
—
1,595
—
—
652
133
2,380
8
—
$2,522
1,792
800
—
3,847
5,795
976
13,210
1
—
31,411
77,497
7,744
109,783
103,014
24,544
353,993
7,782
(857)
$15,112 $448,196
F-21
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Interest income on non-accrual loans that would have been recorded had those loans performed in accordance
with their initial terms was $1,130, $1,213, and $752 for 2013, 2012, and 2011, respectively.
Insider Loans
Certain related parties of the Company, principally directors and their affiliates, were loan customers of the
Bank in the ordinary course of business during 2013 and 2012. Total related party loans outstanding at
December 31, 2013 and 2012 to executive officers and directors were $66 and $385, respectively. During 2013
and 2012, new loans of $5 and $454, respectively, were made, and repayments totaled $324 and $1,051,
respectively. In management’s opinion, these loans and transactions were on the same terms as those for
comparable loans and transactions with non-related parties. No loans to related parties were on non-accrual,
past due or restructured at December 31, 2013.
Impaired Loans
Following is a summary of information pertaining to impaired loans at December 31, 2013, and for the year
then ended:
Unpaid
Principal
Balance
$
608
53
815
1,714
6,776
955
3,685
—
—
608
53
815
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$—
—
—
$ 1,270
11
1,045
$
9
1
25
24
40
—
78
—
—
9
1
25
2,482
5,195
959
1,582
2
40
1,270
13
1,085
2,482
5,195
959
1,582
$12,586
24
40
—
78
$177
—
—
—
—
—
—
—
—
—
—
—
—
—
$—
Recorded
Investment
With no related allowance recorded:
Commercial . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate . . . . . . . . . . . . . . . .
$ 587
53
626
Commercial real estate:
CRE − owner occupied . . . . . . . . . . . . .
CRE − non-owner occupied . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . .
Construction and development
1,714
4,579
955
1,408
With an allowance recorded:
Consumer . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate . . . . . . . . . . . . . . . .
—
—
Total:
Commercial . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate . . . . . . . . . . . . . . . .
$ 587
53
626
$
Commercial real estate:
CRE − owner occupied . . . . . . . . . . . . .
CRE − non-owner occupied . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . .
Construction and development
Total . . . . . . . . . . . . . . . . . . . . . . . .
1,714
4,579
955
1,408
$9,922
1,714
6,776
955
3,685
$14,606
F-22
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Following is a summary of information pertaining to impaired loans at December 31, 2012, and for the year
then ended:
Recorded
Investment
With no related allowance recorded:
Commercial . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate . . . . . . . . . . . . . . . .
$ 2,219
—
868
Commercial real estate:
CRE − owner occupied . . . . . . . . . . . . .
CRE − non-owner occupied . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . .
Construction and development
3,134
5,795
976
1,792
With an allowance recorded:
Residential real estate . . . . . . . . . . . . . . . .
Commercial real estate:
CRE − non-owner occupied . . . . . . . . . .
. . . . . . . .
Construction and development
—
—
—
Total:
Commercial . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . .
Residential real estate . . . . . . . . . . . . . . . .
2,219
—
868
Commercial real estate:
CRE − owner occupied . . . . . . . . . . . . .
CRE − non-owner occupied . . . . . . . . . .
Farmland . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . .
Construction and development
Total . . . . . . . . . . . . . . . . . . . . . . . .
3,134
5,795
976
1,792
$14,784
Modifications
Unpaid
Principal
Balance
$ 2,219
—
1,100
3,166
6,401
976
4,053
—
—
—
2,219
—
1,100
3,166
6,401
976
4,053
$17,915
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$—
—
—
$
966
45
756
$ 30
—
17
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$—
1,259
3,272
195
2,707
97
2,845
189
966
45
853
2
84
—
81
—
—
12
30
—
17
1,259
6,117
195
2,896
$12,331
2
84
—
93
$226
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.
F-23
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 4 — Loans − (continued)
Loans modified in a TDR are typically already on non-accrual status and partial charge-offs have in some cases
already been taken against the outstanding loan balance. As a result, 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 semi-annually. During the twelve months ended December 31, 2012,
there was no impact on the allowance from TDRs during the periods, as the loans classified as TDRs during
the time of
the periods did not have a specific reserve and were already considered impaired loans at
modification.
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.
The following tables present TDRs for the twelve months ended December 31, 2013 all of which were
modified due to financial stress of the borrower.
Commercial and agriculture . . . .
Construction & development
. . .
Residential real estate . . . . . . . .
CRE − owner occupied . . . . . . .
CRE − non-owner occupied . . . .
Ending balance(1)
. . . . . . . . . .
Current TDRs
Pre-TDR
Outstanding
Recorded
Investment
$ 335
2,972
272
59
2,180
$5,818
Post-TDR
Outstanding
Recorded
Investment
$ 302
1,408
227
55
2,096
$4,088
Number of
Contracts
1
3
2
1
1
8
Subsequently Defaulted TDRs
Pre-TDR
Outstanding
Recorded
Investment
$—
—
—
—
—
$—
Post-TDR
Outstanding
Recorded
Investment
$—
—
—
—
—
$—
Number of
Contracts
—
—
—
—
—
—
(1) The period end balances are inclusive of all partial paydowns and charge-offs since the modification date.
There were no loans modified as a TDR within the previous 12 months that subsequently defaulted during the
year ended December 31, 2013. Loans classified as TDRs are considered impaired loans. The Company had no
commitments to lend additional funds for loans classified as troubled debt restructured at December 31, 2013.
TDRs as of December 31, 2012 are as follows:
Commercial and agriculture . . . .
. . .
Construction & development
Residential real estate . . . . . . . .
CRE − owner occupied . . . . . . .
CRE − non-owner occupied . . . .
Ending balance . . . . . . . . . . . .
Current TDRs
Pre-TDR
Outstanding
Recorded
Investment
$ 335
2,972
342
59
2,180
$5,888
Post-TDR
Outstanding
Recorded
Investment
$ 319
1,547
299
57
2,152
$4,374
Number of
Contracts
1
3
3
1
1
9
F-24
Subsequently Defaulted TDRs
Pre-TDR
Outstanding
Recorded
Investment
$—
—
—
—
—
$—
Post-TDR
Outstanding
Recorded
Investment
$—
—
—
—
—
$—
Number of
Contracts
—
—
—
—
—
—
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 5 — Accumulated Other Comprehensive Loss
The following table presents the changes in each component of accumulated other comprehensive income, net
of tax, for the twelve months ended December 31, 2013 and 2012:
Balance, January 1, 2013 . . . . . . . . . . . . . . . . . . . . .
Other comprehensive loss before reclassifications . . . .
Amounts reclassified from AOCI . . . . . . . . . . . . . . .
Net current period other comprehensive income
(loss)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance, December 31, 2013 . . . . . . . . . . . . . . . . . . .
Balance, January 1, 2012 . . . . . . . . . . . . . . . . . . . . .
Other comprehensive loss before reclassifications . . . .
Amounts reclassified from AOCI . . . . . . . . . . . . . . .
Net current period other comprehensive income
(loss)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance, December 31, 2012 . . . . . . . . . . . . . . . . . . .
Net Unrealized
Gains and Losses
on Investment
Securities
956
$
(1,632)
(243)
(1,875)
$ (919)
$
$
420
556
(20)
536
956
Defined
Benefit
Plans
$(535)
85
—
85
$(450)
$(665)
130
—
130
$(535)
Total
$
421
(1,547)
(243)
(1,790)
$(1,369)
$ (245)
686
(20)
666
421
$
The following table presents the amounts reclassified out of each component of accumulated other
comprehensive income (‘‘AOCI’’) for the twelve months ended December 31, 2013:
Details about Accumulated Other
Comprehensive Income Components
Net Unrealized Gains and Losses
on Investment Securities
. . . . .
Amount Reclassified
from AOCI
Twelve Months
Ended
December 31, 2013
$(405)
37
125
$(243)
Affected Line Item in the Statement Where
Net Income is Presented
Gain on sales of investments available
for sale
Net OTTI losses
Income tax expense
Net of tax
F-25
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 5 — Accumulated Other Comprehensive Loss − (continued)
The following table presents the components of other comprehensive income (loss) for the twelve months
ended December 31, 2013 and 2012.
Before Tax
Tax Effect
Net of Tax
Twelve Months Ended December 31, 2013
Net unrealized losses on investment securities:
Net unrealized losses arising during the period . . . . . . . . . . . . . . . . .
Less: reclassification adjustment for net gains including OTTI losses
$(2,473)
$(841)
$(1,632)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
realized in net income
Net unrealized losses on investment securities . . . . . . . . . . . . . . . .
(368)
(2,841)
(125)
(966)
(243)
(1,875)
Defined Benefit Plans:
Amortization of unrecognized prior service costs and net actuarial gains/
losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other Comprehensive Loss
129
$(2,712)
44
$(922)
85
$(1,790)
Twelve Months Ended December 31, 2012
Net unrealized gains on investment securities:
Net unrealized gains arising during the period . . . . . . . . . . . . . . . . . .
. .
Less: reclassification adjustment for net gains realized in net income
Net unrealized gains on investment securities . . . . . . . . . . . . . . . . .
$
842
30
812
$ 286
10
276
$
556
20
536
Defined Benefit Plans:
Amortization of unrecognized prior service costs and net actuarial gains/
losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other Comprehensive Income . . . . . . . . . . . . . . . . . . . . . . . . . . . .
197
$ 1,009
67
$ 343
130
666
$
Note 6 — Premises and Equipment
The components of premises and equipment at December 31 are as follows:
Land and premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment, furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less accumulated depreciation and amortization . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Total premises and equipment
2013
$19,859
8,142
167
28,168
11,378
$16,790
2012
$17,999
7,648
159
25,806
11,213
$14,593
Depreciation expense was $1,013, $989, and $1,022 for 2013, 2012 and 2011, respectively. The Bank leases
premises under operating leases. Rental expense of leased premises was $544, $442 and $375 for 2013, 2012
and 2011, respectively, which is included in occupancy expense.
F-26
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 6 — Premises and Equipment − (continued)
Minimum net rental commitments under non-cancelable operating leases having an original or remaining term
of more than one year for future years ending December 31 are as follows:
2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total minimum payments required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 461
397
236
152
157
$1,403
Certain leases contain renewal options from five to ten years and escalation clauses based on increases in
property taxes and other costs.
Note 7 — Other Real Estate Owned
The following table presents the activity related to OREO for the years ended December 31:
Balance at beginning of year
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dispositions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair value write-downs
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$ 4,679
1,756
(2,718)
(946)
$ 2,771
2012
$ 7,725
3,082
(4,814)
(1,314)
$ 4,679
At December 31, 2013, OREO consisted of 17 properties as follows: five land acquisition and development
properties totaling $237; eight commercial real estate properties totaling $1,862; and four residential real estate
properties totaling $672. Net gains and (losses) on sales of OREO totaled $40, $331 and $(83) for the years
ended December 31, 2013, 2012 and 2011, respectively.
Note 8 — Deposits
The composition of deposits at December 31 is as follows:
Demand deposits, non-interest bearing . . . . . . . . . . . . . . . . . . . . . . . .
NOW and money market accounts
. . . . . . . . . . . . . . . . . . . . . . . . . .
Savings deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Time certificates, $100,000 or more
. . . . . . . . . . . . . . . . . . . . . . . . .
Other time certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$145,028
262,848
73,412
76,628
49,431
$607,347
2012
$115,138
232,607
62,493
87,355
50,650
$548,243
F-27
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 8 — Deposits − (continued)
Scheduled maturities of time certificates of deposit are as follows for future years ending December 31:
2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 65,367
25,537
20,309
8,288
5,834
724
$126,059
Note 9 — Borrowings
Long-term borrowings at December 31, 2013 and 2012 represent advances from the Federal Home Loan Bank
of Seattle (‘‘FHLB’’). Advances at December 31, 2013 bear interest at 0.47% to 2.94% and mature in various
years as follows: 2015 — $5,000 and 2016 — $5,000. The Bank has pledged $168,136 of loans as collateral
for these borrowings at December 31, 2013.
Short-term borrowings represent FHLB term borrowings with scheduled maturity dates within one year. Short-
term borrowings may also include federal funds purchased that generally mature within one to four days from
the transaction date; however there were no federal funds purchased at December 31, 2013, and 2012. The
following is a summary of short-term borrowings for the years ended:
Amount outstanding at end of year . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted average interest rate at December 31 . . . . . . . . . . . . . . . . . .
Maximum month-end balance during the year . . . . . . . . . . . . . . . . . . .
Average balance during the year . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average interest rate during the year . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$ —
—
3,000
303
2.94%
2012
$3,000
2.94%
3,000
2,697
2.94%
Note 10 — Junior Subordinated Debentures
two wholly-owned subsidiary grantor trusts established by the Company had
At December 31, 2013,
outstanding $13,000 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.
F-28
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 10 — Junior Subordinated Debentures − (continued)
The following table is a summary of the trust preferred securities and debentures at December 31, 2013:
Issuance Trust
PFC Statutory Trust I
. . . . . . . . .
PFC Statutory Trust II . . . . . . . . .
Issuance
Date
12/2005
6/2006
Preferred
Security
$5,000
$8,000
Rate
Type
Variable(1)
Variable(1)
Initial
Rate
6.39%
7.02%
Rate at 12/
31/13
1.69%
1.84%
Maturity
Date
3/2036
7/2036
(1) The variable rate preferred securities reprice quarterly based on the three month LIBOR rate.
The Debentures issued by the Company to the grantor trusts totaling $13,000 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 recorded $403 in the consolidated balance sheet at December 31, 2013 and 2012,
respectively, for the common capital securities issued by the issuer trusts.
As of December 31, 2013, regular accrued interest on junior subordinated debentures totaled $40 and is
included in accrued interest payable on the balance sheet. As of December 31, 2012, accrued interest
totaled $41.
Note 11 — Income Taxes
Income taxes for the years ended December 31 is as follows:
Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total income tax benefit
. . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$586
386
$972
2012
$1,237
63
$1,300
2011
$1,148
(815)
$ 333
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and
liabilities at December 31 are:
2013
2012
Deferred Tax Assets
Allowance for credit losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplemental executive retirement plan . . . . . . . . . . . . . . . . . . . . . . .
Unrealized loss on securities available for sale . . . . . . . . . . . . . . . . . .
Loan fees/costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
OREO write-downs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
OREO operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax credit carry-forwards
Non-accrual loan interest
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
OTTI write-downs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,892
111
1,039
473
393
305
174
534
108
—
170
6,199
$3,238
116
922
—
297
657
161
156
194
229
96
6,066
F-29
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 11 — Income Taxes − (continued)
Deferred Tax Liabilities
2013
2012
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan fees/costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized gain on securities available for sale . . . . . . . . . . . . . . . .
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
FHLB dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 172
1,185
—
108
137
51
1,653
$4,546
$ 127
1,150
493
111
143
29
2,053
$4,013
Net deferred tax assets are recorded in other assets in the consolidated financial statements.
The following is a reconciliation between the statutory and effective federal income tax rate for the years
ended December 31:
Income (loss) tax at statutory rate . . . . . . . .
Adjustments resulting from:
2013
Amount
$1,646
Percent of
Pre-tax
Income
2012
Amount
35.0% $2,130
Percent of
2011
Pre-tax
Income
Amount
35.0% $1,103
Percent of
Pre-tax
Income
35.0%
Tax-exempt income . . . . . . . . . . . . . . . .
. . .
Net earnings on life insurance policies
Low income housing tax credit
. . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . .
Total income tax (benefit) expense . . . . . . .
(483)
(152)
(101)
62
$ 972
(10.3)
(542)
(3.2)
(178)
(2.1)
(109)
(1)
1.3
20.7% $1,300
(8.9)
(519)
(2.9)
(171)
(1.8)
(108)
28
0.0
21.4% $ 333
(16.5)
(5.4)
(3.4)
0.9
10.6%
As of December 31, 2013, the Company believes that it is more likely than not that it will be able to fully
realize its DTA and therefore has not recorded a valuation allowance.
Note 12 — Employee Benefits
Incentive Compensation Plan
The Bank has a plan that provides incentive compensation to key employees if the Bank meets certain
performance criteria established by the Board of Directors. The cost of this plan was $272, $400, and $80 in
2013, 2012 and 2011, respectively.
401(k) Plans
The Bank has established a 401(k) profit sharing plan for those employees who meet
the eligibility
requirements set forth in the plan. Eligible employees may contribute up to 15% of their compensation.
Matching contributions by the Bank are at the discretion of the Board of Directors. Contributions totaled $161,
$152 and $58 for 2013, 2012 and 2011, respectively.
Director and Employee Deferred Compensation Plans
The Company has director and employee deferred compensation plans. Under the terms of the plans, a director
or employee may participate upon approval by the Board. The participant may then elect to defer a portion of
his or her earnings (directors’ fees or salary) as designated at the beginning of each plan year. Payments begin
upon retirement, termination, death or permanent disability, sale of the Company, the ten-year anniversary of
the participant’s participation date, or at the discretion of the Company. There are currently no participants in
the director or employee deferred compensation plan. Total deferrals plus earnings in the employee deferred
compensation plan were $0, $0 and $35 at December 31, 2013, 2012 and 2011, respectively. There is no
ongoing expense to the Company for these plans.
F-30
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 12 — Employee Benefits − (continued)
The directors of a bank acquired by the Company in 1999 adopted two deferred compensation plans for
directors — one plan providing retirement
income benefits for all directors and the other, a deferred
compensation plan, covering only those directors who have chosen to participate in the plan. At the time of
adopting these plans, the Bank purchased life insurance policies on directors participating in both plans which
may be used to fund payments to them under these plans. Cash surrender values on these policies were $3,911
and $3,804 at December 31, 2013 and 2012, respectively. In 2013, 2012 and 2011, the net benefit recorded
from these plans, including the cost of the related life insurance, was $354, $396 and $402, respectively. Both
of these plans were fully funded and frozen as of September 30, 2001. Plan participants were given the option
to either remain in the plan until reaching the age of 70 or to receive a lump-sum distribution. Participants
electing to remain in the plan will receive annual payments over a ten-year period upon reaching 70 years of
age. The liability associated with these plans totaled $322 and $334 at December 31, 2013 and 2012,
respectively.
Executive Long-Term Compensation Agreements
The Company has executive long-term compensation agreements to selected employees that provide incentive
for those covered employees to remain employed with the Company for a defined period of time. The cost of
these agreements was $107, $95 and $79 in 2013, 2012 and 2011, respectively.
Supplemental Executive Retirement Plan
Effective January 1, 2007, the Company adopted a non-qualified Supplemental Executive Retirement Plan
(SERP) that provides retirement benefits to its executive officers. The SERP is unsecured and unfunded and
there are no plan assets. The post-retirement benefit provided by the SERP is designed to supplement a
participating officer’s retirement benefits from social security, in order to provide the officer with a certain
percentage of final average income at retirement age. The benefit is generally based on average earnings, years
of service and age at retirement. At the inception of the SERP, the Company recorded a prior service cost to
accumulated other comprehensive income of $704. The Company has purchased bank owned life insurance
covering all participants in the SERP. The cash surrender value of these policies totaled $5,817 and $5,736 at
December 31, 2013 and 2012, respectively.
The following table sets forth the net periodic pension cost and obligation assumptions used in the
measurement of the benefit obligation for the years ended December 31:
Net periodic pension cost:
Service Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . .
Amortization of prior service cost
Amortization of net (gain)/loss . . . . . . . . . . . . . . . . . . . . . . .
Net periodic pension cost . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 145
104
90
22
$ 361
$ 167
106
90
27
$ 390
$ 143
97
90
3
$ 333
2013
2012
2011
Weighted average assumptions:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rate of compensation increases . . . . . . . . . . . . . . . . . . . . .
4.37%
n/a
4.47%
n/a
5.12%
n/a
F-31
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 12 — Employee Benefits − (continued)
The following table sets forth the change in benefit obligation at December 31:
Change in Benefit Obligation:
Benefit obligation at beginning of year . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Service cost
Interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actuarial gain (loss)
Benefit obligation at end of year . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,342
145
104
(45)
27
$2,573
$2,082
167
106
—
(13)
$2,342
2013
2012
Amounts recognized in accumulated other comprehensive income (loss) at December 31 are as follows:
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Gain) loss
Prior service cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total recognized in accumulative other comprehensive income (loss) . .
2013
$179
271
$450
2012
$173
362
$535
The following table summarizes the projected and accumulated benefit obligations at December 31:
Projected benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Estimated future benefit payments as of December 31, 2013 are as follows:
2013
$2,573
2,573
2012
$2,342
2,342
2014 − 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 − 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 505
1,356
Note 13 — Dividend Reinvestment Plan
In November 2005, the Company instituted a dividend reinvestment plan which allows for all or part of cash
dividends to be reinvested in shares of Company common stock based upon participant elections. Under the
plan, 1,100,000 shares were authorized for dividend reinvestment, of which 89,771 shares have been issued
through December 31, 2013. The plan is currently suspended.
Note 14 — Commitments and Contingencies
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.
F-32
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 14 — Commitments and Contingencies − (continued)
loss in the event of nonperformance by the other party to the financial
The Bank’s exposure to credit
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
the Bank’s commitments at
December 31 is as follows:
instruments. A summary of
Commitments to extend credit
Standby letters of credit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$106,017
1,733
2012
$84,493
1,975
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. Those guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers. Collateral held varies as specified above and is required in instances
where the Bank deems necessary.
Certain executive officers have entered into employment contracts with the Bank which provide for contingent
payments subject to future events.
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 consolidated financial statements.
The Bank has agreements with commercial banks for lines of credit totaling $16,000, of which none was used
at December 31, 2013. In addition, the Bank has a credit line with the Federal Home Loan Bank of Seattle
totaling 20% of assets, $10,000 of which was used at December 31, 2013. These borrowings are collateralized
under blanket pledge and custody agreements. As of December 31, 2013, loans carried at $168,136 were
pledged as collateral to the Federal Home Loan Bank. The Bank also has a borrowing arrangement with the
Federal Reserve Bank under the Borrower-in-Custody program. Under this program, the Bank has an available
credit facility of $53,187, subject to pledged collateral. As of December 31, 2013, loans carried at $79,422
were pledged as collateral to the Federal Reserve Bank.
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 financial condition, results of operations or cash flows of the Company.
F-33
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 15 — Significant Concentrations of Credit Risk
Most of the Bank’s business activity is with customers and governmental entities located in the states of
Washington and Oregon, including investments in state and municipal securities. Loans to any single borrower
or group of borrowers are generally limited by state banking regulations to 20% of the Bank’s shareholder’s
equity, excluding accumulated other comprehensive income (loss). Standby letters of credit were granted
primarily to commercial borrowers. The Bank, as a matter of practice, generally does not extend credit to any
single borrower or group of borrowers in excess of $7,500.
Note 16 — Stock Based Compensation
Stock Options
The Company’s 2000 Stock Incentive Plan provided for incentive and non-qualified stock options and other
types of stock based awards, as defined under current tax laws, to key personnel. Under the plan, the Company
was authorized to issue up to 1,100,000 shares; however the plan expired January 1, 2011. On April 27, 2011,
the shareholders of the Company approved the 2011 Equity Incentive Plan, pursuant to which the Company is
authorized to issue up to 900,000 shares of common stock in connection with awards under the plan (803,869
shares are available for grant at December 31, 2013). Under the plan, options either become exercisable ratably
over five years or vest fully five years from the date of grant.
The Company uses the Black-Scholes option pricing model to calculate the fair value of stock-based awards
based on assumptions noted in the following table. Expected volatility is based on historical volatility of the
Company’s common shares. 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
December 31, 2013 . . . . . . . . . . . . .
December 31, 2012 . . . . . . . . . . . . .
December 31, 2011 . . . . . . . . . . . . .
Expected
Life
6.5 years
6.5 years
6.5 years
Risk Free
Interest Rate
1.36%
1.34%
1.50%
Expected
Volatility
23.05%
22.43%
22.51%
Dividend
Yield
4.13%
—%
—%
Average
Fair Value
$0.58
$0.77
$1.05
F-34
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 16 — Stock Based Compensation − (continued)
A summary of the status of the Company’s stock option plans as of December 31, 2013, 2012 and 2011, and
changes during the years ending on those dates, is presented below:
Outstanding at beginning of year . .
Granted . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . .
Expired . . . . . . . . . . . . . . . . . . .
Forfeited . . . . . . . . . . . . . . . . . .
Outstanding at end of year
. . . .
Exercisable at end of year . . . . .
2013
2012
2011
Weighted
Average
Exercise
Price
$11.28
5.05
—
11.36
9.25
$ 9.53
Shares
537,107
186,000
—
(64,337)
(33,275)
625,495
Weighted
Average
Exercise
Price
$11.32
5.00
—
10.44
10.57
$11.28
Shares
586,448
10,500
—
(12,550)
(47,291)
537,107
Weighted
Average
Exercise
Price
$11.07
3.95
—
10.10
10.98
$11.32
Shares
818,612
5,000
—
(178,439)
(58,725)
586,448
328,845
$12.95
389,827
$12.98
411,708
$12.93
A summary of the status of the Company’s nonvested options as of December 31, 2013 and 2012 and changes
during the period then ended are presented below:
Non-vested beginning of period . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-vested end of period . . . . . . . . . . . . . . . . . . .
2013
2012
Shares
147,280
186,000
(17,875)
(18,755)
296,650
Weighted
Average
Fair Value
$0.31
0.57
0.32
0.40
$0.47
Shares
174,740
10,500
(32,050)
(5,910)
147,280
Weighted
Average
Fair Value
$0.37
0.77
0.83
0.27
$0.31
F-35
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 16 — Stock Based Compensation − (continued)
The following information summarizes information about stock options outstanding and exercisable at
December 31, 2013:
Range of exercise prices
0.00 − 11.10 . . . . . . . . . . . .
11.11 − 12.49 . . . . . . . . . . .
12.50 − 14.74 . . . . . . . . . . .
14.75 − 16.00 . . . . . . . . . . .
Options Outstanding
Weighted
average
remaining
contractual
life (years)
7.6
4.0
2.0
1.0
5.1
Weighted
average
exercise
price
$ 5.94
12.11
14.29
15.10
$ 9.53
Number
361,000
26,125
125,675
112,695
625,495
Options Exercisable
Weighted
average
remaining
contractual
life (years)
6.0
4.0
2.0
1.0
2.6
Weighted
average
exercise
price
$ 6.92
12.11
14.29
15.10
$12.95
Number
64,350
26,125
125,675
112,695
328,845
The aggregate intrinsic value of all options outstanding at December 31, 2013 and 2012 was $303 and $0,
respectively. The aggregate intrinsic value of all options that were exercisable at December 31, 2013 and 2012
was $0 and $0, respectively. There were no options exercised during 2012 or 2013. Stock based compensation
recognized in 2013 and 2012 was $50 ($33 net of tax) and $24 ($16 net of tax), respectively. Future
compensation expense for unvested awards outstanding as of December 31, 2013 is estimated to be $80
recognized over a weighted average period of 1.8 years.
Restricted Stock Units
During 2012 and 2013, the Company granted restricted stock units (‘‘RSU’’) to certain employees receiving
awards under the Company’s Annual Incentive Compensation Plan. Recipients of RSUs will be issued a
specified number of shares of the Company’s common stock upon the lapse of their applicable restrictions.
Restrictions require the employee to continue in employment for a period of three years from the date the RSU
is awarded.
The following table summarizes RSU activity during the years ended December 31, 2013 and 2012. There was
no RSU activity prior to 2012.
Outstanding, January 1, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding, December 31, 2013 . . . . . . . . . . . . . . . . . . . . . . .
Outstanding, January 1, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding, December 31, 2012 . . . . . . . . . . . . . . . . . . . . . . .
Weighted
average
remaining
contractual
terms
(in years)
Weighted
average
grant price
$4.93
$4.93
$4.43
$4.43
2.0
2.5
Shares
16,059
35,476
(1,511)
50,024
—
16,604
(545)
16,059
F-36
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 16 — Stock Based Compensation − (continued)
For the years ended December 31, 2013 and 2012, the Company recognized compensation expense related to
RSUs of $66 ($44 net of tax) and $8 ($5 net of tax), respectively. As of December 31, 2013, there was $172 of
total unrecognized compensation expense related to non-vested RSUs.
Note 17 — Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal
banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the
Company’s consolidated financial statements. Under capital adequacy guidelines on the regulatory framework
for prompt corrective action, the Bank must meet specific capital adequacy guidelines that involve quantitative
measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank’s capital classification is also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank
to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined in the
regulations) to total average assets (as defined), and minimum ratios of Tier 1 and total capital (as defined) to
risk-weighted assets (as defined).
As of December 31, 2013, the Bank was well capitalized under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-
based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution’s category.
The Company and the Bank’s actual capital amounts and ratios are presented in the table below. Management
believes, as of December 31, 2013, the Company and the Bank meet all capital requirements to which they are
subject.
Actual
Amount
Ratio
Capital
Adequacy
Purposes
Amount
Ratio
To be Well
Capitalized
Under Prompt
Corrective Action
Provisions
Amount
Ratio
December 31, 2013
Tier 1 capital (to average assets):
Company . . . . . . . . . . . . . . . . . . $67,856
67,420
Bank . . . . . . . . . . . . . . . . . . . . .
9.83% $27,604
27,591
9.77
4.00%
4.00
NA
$34,489
NA
5.00%
Tier 1 capital (to risk-weighted
assets):
Company . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . .
Total capital (to risk-weighted assets):
Company . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . .
67,856
67,420
12.85
12.78
21,119
21,101
74,477
74,036
14.11
14.03
42,237
42,202
4.00
4.00
8.00
8.00
NA
31,652
NA
52,753
NA
6.00
NA
10.00
F-37
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 17 — Regulatory Matters − (continued)
Actual
Amount
Ratio
Capital
Adequacy
Purposes
Amount
Ratio
To be Well
Capitalized
Under Prompt
Corrective Action
Provisions
Amount
Ratio
December 31, 2012
Tier 1 capital (to average assets):
Company . . . . . . . . . . . . . . . . . . $66,750
66,712
Bank . . . . . . . . . . . . . . . . . . . . .
10.69% $24,975
24,966
10.69
4.00%
4.00
NA
$31,207
NA
5.00%
Tier 1 capital (to risk-weighted assets):
Company . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . .
Total capital (to risk-weighted assets):
Company . . . . . . . . . . . . . . . . . .
Bank . . . . . . . . . . . . . . . . . . . . .
66,750
66,712
14.95
14.96
17,855
17,842
72,376
72,334
16.21
16.22
35,710
35,685
4.00
4.00
8.00
8.00
NA
26,764
NA
44,606
NA
6.00
NA
10.00
The primary source for dividends paid to our shareholders is dividends paid to us from our subsidiary Bank of
the Pacific. There are regulatory restrictions on the ability of our subsidiary bank to pay dividends. Under
federal regulations, the dollar amount of dividends the bank may pay depends upon its capital position and
recent net income. Generally, if an institution satisfies its regulatory capital requirements, it may make dividend
payments up to the limits prescribed under state law and FDIC regulations. In addition, the Company is subject
to certain restrictions on the amount of dividends that it may declare without prior regulatory approval.
Note 18 — Fair Value of Financial Instruments
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.
F-38
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 18 — Fair Value of Financial Instruments − (continued)
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 observable market data. 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 analysis 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 December 31, 2013 or 2012.
The following table presents the balances of assets and liabilities measured at fair value on a recurring basis at
December 31, 2013 and December 31, 2012:
December 31, 2013
Securities available-for-sale
Readily
Available
Market Inputs
Level 1
Observable
Market Inputs
Level 2
Significant
Unobservable
Inputs
Level 3
U.S. Government agency securities . . . . . . .
State and municipal securities . . . . . . . . . . .
Agency MBS . . . . . . . . . . . . . . . . . . . . . .
Non-agency MBS . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . .
$—
—
—
—
—
$—
$ 8,811
30,741
52,180
2,011
982
$94,725
$ —
1,419
—
—
—
$1,419
Total
$ 8,811
32,160
52,180
2,011
982
$96,144
F-39
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 18 — Fair Value of Financial Instruments − (continued)
December 31, 2012
Securities available-for-sale
Readily
Available
Market Inputs
Level 1
Observable
Market Inputs
Level 2
Significant
Unobservable
Inputs
Level 3
U.S. Government agency securities . . . . . . .
State and municipal securities . . . . . . . . . . .
Agency MBS . . . . . . . . . . . . . . . . . . . . . .
Non-agency MBS . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . .
$ —
—
—
—
1,957
$1,957
$ 5,952
25,807
22,159
2,544
1,588
$58,050
$ —
1,099
—
—
—
$1,099
Total
$ 5,952
26,906
22,159
2,544
3,545
$61,106
As of December 31, 2013 and 2012, the Company had two 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,
observable market data is limited and, management determined that these securities should be classified as
Level 3 within the fair value hierarchy. These securities are considered sensitive 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 years ended December 31, 2013 and 2012, respectively.
There were no transfers of assets into or out of Level 1, into level 2, or out of level 3 during 2013. During
2013,
the Company concluded that certain municipal securities were valued a discount rate that was a
significant unobservable input due to the lack of liquidity and observable information related to the credit
spread for these securities and transferred these assets from Level 2 to Level 3. There were no transfers into or
out of Level 1, 2, or 3 during 2012.
Balance beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transfers in to Level 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in FV included in other comprehensive income . . . . . . . . . . . . . . . . . . .
Matured . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$1,099
464
(144)
—
$1,419
2012
$1,140
—
(41)
—
$1,099
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:
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 primarily rely on third party appraisals by qualified licensed appraisers, less costs to sell. These appraisals
may utilize a single valuation approach or a combination of approaches including comparable sales and the
income approach.
F-40
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 18 — Fair Value of Financial Instruments − (continued)
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 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.
F-41
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 18 — Fair Value of Financial Instruments − (continued)
The following table presents the Company’s assets that were accounted for at fair value on a nonrecurring
basis at December 31, 2013 and 2012:
Readily
Available
Market Inputs
Level 1
Observable
Market Inputs
Level 2
Significant
Unobservable
Inputs
Level 3
December 31, 2013
Impaired loans . . . . . . . . . . . . . . . . . . . . . . .
OREO . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2012
Impaired loans . . . . . . . . . . . . . . . . . . . . . . .
OREO . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$—
$—
$—
$—
$—
$—
$—
$—
$ 162
$1,960
$5,053
$4,807
Total
$ 162
$1,960
$5,053
$4,807
Other real estate owned with a pre-foreclosure loan balance of $1,821 was acquired during the year ended
December 31, 2013. Upon foreclosure, these assets were written down $64 to their fair value, less estimated
costs to sell, which was charged to the allowance for credit losses during the period.
The following table presents quantitative information about Level 3 inputs for financial instruments measured
at fair value on a nonrecurring basis at December 31, 2013:
Impaired loans . . . .
OREO . . . . . . . . . .
Fair Value
$ 162
$1,960
Valuation
Technique
Significant
Unobservable Inputs
Appraised value Adjustment for market conditions
Appraised value Adjustment for market conditions
Range (Weighted
Average)
0 − 10% (1.9%)
0 − 10% (4.2%)
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 and interest bearing deposits at other financial institutions 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.
F-42
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 18 — Fair Value of Financial Instruments − (continued)
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.
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 determined 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 based on
interest rates currently offered on similar certificates.
Short-term borrowings
The fair values 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.
Long-term borrowings
The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analysis
based on the Company’s incremental borrowing rates for similar types of borrowing arrangements.
Secured borrowings
For variable rate secured borrowings that reprice frequently and have no significant change in credit risk,
fair values are based on carrying values.
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
junior subordinated
debentures.
rates currently available for
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,
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.
taking into account
F-43
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 18 — Fair Value of Financial Instruments − (continued)
The estimated fair values of the Company’s financial instruments at December 31, 2013 and December 31,
2012 are as follows:
December 31, 2013
Financial Assets
Cash and interest bearing deposits in
Carrying
Amount
Level 1
Level 2
Level 3
Total Fair
Value
banks . . . . . . . . . . . . . . . . . . . . .
$ 35,948
$35,948
$
— $
—
$ 35,948
Certificates of deposits held for
investment
. . . . . . . . . . . . . . . . .
Securities available-for sale . . . . . . .
Securities held-to-maturity . . . . . . . .
Federal Home Loan Bank stock . . . .
Loans held for sale . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . .
Loans, net
Financial Liabilities
. . . . . . . . . . . . . . . . . . . .
Deposits
Short-term borrowings . . . . . . . . . . .
Long-term borrowings . . . . . . . . . . .
Junior subordinated debentures . . . . .
December 31, 2012
Financial Assets
Cash and interest bearing deposits in
2,727
96,144
2,132
3,013
7,765
496,307
$607,347
—
10,000
13,403
Carrying
Amount
2,727
—
—
—
—
—
—
94,725
2,158
3,013
7,765
—
—
1,419
—
—
—
473,224
$ —
—
—
—
$606,654
—
10,195
—
$
—
—
—
7,646
Level 1
Level 2
Level 3
2,727
96,144
2,158
3,013
7,765
473,224
$606,645
—
10,195
7,646
Total Fair
Value
banks . . . . . . . . . . . . . . . . . . . . .
$ 56,855
$56,855
$
— $
—
$ 56,855
Certificates of deposits held for
investment
. . . . . . . . . . . . . . . . .
Securities available-for sale . . . . . . .
Securities held-to-maturity . . . . . . . .
Federal Home Loan Bank stock . . . .
Loans held for sale . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . .
Loans, net
2,985
61,106
6,937
3,126
12,950
438,838
2,985
1,957
—
—
—
—
—
58,050
6,985
3,126
12,977
—
1,099
—
—
—
401,224
2,985
61,106
6,985
3,126
12,977
401,224
Financial Liabilities
Deposits
Short-term borrowings . . . . . . . . . . .
Long-term borrowings . . . . . . . . . . .
Secured borrowings . . . . . . . . . . . . .
Junior subordinated debentures . . . . .
$548,243
3,000
7,500
13,403
$ —
—
—
—
$549,504
3,042
7,765
—
$
—
—
—
8,318
$549,504
3,042
7,765
8,318
F-44
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 19 — Earnings Per Share Disclosures
Following is information regarding the calculation of basic and diluted earnings per share for the years
indicated.
Year Ended December 31, 2013
Basic earnings per share:
Effect of dilutive securities:
. . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .
Diluted earnings per share: . . . . . . . . . . . . . . . . . . . .
Year Ended December 31, 2012
Basic earnings per share:
Effect of dilutive securities:
. . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .
Diluted earnings per share: . . . . . . . . . . . . . . . . . . . .
Year Ended December 31, 2011
Basic earnings per share:
Effect of dilutive securities:
. . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .
Diluted earnings per share: . . . . . . . . . . . . . . . . . . . .
Net Income
(Numerator)
Shares
(Denominator)
Per Share
Amount
$3,731
—
$3,731
$4,785
—
$4,785
$2,818
—
$2,818
10,121,738
66,150
10,189,888
10,121,853
4,391
10,126,244
10,121,853
17
10,121,870
$0.37
—
$0.37
$0.47
—
$0.47
$0.28
—
$0.28
The number of shares shown for ‘‘options’’ is the number of incremental shares that would result from the
exercise of options and use of the proceeds to repurchase shares at the average market price during the year.
Note 20 — Business Combination
On January 28, 2013, the Bank and Sterling Savings Bank, a Washington state-chartered bank (‘‘Sterling’’),
entered into a Purchase and Assumption Agreement (the ‘‘Agreement’’) pursuant to which the Bank agreed to
purchase from Sterling three branches located in Aberdeen, Washington; Astoria, Oregon; and Seaside, Oregon,
including certain deposit liabilities, loans and other assets and liabilities associated with such branch locations.
The actual amount of loans and deposits, the value of other assets and liabilities transferred to the Bank and
the actual price paid were determined at the time of the closing of the transaction on June 1, 2013, in
accordance with the terms of the Agreement. The purchase price was $976 and exceeded the estimated fair
value of tangible net assets acquired by approximately $1,127, which was recorded as goodwill and intangible
assets.
Cash flow information relative to the asset purchase agreement is as follows (in thousands):
Fair value of tangible net assets acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash paid for deposit premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liabilities assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill and intangible assets recorded . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 37,533
(976)
(37,684)
$ 1,127
The primary purpose of the acquisition is to expand the Company’s market share in the northern Oregon coast,
to provide existing customers with added convenience and service, and to provide our new customers with the
opportunity to enjoy the outstanding personalized service and commitment of our community-based bank.
F-45
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 20 — Business Combination − (continued)
Fair value adjustments and related goodwill were recorded in the statement of financial condition of the
Company. The following is a condensed balance sheet disclosing the estimated fair value amounts of the
acquired branches of Sterling assigned to the major consolidated asset and liability captions at the acquisition
date (in thousands):
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Premises and equipment
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill and intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deposits and accrued interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$31,941
3,989
604
1,127
23
$37,684
$37,636
47
1
—
$37,684
The core deposit intangible asset that was recognized as part of the business combination was $242 and will be
amortized over its estimated useful life of approximately ten years utilizing an accelerated method. The
goodwill of $885 will not be amortized for financial statement purposes; instead, it will be reviewed annually
for impairment.
The fair value of savings and transaction deposit accounts acquired from Sterling was assumed to approximate
the carrying value as these accounts have no stated maturity and are payable on demand. Certificates of deposit
were valued by comparing the contractual cost of the portfolio to an identical portfolio bearing current market
rates. The projected cash flows from maturing certificates were calculated based on contractual rates. The fair
value of certificates of deposit was calculated by discounting their contractual cash flows at a market rate for a
certificate of deposit with a corresponding maturity.
Direct costs related to the Sterling acquisition will be expensed as incurred in the year ended December 31,
2013. These acquisition and integration expenses will
technology and
communications, occupancy and equipment, professional services and other noninterest expenses. For the year
ended December 31, 2013, the Company incurred $615,000 of expenses related to acquisition costs.
The following table presents an unaudited pro forma balance sheet of the Company as if the acquisition of the
Sterling branches had occurred on December 31, 2012. The pro forma balance sheet does not necessarily reflect
the combined balance sheet that resulted as of the closing of the branch acquisition of the Sterling branches.
include salaries and benefits,
ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment securities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans receivable, net
Premises and equipment
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill and intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets
Total assets
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits and accrued interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31,
2012
$ 91,781
68,043
455,777
15,197
13,677
36,803
$681,278
$586,092
23,903
4,562
66,721
$681,278
F-46
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 20 — Business Combination − (continued)
The following table presents the unaudited pro forma results of operations for the twelve months ended
December 31, 2012 as if the acquisition of the Sterling branches had occurred on January 1, 2012. This pro
forma information gives effect to certain adjustments, including purchase accounting fair value adjustments and
amortization of the core deposit intangible asset. Significant assumptions utilized include the acquisition cost
noted above, accretion of interest rate fair value adjustment, amortization of the core deposit intangible asset
and a 21% effective tax rate. The pro forma information does not necessarily reflect the results of operations
that would have occurred had the Company purchased and assumed the assets and liabilities of the Sterling
branches at January 1, 2012. Cost savings are also not reflected in the unaudited pro forma amounts for the
twelve months ended December 31, 2012.
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Twelve Months
Ended
December 31,
2012
$25,357
9,776
30,131
1,072
$ 3,930
Pro forma earnings per share
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
0.39
0.39
Operations of the branches acquired have been included in the consolidated financial statements since June 1,
2013. The Company does not consider these branches a separate reporting unit and does not track the amount
of revenue and net income attributable to these branches since the acquisition, two of which were subsequently
consolidated into existing operations. As such, it is impracticable to determine such amounts for the twelve
months ended December 31, 2013 for both the balance sheet and income statement.
F-47
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 21 — Condensed Financial Information — Parent Company Only
Condensed Balance Sheets — December 31,
Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment in the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liabilities and Shareholders’ Equity
Junior subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due to the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . .
Condensed Statements of Income — Years Ended December 31,
Dividend Income from the Bank . . . . . . . . . . . . . . . . . . . . . .
Other Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . .
Income Tax Benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income (loss) before income tax benefit
Income (loss) before equity in undistributed
Income of the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity in Undistributed Income of the Bank . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013
$2,400
7
2,407
(608)
1,799
124
1,923
1,808
$3,731
There are no items of other comprehensive income at the parent company.
2013
2012
$ 2,483
79,701
432
$82,616
$13,403
—
2,036
40
67,137
$82,616
2012
$3,500
10
3,510
(517)
2,993
101
3,094
1,691
$4,785
$
173
79,684
403
$80,260
$13,403
95
—
41
66,721
$80,260
2011
$ —
8
8
(600)
(592)
—
(592)
3,410
$2,818
F-48
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 21 — Condensed Financial Information — Parent Company Only − (continued)
Condensed Statements of Cash Flows — Years Ended December 31,
Operating Activities
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 3,731
$ 4,785
$ 2,818
2013
2012
2011
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Equity in undistributed income of subsidiary . . . . . . . . . . .
Net change in other assets
. . . . . . . . . . . . . . . . . . . . . . .
Net change in other liabilities . . . . . . . . . . . . . . . . . . . . .
Other − net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . .
Net cash provided by (used in) operating activities
Financing Activities
Common stock issued . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in financing activities . . . . . . . . . . . . . . . . .
Net decrease in cash . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash
(1,808)
(29)
(96)
117
1,915
394
—
394
2,309
(1,691)
35
(1,312)
24
1,841
—
(2,024)
(2,024)
(183)
(3,410)
(8)
352
26
(222)
—
—
—
(222)
Beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
End of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
173
$ 2,483
356
173
$
578
356
$
F-49
Pacific Financial Corporation and Subsidiary
December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
Note 21 — Condensed Financial Information — Parent Company Only − (continued)
Quarterly Data (Unaudited)
Year Ended December 31, 2013
Interest income . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income
. . . . . . . . . . . . . . . . . . . .
Provision for (recapture of) credit losses . . . . . . .
Non-interest income . . . . . . . . . . . . . . . . . . . . .
Non-interest expenses . . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . .
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . .
First
Quarter
$6,271
689
5,582
—
2,626
7,419
789
88
$ 701
Earnings per common share:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
.07
.07
Year Ended December 31, 2012
Interest income . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income
. . . . . . . . . . . . . . . . . . . .
Provision for (recapture of) credit losses . . . . . . .
Non-interest income . . . . . . . . . . . . . . . . . . . . .
Non-interest expenses . . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . .
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . .
$7,034
984
6,050
100
1,848
6,599
1,199
181
$1,018
Earnings per common share:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
.10
.10
Second
Quarter
$6,600
648
5,952
(450)
3,175
7,872
1,705
373
$1,332
$
.13
.13
$7,037
907
6,130
300
2,409
6,910
1,329
256
$1,073
$
.11
.11
Third
Quarter
$6,605
590
6,015
—
2,232
7,089
1,158
249
$ 909
$
.09
.09
$6,751
829
5,922
—
2,443
7,070
1,295
280
$1,015
$
.10
.10
Fourth
Quarter
$ 6,814
563
6,251
—
1,922
7,122
1,051
262
789
$
$
.08
.08
$ 6,673
764
5,909
(1,500)
2,691
7,838
2,262
583
$ 1,679
$
.16
.16
F-50
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the
21th day of March, 2014.
SIGNATURES
PACIFIC FINANCIAL CORPORATION
(Registrant)
/s/ Dennis A. Long
Dennis A. Long, President and CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated, on the 21th day of March, 2014.
Principal Executive Officer and Director
Principal Financial and Accounting Officer
/s/ Dennis A. Long
Dennis A. Long, President and CEO and Director
/s/ Douglas N. Biddle
Douglas N. Biddle, Treasurer
Remaining Directors
/s/ Gary C. Forcum
Gary C. Forcum (Chairman of the Board)
/s/ Randy W. Rognlin
Randy W. Rognlin
/s/ Randy Rust
Randy Rust
/s/ Douglas M. Schermer
Douglas M. Schermer
/s/ Denise Portmann
Denise Portmann
/s/ John Van Dijk
John Van Dijk
/s/ Edwin Ketel
Edwin Ketel
/s/ Dwayne Carter
Dwayne Carter
/s/ Susan C. Freese
Susan C. Freese
/s/ Lori Reece
Lori Reece
61
EXHIBIT NO.
Exhibit Index
EXHIBIT
3.1
3.2
4.1
4.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
Restated Articles of Incorporation. Incorporated by reference to Exhibit 3.2 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.
Bylaws. Incorporated by reference to Exhibit 2b to Form 8-A filed by the Company and
declared effective on March 7, 2000 (Registration No. 000-29329).
Form of Warrant to purchase shares of Common Stock issued to Ithan Creek Master Investors
(Cayman) L.P. (the Purchaser). Incorporated by reference to Exhibit 4.1 to the Company’s
Current Report on Form 8-K dated August 25, 2009 (the 2009 8-K).
Form of Warrant to purchase shares of Common Stock issued to investors in 2009 private
placement other than the Purchaser referred to in Exhibit 4.1. Incorporated by reference to
Exhibit 4.2 to the Company’s Annual Report on Form 10-K for the year ended December 31,
2009.
Amended and Restated Employment Agreement with Dennis A. Long dated December 29,
2008. Incorporated by reference to Exhibit 10.1 of the Company’s Annual Report on
Form 10-K for the year ended December 31, 2008 (the 2008 10-K).*
First Amendment to Amended and Restated Employment Agreement with Dennis A. Long
dated January 11, 2013. Incorporated by reference to Exhibit 10.1 of the Company’s Current
Report on Form 8-K dated January 11, 2013.*
Amended and Restated Employment Agreement with Bruce D. MacNaughton dated December
29, 2008. Incorporated by reference to Exhibit 10.3 to the 2008 10-K.*
First Amendment
to Amended and Restated Employment Agreement with Bruce D.
MacNaughton dated January 11, 2013. Incorporated by reference to Exhibit 10.1 of the
Company’s Current Report on Form 8-K dated January 11, 2013.*
Amended and Restated Employment Agreement with Denise Portmann dated December 29,
2008. Incorporated by reference to Exhibit 10.4 to the 2008 10-K.*
First Amendment to Amended and Restated Employment Agreement with Denise J. Portmann
dated January 11, 2013. Incorporated by reference to Exhibit 10.1 of the Company’s Current
Report on Form 8-K dated January 11, 2013.*
Employment Agreement with Douglas N. Biddle dated February 10, 2014. Incorporated by
reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated February 10,
2014.
2000 Stock Incentive Compensation Plan, as amended (the 2000 Plan). Incorporated by
reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2007 (the March 2007 10-Q).*
Forms of stock option agreements under the 2000 Plan. Incorporated by reference to
Exhibits 10.2 and 10.3 to the March 2007 10-Q.*
Supplemental Executive Retirement Plan effective January 1, 2007. Incorporated by reference
to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 13, 2008 (the
March 2008 8-K).*
Individual Participation Agreement (SERP) dated March 13, 2008, between the Company and
Dennis A. Long. Incorporated by reference to Exhibit 10.2 to the March 2008 8-K.*
Individual Participation Agreement (SERP) dated March 13, 2008, between the Company and
John Van Dijk. Incorporated by reference to Exhibit 10.3 to the March 2008 8-K.*
Individual Participation Agreement (SERP) dated March 13, 2008, between the Company and
Bruce MacNaughton. Incorporated by reference to Exhibit 10.4 to the March 2008 8-K.*
Individual Participation Agreement (SERP) dated March 13, 2008, between the Company and
Denise Portmann. Incorporated by reference to Exhibit 10.5 to the March 2008 8-K.*
62
EXHIBIT NO.
10.15
10.16
10.17
21
23.1
31.1
31.2
32
EXHIBIT
Pacific Financial Corporation Annual Incentive Compensation Plan, approved March 9, 2011.
Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K
dated March 9, 2011.*
Pacific Financial Corporation Amended and Restated 2011 Equity Incentive Plan.
Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q
for the quarter ended March 31, 2013
Forms of nonqualified option, incentive option and restricted unit award statements for use
under the 2011 Plan.*
Subsidiaries of Registrant
Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
Certification Pursuant to 18 U.S.C. 1350
*
Listed document is a management contract, compensation plan or arrangement.
63
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Forms of Nonqualified Stock Option, Incentive Stock Option and Restricted Unit
Award Statements under 2011 Equity Incentive Plan
PACIFIC FINANCIAL CORPORATION
2011 EQUITY INCENTIVE PLAN
NONQUALIFIED STOCK OPTION AWARD STATEMENT
EXHIBIT 10.17
(A)
(B)
(C)
(D)
(E)
Name of Holder:
Grant Date:
Number of Shares:
Exercise Price:
Expiration Date:
THIS NONQUALIFIED STOCK OPTION AWARD STATEMENT (this ‘‘Statement’’) is made and
entered into as of the date set forth in Item (B) above (the ‘‘Grant Date’’) between Pacific Financial
Corporation, a Washington corporation (the ‘‘Company’’), and the person named in Item (A) above
(‘‘Holder’’).
THE PARTIES AGREE AS FOLLOWS:
1. Grant of Option; Grant Date. The Company hereby grants to Holder pursuant to the Company’s
2011 Equity Incentive Plan, as amended from time to time (the ‘‘Plan’’), a copy of which is available from the
Company on request, the right (the ‘‘Option’’) to purchase up to the number of shares of the Company Stock
listed in Item (C) above (the ‘‘Option Shares’’) at the price per share set forth in Item (D) above (the
‘‘Exercise Price’’), on the terms and conditions set forth in this Statement and in the Plan, the terms and
conditions of the Plan being incorporated into this Statement by reference. This Option is not intended to
qualify as an incentive stock option for purposes of Section 422 of the Internal Revenue Code of 1986, as
amended. The number and kind of Option Shares and the Exercise Price may be adjusted in certain
circumstances in accordance with the provisions of Section 10.2 of the Plan.
2. Definitions. The following terms, as used in this Statement, shall have these meanings:
‘‘Cause’’ has the meaning set forth in Holder’s employment agreement with the Company, and if not so
defined means dishonesty, fraud, misconduct, disclosure of confidential information, conviction of, or a plea of
guilty or no contest to, a felony under the laws of the United States or any state thereof, habitual absence from
work for reasons other than illness, intentional conduct which causes significant injury to the Company,
habitual abuse of alcohol or a controlled substance, in each case as determined by the Committee, and its
determination shall be conclusive and binding.
‘‘Disability’’ means a medically determinable mental or physical impairment or condition of the Holder
that is expected to result in death or which has lasted or is expected to last for a continuous period of
12 months or more and which causes the Holder to be unable, in the opinion of the Committee on the basis of
evidence acceptable to it, to perform his or her duties to the Company. Upon making a determination of
Disability, the Committee shall, for purposes of this Statement, determine the date of the Holder’s termination
of employment or service.
Terms used but not otherwise defined in this Statement have the meanings set forth in the Plan.
3. Exercise of Options
3.1 Exercise Schedule. The Option shall vest and be exercisable according to the following
schedule: (a) 20% on the date one year after the Grant Date; and (b) an additional 20% each successive
year thereafter, so that 100% of the Option shall be fully vested and exercisable on and after the date
which is five years after the Grant Date. The unvested portion of the Option, if any, shall terminate
1
immediately upon the Holder’s termination of employment by or service to the Company for any reason
whatsoever. This Agreement and the Option shall be subject to the change in control provisions of
Article IX of the Plan.
[Alternative: 3.1 Exercise Schedule. The Option shall be fully vested and exercisable on and after the date
which is five (5) years after the Grant Date. The Option shall terminate immediately upon the Holder’s
termination of employment, prior to the five (5) years vesting period, or service to the Company for any reason
whatsoever. This Agreement and the Option shall be subject to the change in control provisions of Article IX
of the Plan.]
3.2 Manner of Exercise. Holder may exercise the Option as provided in Section 5.4 of the Plan.
The Option may only be exercised to purchase that number of Shares having an aggregate Fair Market
Value on the date of exercise greater than or equal to $2,500 (or the lesser number of remaining shares
covered by this Statement).
4. Termination of Option. Any vested portion of the Option shall
terminate,
to the extent not
previously exercised, upon the first to occur of the following events:
(a) ten years from the Grant Date;
(b) the expiration of three months from the date of Holder’s termination of employment by or
services to the Company for any reason other than death or Disability;
(c) the expiration of one year from (i) the date of Holder’s death or (ii) Holder’s termination of
employment by or service to the Company coincident with Disability; or
(d) immediately upon Holder’s termination of employment by or service to the Company for Cause.
5. Nonassignability of Option. The Option is not assignable or transferable by Holder except
in
accordance with Section 10.1 of the Plan. Any attempt to assign, pledge, transfer, hypothecate or otherwise
dispose of the Option in a manner not herein permitted, and any levy of execution, attachment, or similar
process on the Option, shall be null and void.
6. Restriction on Issuance of Shares.
6.1 Legality of Issuance. The Company shall not be obligated to issue any Option Shares pursuant
to this Statement if such sale or issuance, in the judgment of the Company and the Company’s counsel,
might constitute a violation by the Company of any provision of law, including without limitation the
provisions of the Securities Act of 1933, as amended (the ‘‘Securities Act’’).
6.2 Registration or Qualification of Securities. The Company may, but shall not be required to,
register or qualify the sale of any Option Shares under the Securities Act or any other applicable law. The
Company shall not be obligated to take any affirmative action in order to cause the grant or exercise of
this Option or the issuance or sale of any Option Shares pursuant thereto to comply with any law.
7. Restriction on Transfer. Regardless of whether a sale of the Option Shares has been registered under
the Securities Act or has been registered or qualified under the securities laws of any state, the Company may
impose restrictions upon the sale, pledge, or other transfer of Option Shares (including the placement of
appropriate legends on stock certificates) if, in the judgment of the Company and the Company’s counsel, such
restrictions are necessary or desirable in order to achieve compliance with the provisions of the Securities Act,
the securities laws of any state, or any other law, or if the Company does not desire to have a trading market
develop for its securities.
8. Professional Advice. The acceptance and exercise of the Option and the sale of Option Shares has
consequences under federal and state tax and securities laws which may vary depending upon the individual
circumstances of the Holder. Accordingly, Holder acknowledges that he or she has been advised to consult his
or her personal legal and tax advisor in connection with this Statement and Holder’s dealings with respect to
the Option and the Option Shares. Holder further acknowledges that the Company has made no warranties or
2
representations to Holder with respect to the income tax consequences of the grant and exercise of this Option
or the sale of the Option Shares and Holder is in no manner relying on the Company or its representatives for
an assessment of such consequences.
9. Assignment; Binding Effect. Subject to the limitations set forth in this Statement, this Statement
shall be binding upon and inure to the benefit of the executors, administrators, heirs, legal representatives, and
successors of the parties hereto; provided, however, that Holder may not assign any of Holder’s rights under
this Statement.
10. Damages. Holder shall be liable to the Company for all costs and damages, including incidental and
consequential damages, resulting from a disposition of Option Shares, which is not in conformity with the
provisions of this Statement.
11. Governing Law. This Statement shall be governed by, and construed in accordance with, the laws of
the State of Washington excluding those laws that direct the application of the laws of another jurisdiction.
12. Notices. All notices and other communications under this Statement shall be in writing. Unless and
until Holder is notified in writing to the contrary, all notices, communications, and documents directed to the
Company and related to the Statement if not delivered by hand, shall be mailed, addressed as follows:
Pacific Financial Corporation
300 East Market Street
Aberdeen, Washington 98520
c/o Corporate Secretary
Unless and until the Company is notified in writing to the contrary, all notices, communications, and
documents intended for Holder and related to this Statement, if not delivered by hand, shall be mailed to
Holder’s last known address as shown on the Company’s books. Notices and communications shall be mailed
by first class mail, postage prepaid; documents shall be mailed by registered mail, return receipt requested,
postage prepaid. All mailings and deliveries related to this Statement shall be deemed received when actually
received, if by hand delivery, and two business days after mailing, if by mail.
13. Arbitration. Any and all disputes or controversies arising out of this Statement shall be finally
settled by arbitration conducted in Seattle, Washington, in accordance with the then existing rules of the
American Arbitration Association, and judgment upon the award rendered by the arbitrators may be entered in
any court having jurisdiction thereof, provided that nothing in this Section 13 shall prevent a party from
applying to a court of competent jurisdiction to obtain temporary relief pending resolution of the dispute
through arbitration. The parties hereby agree that service of any notices in the course of such arbitration at
their respective addresses as provided for in Section 12 shall be valid and sufficient.
14. Rights of Holder. Neither this Option, the execution of this Statement nor the exercise of any
portion of this Option shall confer upon Holder any right to, or guarantee of, continued employment by, or
service as a director or consultant to, the Company, or in any way limit the right of the Company to terminate
Holder’s relationship with the Company.
15. Statement Subject to Plan. This Statement and the Option are subject to the terms and conditions
set forth in the Plan and in any amendments to the Plan existing now or in the future, which terms and
conditions are incorporated herein by reference. This Statement and the Plan set forth the entire and exclusive
understanding between the Company and Holder with respect to the Option and shall be deemed to integrate,
replace and supersede all previous communications, representations or agreements between the parties, whether
written or oral, regarding the grant of stock options or the purchase by or issuances of shares to Holder.
Neither this Statement nor any term hereof may be changed, waived, discharged or terminated except by an
instrument in writing signed by the Company and the Holder.
3
IN WITNESS WHEREOF, the parties have executed this Statement as of the Grant Date.
PACIFIC FINANCIAL CORPORATION
By:
Name: Dennis Long
Title: CEO
Holder hereby accepts and agrees to be bound by all of the terms and conditions of this Statement and the
Plan.
Holder:
Dated Signed:
4
PACIFIC FINANCIAL CORPORATION
2011 EQUITY INCENTIVE PLAN
INCENTIVE STOCK OPTION AWARD STATEMENT
(A) Name of Holder:
(B) Grant Date:
(C) Number of Shares:
(D) Exercise Price:
THIS INCENTIVE STOCK OPTION AWARD STATEMENT (this ‘‘Statement’’) is made and entered into
as of the date set forth in Item (B) above (the ‘‘Grant Date’’) between Pacific Financial Corporation, a
Washington corporation (the ‘‘Company’’), and the person named in Item A above (‘‘Holder’’).
THE PARTIES AGREE AS FOLLOWS:
1. Grant of Option; Grant Date. The Company hereby grants to Holder pursuant to the Company’s
2011 Equity Incentive Plan, as amended from time to time (the ‘‘Plan’’), a copy of which is available from the
Company on request, the right (the ‘‘Option’’) to purchase up to the number of shares of the Company Stock
listed in Item (C) above (the ‘‘Option Shares’’) at the price per share set forth in Item (D) above (the
‘‘Exercise Price’’), on the terms and conditions set forth in this Statement and in the Plan, the terms and
conditions of the Plan being incorporated into this Statement by reference. This Option is intended to qualify
as an incentive stock option for purposes of Section 422 of the Internal Revenue Code of 1986, as amended.
The number and kind of Option Shares and the Exercise Price may be adjusted in certain circumstances in
accordance with the provisions of Section 10.2 of the Plan.
2. Definitions. The following terms, as used in this Statement, shall have these meanings:
‘‘Cause’’ has the meaning set forth in Holder’s employment agreement with the Company, and if not so
defined means dishonesty, fraud, misconduct, disclosure of confidential information, conviction of, or a plea of
guilty or no contest to, a felony under the laws of the United States or any state thereof, habitual absence from
work for reasons other than illness, intentional conduct which causes significant injury to the Company,
habitual abuse of alcohol or a controlled substance, in each case as determined by the Committee, and its
determination shall be conclusive and binding.
‘‘Disability’’ means a medically determinable mental or physical impairment or condition of the Holder
that is expected to result in death or which has lasted or is expected to last for a continuous period of
12 months or more and which causes the Holder to be unable, in the opinion of the Committee on the basis of
evidence acceptable to it, to be engaged in any substantial gainful activity. Upon making a determination of
Disability, the Committee shall, for purposes of this Statement, determine the date of the Holder’s termination
of employment or service.
Terms used but not otherwise defined in this Statement have the meanings set forth in the Plan.
3. Exercise of Options
3.1 Exercise Schedule. The Option shall vest and be exercisable according to the following
schedule: (a) 20% on the date one year after the Grant Date; and (b) an additional 20% each successive
year thereafter, so that 100% of the Option shall be fully vested and exercisable on and after the date
which is five years after the Grant Date. The unvested portion of the Option, if any, shall terminate
immediately upon the Holder’s termination of employment by or service to the Company for any reason
whatsoever. This Agreement and the Option shall be subject to the change in control provisions of
Article IX of the Plan.
1
3.2 Manner of Exercise. Holder may exercise the Option as provided in Section 5.4 of the Plan.
The Option may only be exercised to purchase that number of Shares having an aggregate Fair Market
Value on the date of exercise greater than or equal to $2,500 (or the lesser number of remaining shares
covered by this Statement).
4. Termination of Option. Any vested portion of the Option shall
terminate,
to the extent not
previously exercised, upon the first to occur of the following events:
(a) ten years from the Grant Date;
(b) the expiration of three months from the date of Holder’s termination of employment by or
services to the Company for any reason other than death or Disability;
(c) the expiration of one year from (i) the date of Holder’s death or (ii) Holder’s termination of
employment by or service to the Company coincident with Disability; or
(d) immediately upon Holder’s termination of employment by or service to the Company for Cause.
5. Nonassignability of Option. The Option is not assignable or transferable by Holder except
in
accordance with Section 10.1 of the Plan. Any attempt to assign, pledge, transfer, hypothecate or otherwise
dispose of the Option in a manner not herein permitted, and any levy of execution, attachment, or similar
process on the Option, shall be null and void.
6. Restriction on Issuance of Shares.
6.1 Legality of Issuance. The Company shall not be obligated to issue any Option Shares pursuant
to this Statement if such sale or issuance, in the judgment of the Company and the Company’s counsel,
might constitute a violation by the Company of any provision of law, including without limitation the
provisions of the Securities Act of 1933, as amended (the ‘‘Securities Act’’).
6.2 Registration or Qualification of Securities. The Company may, but shall not be required to,
register or qualify the sale of any Option Shares under the Securities Act or any other applicable law. The
Company shall not be obligated to take any affirmative action in order to cause the grant or exercise of
this Option or the issuance or sale of any Option Shares pursuant thereto to comply with any law.
7. Restriction on Transfer. Regardless of whether a sale of the Option Shares has been registered under
the Securities Act or has been registered or qualified under the securities laws of any state, the Company may
impose restrictions upon the sale, pledge, or other transfer of Option Shares (including the placement of
appropriate legends on stock certificates) if, in the judgment of the Company and the Company’s counsel, such
restrictions are necessary or desirable in order to achieve compliance with the provisions of the Securities Act,
the securities laws of any state, or any other law, or if the Company does not desire to have a trading market
develop for its securities.
8. Professional Advice. The acceptance and exercise of the Option and the sale of Option Shares has
consequences under federal and state tax and securities laws which may vary depending upon the individual
circumstances of the Holder. Accordingly, Holder acknowledges that he or she has been advised to consult his
or her personal legal and tax advisor in connection with this Statement and Holder’s dealings with respect to
the Option and the Option Shares. Holder further acknowledges that the Company has made no warranties or
representations to Holder with respect to the income tax consequences of the grant and exercise of this Option
or the sale of the Option Shares and Holder is in no manner relying on the Company or its representatives for
an assessment of such consequences.
9. Assignment; Binding Effect. Subject to the limitations set forth in this Statement, this Statement
shall be binding upon and inure to the benefit of the executors, administrators, heirs, legal representatives, and
successors of the parties hereto; provided, however, that Holder may not assign any of Holder’s rights under
this Statement.
10. Damages. Holder shall be liable to the Company for all costs and damages, including incidental and
consequential damages, resulting from a disposition of Option Shares, which is not in conformity with the
provisions of this Statement.
2
11. Governing Law. This Statement shall be governed by, and construed in accordance with, the laws of
the State of Washington excluding those laws that direct the application of the laws of another jurisdiction.
12. Notices. All notices and other communications under this Statement shall be in writing. Unless and
until Holder is notified in writing to the contrary, all notices, communications, and documents directed to the
Company and related to the Statement if not delivered by hand, shall be mailed, addressed as follows:
Pacific Financial Corporation
300 East Market Street
Aberdeen, Washington 98520
c/o Corporate Secretary
Unless and until the Company is notified in writing to the contrary, all notices, communications, and
documents intended for Holder and related to this Statement, if not delivered by hand, shall be mailed to
Holder’s last known address as shown on the Company’s books. Notices and communications shall be mailed
by first class mail, postage prepaid; documents shall be mailed by registered mail, return receipt requested,
postage prepaid. All mailings and deliveries related to this Statement shall be deemed received when actually
received, if by hand delivery, and two business days after mailing, if by mail.
13. Arbitration. Any and all disputes or controversies arising out of this Statement shall be finally
settled by arbitration conducted in Seattle, Washington, in accordance with the then existing rules of the
American Arbitration Association, and judgment upon the award rendered by the arbitrators may be entered in
any court having jurisdiction thereof, provided that nothing in this Section 13 shall prevent a party from
applying to a court of competent jurisdiction to obtain temporary relief pending resolution of the dispute
through arbitration. The parties hereby agree that service of any notices in the course of such arbitration at
their respective addresses as provided for in Section 12 shall be valid and sufficient.
14. Rights of Holder. Neither this Option, the execution of this Statement nor the exercise of any
portion of this Option shall confer upon Holder any right to, or guarantee of, continued employment by, or
service as a director or consultant to, the Company, or in any way limit the right of the Company to terminate
Holder’s relationship with the Company.
15. Statement Subject to Plan. This Statement and the Option are subject to the terms and conditions
set forth in the Plan and in any amendments to the Plan existing now or in the future, which terms and
conditions are incorporated herein by reference. This Statement and the Plan set forth the entire and exclusive
understanding between the Company and Holder with respect to the Option and shall be deemed to integrate,
replace and supersede all previous communications, representations or agreements between the parties, whether
written or oral, regarding the grant of stock options or the purchase by or issuances of shares to Holder.
Neither this Statement nor any term hereof may be changed, waived, discharged or terminated except by an
instrument in writing signed by the Company and the Holder.
IN WITNESS WHEREOF, the parties have executed this Statement as of the Grant Date.
PACIFIC FINANCIAL CORPORATION
Holder hereby accepts and agrees to be bound by all of the terms and conditions of this Statement and the
Plan.
By:
Name:
Title:
Holder:
Dated Signed:
3
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PACIFIC FINANCIAL CORPORATION
2011 EQUITY INCENTIVE PLAN
RESTRICTED UNIT AWARD STATEMENT
(A) Name of Holder:
(B) Grant Date:
(C) Number of Restricted Units:
THIS RESTRICTED UNIT AWARD STATEMENT (this ‘‘Statement’’) is made and entered into as of the
date set forth in Item (B) above (the ‘‘Grant Date’’) between Pacific Financial Corporation, a Washington
corporation (the ‘‘Company’’) and the person named in Item (A) above (‘‘Holder’’).
THE PARTIES AGREE AS FOLLOWS:
1. Terms of Restricted Unit Award.
1.1 Restricted Unit Award. The Company hereby grants to Holder pursuant to the Company’s 2011
Equity Incentive Plan, as amended from time to time (the ‘‘Plan’’), a copy of which is available from the
Company on request, the number of Restricted Units specified in Item (C) above (the ‘‘RSUs’’). Each
RSU represents a hypothetical share of Company Stock. As a holder of RSUs, Holder will have only the
rights of a general unsecured creditor of the Company until delivery of shares of Company Stock is made
as specified in this Statement. Any capitalized term used in this Statement but not otherwise defined
herein shall have the meaning ascribed to it in the Plan.
1.2 Restriction Period. The ‘‘Restriction Period’’ commences on the Grant Date and ends on the
third anniversary of the Grant Date.
1.3 Vesting of RSUs. The RSUs are initially unvested and, if not previously forfeited, will become
fully vested and non-forfeitable upon the earlier of the expiration of the Restriction Period or the
occurrence of an Acceleration Event.
1.4 Forfeiture of RSUs.
In the event that during the Restriction Period Holder either (a) ceases to
be an employee of the Company for any reason other than an Acceleration Event or (b) is placed on
probation by the Company, all RSUs will be forfeited (unless previously vested due to the occurrence of
an Acceleration Event).
1.5 Acceleration. The RSUs will become immediately fully vested and non-forfeitable upon the
occurrence of the following ‘‘Acceleration Events’’:
(i) The death or Disability of the Holder; or
(ii) The Holder is involuntarily terminated by the Company without Cause within 24 months
following a Change in Control of the Company.
2. Definitions. The following terms, as used in this Statement, shall have these meanings:
(a) ‘‘Cause’’ has the meaning set forth in Holder’s employment agreement with the Company, and if
not so defined means dishonesty, fraud, misconduct, disclosure of confidential information, conviction of,
or a plea of guilty or no contest to, a felony under the laws of the United States or any state thereof,
habitual absence from work for reasons other than illness, intentional conduct which causes significant
injury to the Company, habitual abuse of alcohol or a controlled substance, in each case as determined by
the Committee, and its determination shall be conclusive and binding.
(b) ‘‘Disability’’ means a medically determinable mental or physical impairment or condition of
Holder that is expected to result in death or which has lasted or is expected to last for a continuous period
of 12 months or more and which causes Holder to be unable, in the opinion of the Committee on the
basis of evidence acceptable to it, to perform his or her duties for the Company.
1
3. Settlement of Restricted Unit Award.
3.1 Settlement Date. The RSUs will be settled by the Company on the earlier of (a) the
first business day following the expiration of the Restriction Period or (b) the 30th calendar day following
the occurrence of an Acceleration Event (in either case, the ‘‘Settlement Date’’)
3.2 Form of Settlement. Unless previously forfeited pursuant to Section 1.4, on the Settlement Date,
the Company will deliver to Holder an unrestricted certificate or other evidence of ownership used by the
Company’s transfer agent for a number of shares of Company Stock equal to the number of RSUs granted
pursuant to this Statement. Shares issued upon settlement of RSUs may be subject to additional transfer
restrictions as provided in this Statement.
3.3 Withholding Taxes.
(a) General. Holder will be responsible for payment of all federal, state, and local withholding taxes
and Holder’s portion of any applicable payroll taxes imposed in connection with the settlement of the
RSUs and the issuance of shares (collectively, the ‘‘Applicable Taxes’’). The Company’s obligation to
issue shares of Company Stock in settlement of the RSUs is expressly conditioned on Holder’s making
arrangements satisfactory to the Company, in its sole and absolute discretion, for the payment of all
Applicable Taxes.
(b) Method of Payment. Holder may pay to the Company (in cash or by check) an amount equal to
the Applicable Taxes. In the event
that Holder does not submit payment of the entire amount of
Applicable Taxes, Holder expressly authorizes the Company to withhold a number of unrestricted shares
(thus reducing the number of unrestricted shares to be issued to Holder) having a fair market value (as of
the Settlement Date) equal to the remaining balance of the Applicable Taxes.
4. Stock Award Not Transferable. Neither the RSUs nor any interest or right in the RSUs or this
Statement may be sold, pledged, assigned, or transferred in any manner other than by will or the laws of
descent and distribution, unless and until the RSUs have been settled as provided in this Statement. The RSUs
will not be applicable to the debts, obligations, contracts or engagements of Holder or his or her successors in
interest or be subject to disposition by transfer, alienation, pledge, encumbrance, assignment or any other
means whether such disposition be voluntary or involuntary or by operation of law by judgment,
levy,
attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted
disposition will be null and void and of no effect, except to the extent that such disposition is permitted by the
preceding sentence.
5. Rights as Shareholder. Prior to the issuance of a certificate for shares of Company Stock in
settlement of the RSUs, Holder will have no rights as a shareholder of the Company with respect to this
Statement or the RSUs.
6. Shares to Be Reserved. The Company will at all times during the term of the RSUs reserve and keep
to satisfy the
available under the Plan such number of shares of Company Stock as will be sufficient
requirements of this Statement.
7. Exemption from Code Section 409A. This Statement
from the
requirements of Section 409A of the Internal Revenue Code by reason of all payments under this Statement
being ‘‘short-term deferrals’’ within the meaning of Treasury Regulation Section 1.409A-1(b)(4). All provisions
of this Statement shall be interpreted in a manner consistent with preserving this exemption. In no event will
the Company be liable for any tax, interest, or penalties that may be imposed on Holder by Code Section 409A
or any damages for failing to comply with Code Section 409A. ‘‘Ceases to be an employee,’’ as used in
Section 1.4, and similar terms mean ‘‘separation from service’’ as defined and interpreted in Treasury
Regulation Section 1.409A-1(h) or in subsequent regulations or other guidance issued by the Internal Revenue
Service.
is intended to be exempt
8. Compliance With Securities Laws. Holder acknowledges that the RSUs are intended to conform to
the extent necessary with all provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934
and any and all regulations and rules promulgated by the Securities and Exchange Commission thereunder,
including without limitation Rule 144 under the Securities Act of 1933 and Rule 16b-3 under the Securities
2
Exchange Act of 1934. Notwithstanding anything herein to the contrary, the RSUs are granted only in such a
manner as to conform to such laws, rules and regulations. To the extent permitted by applicable law, this
Statement will be deemed amended to the extent necessary to conform to such laws, rules and regulations. The
Company shall not be obligated to issue any Company Stock pursuant to this Statement if such sale or
issuance, in the judgment of the Company and the Company’s counsel, might constitute a violation by the
Company of any provision of law, including without limitation the provisions of the Securities Act of 1933.
9. Clawback/Recovery. The RSUs and any Company Stock issued in settlement of the RSUs will be
subject to recoupment in accordance with any clawback policy that the Company is required to adopt pursuant
to the listing standards of any national securities exchange or association on which the Company’s securities
are listed or as is otherwise required by the Dodd-Frank Wall Street Reform and Consumer Protection Act or
other applicable law, including the Sarbanes-Oxley Act of 2002. No recovery of compensation under such a
clawback policy will be an event giving rise to a right
to resign for ‘‘good reason’’ or ‘‘constructive
termination’’ (or similar term) under any agreement with the Company.
10. Professional Advice. The acceptance and settlement of the RSUs has consequences under federal
and state tax and securities laws which may vary depending upon the individual circumstances of the Holder.
Accordingly, Holder acknowledges that he or she has been advised to consult his or her personal legal and tax
advisor in connection with this Statement and Holder’s dealings with respect to the RSUs. Holder further
acknowledges that the Company has made no warranties or representations to Holder with respect to the
income tax consequences of the grant and settlement of the RSUs and Holder is in no manner relying on the
Company or its representatives for an assessment of such consequences.
11. Assignment; Binding Effect. Subject to the limitations set forth in this Statement, this Statement
shall be binding upon and inure to the benefit of the executors, administrators, heirs, legal representatives, and
successors of the parties hereto; provided, however, that Holder may not assign any of Holder’s rights under
this Statement.
12. Governing Law. This Statement shall be governed by, and construed in accordance with, the laws
of the State of Washington excluding those laws that direct the application of the laws of another jurisdiction.
13. Notices. All notices and other communications under this Statement shall be in writing. Unless and
until Holder is notified in writing to the contrary, all notices, communications, and documents directed to the
Company and related to the Statement if not delivered by hand, shall be mailed, addressed as follows:
Pacific Financial Corporation
300 East Market Street
Aberdeen, Washington 98520
c/o Corporate Secretary
Unless and until the Company is notified in writing to the contrary, all notices, communications, and
documents intended for Holder and related to this Statement, if not delivered by hand, shall be mailed to
Holder’s last known address as shown on the Company’s books. Notices and communications shall be mailed
by first class mail, postage prepaid; documents shall be mailed by registered mail, return receipt requested,
postage prepaid. All mailings and deliveries related to this Statement shall be deemed received when actually
received, if by hand delivery, and two business days after mailing, if by mail.
14. Arbitration. Any and all disputes or controversies arising out of this Statement shall be finally
settled by arbitration conducted in Seattle, Washington, in accordance with the then existing rules of the
American Arbitration Association, and judgment upon the award rendered by the arbitrators may be entered in
any court having jurisdiction thereof, provided that nothing in this Section 13 shall prevent a party from
applying to a court of competent jurisdiction to obtain temporary relief pending resolution of the dispute
through arbitration. The parties hereby agree that service of any notices in the course of such arbitration at
their respective addresses as provided for in Section 12 shall be valid and sufficient.
3
15. Rights of Holder. Neither this RSU, the execution of this Statement nor the vesting of any portion
of this RSU shall confer upon Holder any right to, or guarantee of, continued employment by, or service as a
director or consultant to, the Company, or in any way limit the right of the Company to terminate Holder’s
relationship with the Company.
16. Statement Subject to Plan. This Statement and the RSUs are subject to the terms and conditions
set forth in the Plan and in any amendments to the Plan existing now or in the future, which terms and
conditions are incorporated herein by reference. This Statement and the Plan set forth the entire and exclusive
understanding between the Company and Holder with respect to the RSUs and shall be deemed to integrate,
replace and supersede all previous communications, representations or agreements between the parties, whether
written or oral, regarding the grant of RSUs or issuance of shares to Holder. Neither this Statement nor any
term hereof may be changed, waived, discharged or terminated except by an instrument in writing signed by
the Company and Holder.
IN WITNESS WHEREOF, the parties have executed this Restricted Unit Award Statement as of the Grant
Date.
PACIFIC FINANCIAL CORPORATION
By:
Name:
Title:
Holder hereby accepts and agrees to be bound by all of the terms and conditions of this Statement and the
Plan.
Holder:
Dated Signed:
4
EXHIBIT 21
The following is a list of the registrant’s subsidiaries at March 20, 2014.
SCHEDULE OF SUBSIDIARIES
Name of Organization
Bank of the Pacific
PFC Statutory Trust I
PFC Statutory Trust II
Coastal Holdings LLC
Coastal Holdings One LLC
Coastal Holdings Two LLC
Opportunity Holdings LLC
State of Incorporation or Organization
Washington
Connecticut
Delaware
Washington
Oregon
Oregon
Washington
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement Nos. 333-113224, 333-51524, and 333-
175723 on Form S-8 and in Registration Statement No. 333-129860 on Form S-3 of our report dated
March 21, 2014, relating to the consolidated financial statements of Pacific Financial Corporation and
subsidiary, appearing in this Annual Report on Form 10-K of Pacific Financial Corporation for the year ended
December 31, 2013.
EXHIBIT 23
/s/ Deloitte & Touche LLP
Portland, Oregon
March 21, 2014
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
UNDER RULE 13a-14(a)
I, Dennis A. Long, certify that:
Exhibit 31.1
1.
I have reviewed this annual report on Form 10-K of Pacific Financial Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and we have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be signed under our supervision, to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures,
as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting
that occurred during the registrant’s most-recent fiscal quarter (the registrant’s fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting.
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 21, 2014
/s/ Dennis A. Long
Dennis A. Long
President and Chief Executive Officer
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
UNDER RULE 13a-14(a)
I, Douglas N. Biddle, certify that:
1.
I have reviewed this annual report on Form 10-K of Pacific Financial Corporation;
a. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and we have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision,
information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
to ensure that material
(b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be signed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this report based on such evaluation;
and
(d) Disclosed in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most-recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect,
the registrant’s internal control over financial
reporting.
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent functions):
(c) All significant deficiencies and material weaknesses in the design or operation of internal
the
reporting which are reasonably likely to adversely affect
control over financial
registrant’s ability to record, process, summarize and report financial information; and
(d) Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant’s internal control over financial reporting.
Date: March 21, 2014
/s/ Douglas N. Biddle
Douglas N. Biddle
Chief Financial Officer
CERTIFICATIONS UNDER 18 U.S.C. §1350
The undersigned certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act
of 2002, that the preceding Annual Report on Form 10-K fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934, and the information contained therein fairly presents, in all
material respects, the financial condition and results of operations of Pacific Financial Corporation.
Exhibit 32
/s/ Dennis A. Long
Dennis A. Long
President and Chief Executive Officer
March 21, 2014
/s/ Douglas N. Biddle
Douglas N. Biddle
Chief Financial Officer
March 21, 2014
GENERAL CORPORATE AND SHAREHOLDER INFORMATION
Administrative Headquarters
1101 S. Boone Street
Aberdeen, WA 98520
(360) 533-8870
Independent Accountants
Deloitte & Touche LLP
Portland, Oregon
Transfer Agent and Registrar
Computershare
P.O. BOX 30170
College Station, TX 77842-3170
Telephone: 1-877-870-2422
Outside the US: 201-680-6578
Hearing Impaired: 800-952-9245
www.computershare.com/investor
Shareholder Services
Computershare, our transfer agent, maintains the records for our registered shareholders and can help you with
a variety of shareholder related services at no charge including:
Change of name or address Lost stock certificates
Consolidation of accounts Transfer of stock to another person
Duplicate mailings Additional administrative services
As a Pacific Financial Corporation shareholder, you are invited to take advantage of our convenient
shareholder services or request more information about Pacific Financial Corporation. Access your investor
statements online 24 hours a day, 7 days a week with MLink. For more information, go to
www.envisionreports.com/PFLC.
Annual Meeting
The annual meeting of shareholders will be held on April 23, 2013 at 7 p.m. at 1101 S. Boone Street,
Aberdeen, WA 98520.
Form 10-K
Our report on Form 10-K, including the financial statements and financial statement schedules, is
available without charge to shareholders or beneficial owners of our common stock upon written
request to Sandra Clark, Asst. Corporate Secretary, Pacific Financial Corporation, P.O. Box 1826,
Aberdeen, Washington 98520.
BOARD OF DIRECTORS
Gary C. Forcum, Chairman
Private Investor
Douglas M. Schermer
Owner
Schermer Construction Inc.
Denise Portmann
President & CEO
Bank of the Pacific
Randy W. Rognlin, Vice Chairman
Co-Owner
Rognlins, Inc.
Randy J. Rust
Private Investor
Lori Reece
Owner
RE/MAX Whatcom County, Inc.
OFFICERS
Dennis A. Long
President & CEO
Pacific Financial Corporation
Denise J. Portmann
Corporate Secretary
President & CEO, Bank of the Pacific
Susan C. Freese
Pharmacist
Dwayne M. Carter
President
Brooks Manufacturing Co.
Edwin W. Ketel
Owner
Oceanside Animal Clinic
Dennis A. Long
President & CEO
Pacific Financial Corporation
John Van Dijk
Retired President & COO
Bank of the Pacific
SUBSIDIARIES
Bank of the Pacific
300 E. Market Street
Aberdeen, WA 98520
360-533-8870
www.bankofthepacific.com
Bruce MacNaughton
Vice President
Executive Vice President & CCO, Bank of the Pacific
Douglas N. Biddle
Treasurer
Executive Vice President & CFO, Bank of the Pacific
This annual report is furnished upon request to customers of Bank of the Pacific pursuant to the
requirements of the Federal Deposit Insurance Corporation (FDIC) to provide an annual disclosure
statement. This statement has not been reviewed or confirmed for accuracy or relevance by the FDIC.