2014
2014
OTCQB: PFLC
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March 26, 2015
My Fellow Shareholders:
We delivered another solid performance in 2014, executing
on our growth strategies, strengthening our balance sheet,
and improving the bottom line.
Profits increased 32% for the full year, with earnings
growing to $4.9 million in 2014, compared to $3.7 million in
2013. The increase in our profitability year-over-year was
driven by increases in net interest income, an improved net
interest margin, continued strong loan production and better
operating efficiencies. As a result of our successes, we
were able to raise our annual cash dividend to 21-cents per
share at the end of 2014, equating to a yield of more than
3.10% at current market levels.
Dennis(cid:2)A.(cid:2)Long(cid:2)
President(cid:2)&(cid:2)Chief(cid:2)Executive(cid:2)Officer(cid:2)
(cid:2)
2014 Accomplishments
(cid:2) Growing the loan portfolio with quality assets is important for our continued success, and we
were able to organically grow loans by 12% to $563.1 million for the year. Noninterest-bearing
deposits also increased 14% and remained strong at 26% of total deposits. Both achievements
were key contributors to our strong financial performance.
(cid:2) Our net interest income increased 14%
to $27.0 million in 2014, from $23.8
million in 2013, and our net interest
margin improved 17 basis points to
4.17%, from 4.00% a year ago.
(cid:2) At the same time, credit quality
continued to improve, with the ratio of
nonperforming assets to total assets at
1.36% at year end, compared to 1.42%
last year.
800,000
Total(cid:2)Net(cid:2)Loans(cid:2)and(cid:2)Deposits
(Dollars(cid:2)in(cid:2)Millions)
600,000
544,954
548,050
548,243
400,000
465,208
478,307
451,788
607,347
635,054
554,74
504,072
200,000
0
Total(cid:2)Net(cid:2)Loans
Total(cid:2)Deposits
(cid:2) We strategically deployed some of our
2010
2011
2012
2013
2014
excess capital this year while
maintaining solid capital ratios, which continued to exceed regulatory requirements.
(cid:2)
(cid:2) Our efficiency ratio improved as a result of our ability to grow earnings within our existing
capacity.
Capital Ratios
Pacific Financial
Corporation
Pacific Financial
Corporation
Well-Capitalized
Financial Institutional Regulatory
Guidelines
December 31
Total Risk-based
Tier 1 Risk-based
Tier 1 Leverage
Tangible Common
Equity
2014
13.61%
12.36%
9.80%
8.05%
2013
14.11%
12.85%
9.83%
7.74%
10.0%
6.0%
5.0%
n/a
(cid:2) As we discussed in last year’s letter, we began the year by hiring Doug Biddle as our Chief
Financial Officer, filling the opening that Denise Portmann vacated when she was promoted to
President and Chief Executive Officer of Bank of the Pacific, on January 1, 2014. Doug has
proven to be a valuable strategic business partner to our senior executive leadership team,
and Denise has demonstrated exceptional leadership in running the bank.
(cid:2)
In April of 2014 Bank of the Pacific received its SBA Preferred Lender Status with the U.S.
Small Business Administration (“SBA”). A bank that has preferred lender status may grant
approval of a small business loan and it is automatically approved by the SBA -- thus speeding
funds into the borrower’s hands. It is the highest bank designation granted by the SBA and is
reserved only for top-tier lenders. In 2014, the Bank originated $8.5 million in 7(a) small
business loans, ranking 20th in the Seattle/Spokane region in number of loans funded.
(cid:2) The following month, we received approval to convert our loan production office (“LPO”) in
Vancouver, Washington, into a full-service commercial banking center. The LPO was originally
opened in March 2013, and total loans have grown to $38.0 million as of December 31, 2014.
(cid:2)
In August, Daniel J. Tupper, a successful business leader in the Twin Harbors region of
Washington State, was appointed to the Board of Directors of Pacific Financial Corporation.
Additionally, we kicked off 2015 by appointing Kristi Gundersen, a partner of Knutzen Farms,
LP, to the Company’s Board of Directors.
(cid:2) Finally, and most notably, in January 2015 we expanded our presence in Oregon, with a
seasoned commercial lending team led by Dan Ebert, Senior Vice President and Manager,
launching a new loan production office in Salem, Oregon. We continue to do what we do best:
serve our communities and constituents.
After a very successful 18 years with Pacific Financial, Dennis Long’s last day will be June 1, 2015.
We have thoroughly enjoyed working together. We are all very comfortable that this thriving franchise
is in good hands and is poised to continue to do well financially. We have developed a very capable
team of internal successors, as we continue our efforts to have Pacific Financial remain a top
performing institution.
(cid:2)
As we head into 2015, we are committed to investing in our strategy centered on responding to the
needs of our customers and our communities. At the same time, we will continue to look for ways to
improve efficiencies while maintaining strong open communications with our shareholders. On behalf
of the Board of Directors and our dedicated employees, thank you for your continuing support. Please
join us for our annual shareholders’ meeting on Wednesday, April 29, 2015, at 7:00 p.m., Pacific Time,
at 1101 South Boone Street, Aberdeen, Washington.
Sincerely,
Gary C. Forcum
Chairman of the Board
Pacific Financial Corporation
Dennis A. Long
President and Chief Executive Officer
Pacific Financial Corporation
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2014
[ ] 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
(I.R.S. Employer
Identification No.)
1101 S. Boone Street
Aberdeen, Washington 98520-5244
(Address of principal executive offices) (Zip Code)
(360) 533-8870
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes
No
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter periods that the Registrant was required to file such reports), and (2) has been
subject to such requirements for the past 90 days. Yes
No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such files). Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. Yes
No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Smaller Reporting Company
Non-accelerated filer
Accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
The aggregate market value of the common stock held by non-affiliates of the registrant at June 30, 2014, was $55,342,407.
The number of shares outstanding of the registrant's common stock, $1.00 par value as of February 28, 2015, was 10,375,460 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 29, 2015 are incorporated
by reference into Part III of this Form 10-K.
Form 10-K
Table of Contents
Part I
Item I. Business
Item IA. Risk Factors
Item IB. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
Part II
2
12
17
17
17
17
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 17
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 8. Financial Statements and Supplementary Data
Item 9. 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
FINANCIAL STATEMENTS
SIGNATURES
19
20
44
44
44
45
45
45
45
46
46
46
F-47-94
95
PART I.
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 operates in western Washington and the north coast of Oregon. The
Company was incorporated in the State of Washington in February, 1997, pursuant to a holding company reorganization of the Bank.
The Company conducts its banking business through the Bank, which operates 17 branches located in communities in Grays Harbor,
Pacific, Clark, Whatcom, Skagit and Wahkiakum counties in the state of Washington and three in Clatsop County, Oregon. In addition,
the Bank operates loan production offices in Burlington and DuPont, Washington and, opened in January 2015, Salem, Oregon. The
Company also has a residential real estate mortgage department.
The Company's common stock is listed on the OTCQB® exchange under the symbol PFLC. Revenue, net income and total assets for the
Company for the years ended December 31, 2014, 2013, and 2012 are presented below:
PACIFIC FINANCIAL CORPORAT ION
(Dollars in T housands)
Revenue:
Net interest income
Non-interest income
T otal revenue
Net income
T otal assets
For Year Ended
December 31,
December 31,
December 31,
2014
2013
2012
$
$
$
27,033 $
23,800 $
8,079
35,112
9,955
33,755
4,927 $
3,731 $
24,011
9,391
33,402
4,785
744,807 $
705,039 $
643,594
For additional selected financial information, please see “Item 6. Selected Financial Data” below.
The Company is presently a reporting company with the Securities and Exchange Commission (“SEC”). 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 Company intends to terminate its registration with the SEC
under the Securities Exchange Act of 1934 during second quarter 2015, terminating its reporting obligations with the SEC.
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, Vancouver, Washington and Salem, Oregon. 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.
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.
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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 Bank provides 24-hour online and mobile 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® or Microsoft's Money®. In addition, the online and mobile banking systems include the ability to transfer
funds, make loan payments, reorder checks, and request statement reprints, provide 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.
Through mobile banking, customers can deposit checks and conduct certain banking activities via text message. 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. In determining whether to take brokered deposits, the Bank considers current market interest
rates, profitability to the Bank, and matching deposits and loan products.
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..
Lending Activities
General. Lending products offered by the Bank include real estate loans, commercial loans, agriculture loans, consumer loans, and
residential mortgage loans. The majority of the Company’s loan portfolio is comprised of real estate loans, which include commercial
real estate, residential construction, land development and other land loans. 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, 2014 and
2013.
The Bank originates loans primarily in its local markets. Loans to borrowers outside of Washington and Oregon total $85.1 million, or
15.1%, of total loans at December 31, 2014. Of this amount, $32.8 million, or 5.8% of total loans, are government guaranteed loans
purchased in the secondary market that were not originated by us. Additionally, our loan portfolio includes $687,000 in loans purchased
from and originated by other financial institutions, representing 0.1% of total loans.
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 lending limits. As part of our credit administration process, we routinely engage external
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 policy also establishes loan approval authorities for certain officers individually. Loan officer lending authority ranges from
$5,000 to $500,000 on a Total Family Debt basis (“TFD”). Commercial Banking Team Leaders have approval authorities up to
$1,000,000 TFD. Credit Risk Officers approve loans up to $3,500,000 TFD. The Chief Credit Officer approves loans up to $4,500,000
TFD. The Management Loan Committee (“MLC”) approves loans greater than $4,500,000 TFD. The MLC is chaired by the Chief
Credit Officer. Other members include the bank’s two Credit Risk Officers, the Commercial Banking Manager and a Commercial
Banking Team Leader. Additionally, loans with a risk rating of substandard or doubtful, with balances of $2,000,000 or more, must also
be approved by the MLC. The Board Loan Committee (“BLC”) meets at least quarterly to review the allowance for loan losses, summary
of loans reviewed by the MLC, loan policy exceptions, concentration reports, key credit metrics and any loan losses. The Bank’s legal
lending limit was $17.0 million at December 31, 2014, however it maintains an internal lending limit of $8.5 million. This represents the
maximum lending limit to individual borrowers and related entities, exceptions from which are made judiciously. 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
3
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.
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, which 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, the Bank's policy is not 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.
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.
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, some of which may be partially guaranteed by
the Small Business Administration or 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.
Commercial Real Estate. The Bank originates owner occupied and non-owner occupied commercial real estate and multifamily loans
within its primary market areas. 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.
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 often 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. 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. 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. Single-family portfolio loans are generally owner-occupied and our underwriting
standards require that loan amounts 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
4
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 originated for sale are
underwritten in accordance with standards of the loan purchaser, as a result, underwriting standards vary.
Consumer. Consumer 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.
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 loan 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.
On an ongoing basis, the Bank reviews borrower financial results, collateral values, and compliance with payment terms and covenant
requirements in order 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 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. 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.
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 loan 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 property acquired in satisfaction of debts previously contracted. 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 loan 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.
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
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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 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.
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.
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, 2014 and 2013.
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. 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.
Competition
Competition in the banking industry is significant. Banks face a number of competitors with respect to providing banking services and
attracting deposits. Competition comes from both bank and non-bank sources and from both large national, regional and smaller local
institutions. 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-established small community banks,
branches of large banks, thrifts and credit unions in Pacific and Wahkiakum Counties in the state of Washington and Clatsop County in
the state of Oregon. In Whatcom, Clark, Thurston and Skagit Counties, Washington, and Salem, Oregon 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, in Washington and the Salem, Oregon area provides opportunities for
expansion, but in pursuing that expansion, it faces greater competitive challenges than it faces in its historical market areas.
Large financial conglomerates frequently offer multiple financial services, including deposit services, brokerage and others and 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 areas, have resulted in increased competition.
There has been significant consolidation trends among financial institutions over the last few years, and the trends may continue. While,
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.
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 the extensive experience of management in its
market area and the business contacts of management and the Company's directors, management believes the Company can continue to
compete effectively.
According to the Market Share Report compiled by the FDIC, as of June 30, 2014, the Company held a deposit market share of 40.8% in
Pacific County, 66.4% in Wahkiakum County, 28.6% in Grays Harbor County, 4.6% in Whatcom County, 1.3% in Skagit County and
7.0% in Clatsop County (Oregon).
Employees
As of December 31, 2014, 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.
6
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 of
substantial civil monetary penalties, the imposition of a cease and desist or similar order, and other regulatory sanctions, as well as private
litigation.
The Company
General
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 must provide it with such additional information as it may require. In
addition, the Federal Reserve periodically examines the Company and the Bank.
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.
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.
The Bank
General
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.
7
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, therefore, does
not believe that these regulatory standards will materially affect the Company's business or operations.
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:
(cid:2) 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.
(cid:2) 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.
(cid:2) Provide for new disclosures and other requirements relating to executive compensation and corporate governance.
(cid:2) 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
8
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.
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.
The Company expects to file a Form 15 to terminate the registration of its common stock under the Exchange Act in April 2015, utilizing
the increased thresholds under the JOBS Act.
The Volcker Rule
On December 10, 2013, the federal banking agencies jointly issued a final rule implementing the so-called “Volcker Rule” (set forth in
Section 619 of the Dodd-Frank Act). The Volcker Rule prohibits depository institutions, companies that control such institutions, bank
holding companies, and the affiliates and subsidiaries of such banking entities, from engaging as principal for the trading account of the
banking entity in any purchase or sale of one or more covered financial instruments (so-called “proprietary trading”) and imposes
limitations upon retaining ownership interests in, sponsoring, investing in and transacting with certain investment funds, including hedge
funds and private equity funds. Certain activities involving underwriting, risk mitigation hedging, and transactions on behalf of customers
as a fiduciary or riskless principal are not prohibited proprietary trading, including purchases and sales of financial instruments which are
either obligations of or issued or guaranteed by (i) the United States or agencies thereof; (ii) a State or political subdivision including
municipal securities; or (iii) the FDIC. Notwithstanding these permissible activities, no such activities are permitted if they would (i)
involve or result in a material conflict of interest between the banking entity and its clients, customers, or counterparties; (ii) result,
directly or indirectly, in a material exposure by the banking entity to a high-risk asset or a high-risk trading strategy; or (iii) pose a threat
to the safety and soundness of the banking entity or to the financial stability of the United States. The effective date of the final rule has
been extended to July 21, 2016. Neither the Company nor the Bank engages in activities prohibited by the Volcker Rule and does not
expect the Volcker Rule to have a material impact upon the Company or the Bank.
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.
The FDIC may make special assessments on insured depository institutions in amounts determined by the FDIC to be necessary to give it
adequate assessment income to repay amounts borrowed from the 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
9
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:
(cid:2) Total reported loans for construction, land development and other land representing 100% or more of the bank's capital; or
(cid:2) 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, 2014 and 2013, the Bank was in compliance with the guidelines described above.
Capital Adequacy
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.
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 be used as a supplement 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 must maintain a minimum leverage ratio of
4.0%. The Bank must maintain a minimum leverage ratio of 5.0% in order to meet the regulatory definition of “Well Capitalized”.
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 January 1, 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 in order to implement the “Basel III” regulatory capital reforms released by the
10
Basel Committee on Banking Supervision. 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.
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 has
elected to opt-out of the inclusion of accumulated other comprehensive income (loss) in its capital calculations 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. This buffer
consists 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 will 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.
On November 18, 2014, the FDIC adopted the Assessments Final Rule which revises the FDIC’s risk-based deposit insurance assessment
system to reflect changes in the regulatory capital rules that are effective commencing January 1, 2015. For smaller financial institutions
(with total assets less than $1 billion and which are not custodial banks), the Final Rule revises and conforms capital ratios and ratio
thresholds to the new prompt corrective action capital ratios and ratio thresholds for “well capitalized” and “adequately capitalized”
evaluations which were adopted by the federal banking agencies as part of the Basel III capital regulations. Consequently, effective
January 1, 2015, the prompt corrective action regulations are amended to the extent described above. 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). A pro forma analysis of the application of these new
capital requirements as of December 31, 2014 has been conducted on the Company and Bank. We have determined that the Company
and Bank meet all new requirements, including the fully phased-in capital conservation buffer requirement, 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.
11
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.
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:
(cid:2) An increase in loan delinquencies, problem assets and foreclosures;
(cid:2) A decrease in the demand for loans and other fee-based products and services;
(cid:2) An increase or decrease in the usage of unfunded commitments; or
(cid:2) 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. A downturn 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 any foreclosure. Commercial real estate loans
also 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 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.
Future credit losses may exceed our allowance for loan 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 loan losses. To the extent loans are not paid timely by borrowers, the loans are placed on
non-accrual status, thereby reducing interest 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.
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, 2014, we recorded a provision for (recapture of) credit losses of $300,000, compared to ($450,000) for
the year ended December 31, 2013. Whether or not we determine to record a provision in a particular period has a significant effect on our
earnings. We recorded net loan charge-offs of $306,000 for the year ended December 31, 2014, compared to $549,000 for the year ended
December 31, 2013. Past due loans represented 1.3% and 1.4% of total loans outstanding at December 31, 2014 and 2013, respectively.
12
While current economic conditions have improved modestly, we may experience increased delinquencies and credit losses if these
improvements falter, resulting in additional provision for credit losses and charge offs and a possible 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.
We hold and acquire other real estate owned 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 debts previously contracted as part of the problem asset resolution
process. OREO balances lead to increased expenses, as we incur costs to manage, maintain, improve in some cases, and dispose of our
OREO properties. We expect that earnings in 2015 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. Loans currently in nonaccrual status may lead to increases in our OREO balance in the
future, if not resolved. 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 loan 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 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 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 were to change, or market conditions were to deteriorate. 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.
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
13
adversely affected if we are unable to reduce our expenses proportionately to the decline in the volume of loan originations and sales. For
2015, 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 local legislation, in regulatory policies or
interpretations, or in regulatory approaches to compliance and 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.
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:
(cid:2)
(cid:2)
(cid:2)
(cid:2)
(cid:2)
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 interchange fees charged to merchants for debit card transactions;
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 revenue and expense, 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. In addition, in the current economic and regulatory environment,
regulators of banks and bank holding 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, and result in regulatory actions if
we were unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with Basel III
could result in our having to lengthen the terms of our funding, restructure our business models, and/or increase our holdings of 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.
14
We rely on dividends from the Bank 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 $0.21 and $0.20 per share for 2014 and
2013, respectively.
The financial services industry is very competitive.
We face competition in attracting and retaining deposits, making loans, and providing other financial services. Our competitors include
other community banks, larger banking institutions, and a wide range of other financial institutions such as credit unions, government-
sponsored enterprises, mutual 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.
Technology implementation problems, computer system failures or information security breaches could adversely affect us.
Our future growth prospects will be highly dependent on the ability of the Bank to implement changes in technology that affect the
delivery of banking services such as the increased demand for computer access to bank accounts and the availability to perform banking
transactions electronically. The Bank’s ability to compete will depend upon its ability to continue to adapt technology on a timely and
cost-effective basis to meet such demands. In addition, our business and operations and those of the Bank could be susceptible to adverse
effects from computer failures, communication and energy disruption, and activities such as fraud of unethical individuals with the
technological ability to cause disruptions or failures of the Bank’s data processing system.
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.
We cannot be certain that the continued implementation of safeguards will eliminate the risk of vulnerability to technological difficulties
or failures or ensure the absence of a breach of information security. The Bank will continue to rely on the services of various vendors
who provide data processing and communication services to the banking industry. Nonetheless, if information security is compromised or
other technology difficulties or failures occur at the Bank or with one of our vendors, information may be lost or misappropriated,
services and operations may be interrupted and the Bank could be exposed to claims from its customers, regulatory actions, reputational
damage, and disruptions in its operations, resulting in a material adverse effect on the Company's 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 or 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:
(cid:2) Potential exposure to unknown or contingent liabilities we acquire;
(cid:2) Exposure to potential asset quality issues;
(cid:2) Difficulty and expense of integrating the operations and personnel of banks and businesses we acquire;
(cid:2) Potential disruption to our business;
(cid:2) Potential restrictions on our business resulting from the regulatory approval process;
(cid:2) Potential diversion of our management’s time and attention; and
(cid:2) 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
opening additional de novo branches or new loan production offices. 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 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
15
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 $93.2 million, or 12.5% of assets, in investments and FHLB stock at December 31, 2014, 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. At December 31, 2014, we had goodwill of $12.2 million, representing approximately 16.8% of
shareholders’ equity.
Further, our balance sheet reflects approximately $3.2 million of net deferred tax assets at December 31, 2014, 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, impacting our earnings during the period in which the valuation allowance is recorded.
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 low trading volumes on the OTCQB exchange sponsored by OTC Markets under the trading symbol
"PFLC." As a result, it may be difficult to liquidate your investment in our shares, and there may be 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 12.3% 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.
16
ITEM 1.B.
Unresolved Staff Comments
None
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. The aggregate monthly lease payment for all leased space is approximately $47,000.
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 $16.3 million at December 31, 2014.
Management believes that the facilities are of sound construction and in good operating condition, are appropriately insured and are
adequately equipped for carrying on the business of the Bank.
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
Not Applicable.
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 Board™ 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.
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:
2014
2013
Estimate d No.
Estimate d No.
Share s Trade d
High
Low
Share s Trade d
High
Low
First Quarter
246,000
$
6.75
$
6.10
131,400
$
5.50
$
4.56
Second Quarter
61,200
$
6.50
$
6.07
92,300
$
6.50
$
5.42
T hird Quarter
175,800
$
6.75
$
6.06
124,600
$
6.99
$
5.59
Fourth Quarter
101,200
$
6.90
$
6.05
83,900
$
6.75
$
6.40
As of February 28, 2015, there were approximately 992 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 2014 and 2013 in the amount of $0.21 and
$0.20 per share, respectively. 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
17
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, 2014. The
maximum number of shares that may yet be purchased under the plan is 250,000 at December 31, 2014.
18
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.
PACIFIC FINANCIAL CORPORAT ION
(Dollars in T housands, Except per Share Data)
December 31,
December 31,
December 31,
December 31,
December 31,
2014
2013
2012
2011
2010
For Year Ended
$
$
$
$
$
27,033 $
23,800 $
24,011 $
23,685 $
300
8,079
28,155
1,730
(450)
9,955
29,502
972
(1,100)
9,391
28,417
1,300
2,500
7,614
25,648
333
4,927 $
3,731 $
4,785 $
2,818 $
$
0.48
0.48
2,178 $
0.21
$
44%
$
0.37
0.37
2,036 $
0.20
$
55%
$
0.47
0.47
2,024 $
0.20
$
42%
$
$
$
0.28
0.28
-
-
-
4.06%
4.17%
80.19%
0.68%
6.92%
3.87%
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%
$
744,807 $
705,039 $
643,594 $
641,254 $
554,746
639,054
24,856
72,483
6.99%
5.68%
9.73%
1.62%
1.48%
91.54%
1.36%
496,307
607,347
23,403
67,137
6.59%
5.25%
9.52%
1.98%
1.66%
115.41%
1.42%
438,838
548,243
23,903
66,721
6.59%
5.35%
10.37%
3.37%
2.09%
61.92%
3.08%
463,766
548,050
24,644
63,270
6.25%
5.01%
9.87%
2.96%
2.34%
79.28%
3.39%
22,879
3,600
8,451
26,400
(304)
1,634
0.16
0.16
-
-
-
3.88%
4.10%
84.26%
0.25%
2.77%
644,403
455,064
544,954
35,328
59,769
5.90%
4.66%
9.28%
2.15%
2.28%
106.18%
2.57%
O pe rations Data
Net interest income
Provision (recapture) for credit losses
Non-interest income
Non-interest expense
Provision (benefit) for income taxes
Ne t income
Net income per share:
Basic(cid:2)¹(cid:3)
Diluted(cid:2)¹(cid:3)
Dividends declared
Dividends declared per share
Dividends payout ratio
Pe rformance Ratios
Interest rate spread
Net interest margin(cid:2)¹(cid:3)
Efficiency ratio(cid:2)²(cid:3)
Return on average assets
Return on average equity
Balance She e t Data
T otal assets
Loans, net
T otal deposits
T otal borrowings
Shareholders' equity
Book value per share(cid:2)³(cid:3)
T angible book value per share(cid:2)(cid:3)(cid:3)
Equity to assets ratio
Asse t Q uality Ratios
Nonperforming loans to total loans
Allowance for loan losses to total loans
Allowance for loan losses to
nonperforming loans
Nonperforming assets to total assets
(cid:2)¹(cid:3) Net interest income divided by average earning assets
(cid:2)²(cid:3) Non-interest expense divided by the sum of net interest income and non-interest income
(cid:2)³(cid:3) Shareholder equity divided by shares outstanding
(cid:2)(cid:3)(cid:3) Shareholder equity less intangibles divided by shares outstanding
19
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Information
This report 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 all
information concerning our possible future results of operations or other actions, including, without limitation, as set forth under
"Management's Discussion and Analysis of Financial Condition and Results of Operations" and can frequently be identified by 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. 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;
2. economic or business conditions, nationally and in the regions in which we do business, that have resulted in, and may continue
to result in, among other things, challenges with respect to credit quality and/or reduced demand for credit and other banking
services due to the dependency of repayment of our loans on the cash flows of the borrower and additional workout and other
real estate owned expenses;
3. 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;
4. 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;
5. a lack of liquidity in the market for our common stock that may make it difficult or impossible for you to liquidate your
investment in our stock or lead to distortions in the market price of our stock; and
6.
integration and other risks relating to the opening of our Salem, Oregon loan production office that may cost more or be less
beneficial to us than expected.
Our management believes 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.
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.
GENERAL
Pacific is a bank holding company providing full-service community banking through 17 branches in Washington and three branches in
Oregon operated by its wholly owned banking subsidiary, Bank of the Pacific. In addition, Pacific has two loan production offices in
Washington, one loan production office in Oregon 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.
20
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:
(cid:2) Total assets at December 31, 2014, increased by $39.8 million, or 5.6%, to $744.8 million compared to $705.0 million at the end
of 2013. Increases in loans were the primary contributors to overall asset growth, which were partially offset by decreases in
investments, interest bearing deposits in banks and loans held for sale. Total loans of $563.1 million at December 31, 2014,
increased $58.4 million, or 11.6%, compared to year-end 2013.
(cid:2) The Bank remains well capitalized with a total risk-based capital ratio of 13.52% at December 31, 2014, compared to 14.03% at
December 31, 2013. Tier one leverage ratio was 9.73% at December 31, 2014, compared to 9.77% at December 31, 2013. The
asset growth mentioned above outpaced the growth in retained earnings during 2014, resulting in the decline in capital ratios.
The Company declared an annual cash dividend of $0.21 per share in 2014, up from $0.20 in 2013.
(cid:2) Non-performing assets (“NPAs”) totaled $10.1 million at December 31, 2014, which represents 1.36% of total assets, versus
$10.0 million, or 1.42% of total assets, at December 31, 2013. NPAs are concentrated in commercial real estate loans and
related OREO, which total $7.8 million, or 76.8%, of our NPAs.
(cid:2) Demand deposits, savings, money market and certificates of deposits less than $100,000, increased during 2014 by $32.7
million, or 6.2%, to $563.4 million and comprise 88.2% of total deposits at year-end. The increase was driven by the Bank’s
second quarter 2013 acquisitions of three branches from Sterling Savings Bank (“Sterling”), in which total deposits assumed
were $37,634,000 and loans acquired were $3,989,000, new deposits generated from growth in commercial banking relationships
and organic deposit growth. The increase in deposits was mostly in commercial demand and money market accounts, coupled
with an increase in public NOW accounts.
The following are significant components of the Company's results of operations for 2014 as compared to 2013.
(cid:2) Net income for 2014 was $4.9 million, or $0.48 per diluted share, compared to net income of $3.7 million, or $0.37 per diluted
share, in 2013.
(cid:2)
In 2014, return on average assets (“ROAA”) and return on average equity (“ROAE”) increased to 0.68% and 6.92%,
respectively, compared to 0.55% and 5.48%, respectively, in 2013.
(cid:2) Net interest income increased to $27.0 million compared to $23.8 million in 2013. The Company experienced growth in loans
during the period. Correspondingly, net interest margin for 2014 increased 17 basis points to 4.17%, as compared to 4.00% in
2013.
(cid:2) Provision for (recapture of) credit losses was $300,000 for 2014, compared to ($450,000) for 2013. Provision expense in the
current year was commensurate with growth in the loan portfolio during that same period. The recapture of provision in the prior
year was 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.
(cid:2) Net charge-offs totaled $306,000 during 2014 compared to $549,000 in 2013. Loans classified as substandard or worse totaled
$18.7 million at December 31, 2014, an increase of $5.9 million, compared to $12.8 million one year ago.
(cid:2) Non-interest income decreased $1.9 million to $8.1 million for 2014, primarily due to decreases in gains on sale of loans and
investment securities. Gains on sale of loans fell by $1.5 million to $3.7 million. This revenue source moderated during the
latter portion of 2013 due to the slowdown in mortgage refinance activity caused by an increase in interest rates. Growth in
annuity commission revenue, which increased to $464,000, from $320,000, partially offset the decrease.
(cid:2) Non-interest expense decreased $1.3 million to $28.2 million for 2014. This decrease is primarily attributable to decreases in
data processing and other conversion expenses associated with the acquisition of the three Sterling Bank branches in 2013 and a
reduction in expenses associated with the holding and disposition of OREO.
21
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 have improved, 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 6.3% at December 31, 2014, compared to
6.6% in 2013 and 7.6% in 2012, and in Oregon the unemployment rate was 6.7% for 2014, compared to 7.0% in 2013 and 8.4% in 2012.
These rates compare to the national unemployment rate of 5.6% at December 31, 2014. 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:
County
Clark
Clatsop
Grays Harbor
Marion
Pacific
Skagit
Wahkiakum
Whatcom
2014
7.2%
5.9%
10.6%
6.6%
9.8%
7.6%
9.7%
6.4%
2013
7.4%
6.1%
11.6%
7.8%
10.5%
8.1%
10.4%
6.4%
2012
8.3%
7.6%
12.4%
9.2%
11.8%
9.1%
12.2%
6.9%
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 and Marion Counties is below the Oregon state, but above the national rate. Overall, the
unemployment rate in all our markets has steadily improved over the last three years.
Sales activity for single-family homes and condominiums has generally rebounded in 2014 within our geographic footprint. Year over
year changes in closed sales activity in Grays Harbor, Pacific, Skagit and Whatcom counties in Washington were 4.0%, 10.8%, -0.5%,
and 7.3% (Runstad Center for Real Estate Research – UW), respectively, during 2014. Home prices exhibited similar increases during the
period. We believe the general increase was due primarily to the gradual improvement in the local economy during 2014. Conversely,
home prices declined in Marion and Clatsop Counties in Oregon in 2014 by 6.9% and 6.5%, respectively. It appears an increased supply
in active listings during the period has resulted in a current softening of prices.
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 loan losses
The Company's allowance for loan losses methodology incorporates a variety of risk considerations, both quantitative and qualitative, in
establishing an allowance for loan 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 individual loans, 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 loan losses if
management's assessment of the above factors were different.
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
22
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, 2014, 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 loan 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.
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 $3.2 million at December 31, 2014, compared to $4.5 million at December 31,
2013. The most significant portions of the deductible temporary differences relate to the allowance for loan losses, supplemental
executive retirement plan and loan fees/costs. As of December 31, 2014, 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.
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.
23
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 2015 are as follows:
(cid:2) 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.
(cid:2) 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.
(cid:2) Mitigate 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 durations less than five years.
(cid:2) Continue to improve asset quality through proactive management of problem loans, monitoring of existing performing loans, and
selling of OREO properties.
(cid:2) Successfully expand on the opportunities available to garner additional profitable banking relationships through 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 branch acquisition from Sterling,
newly opened branch in Warrenton, and opening of a loan production office in Salem.
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.
CONSOLIDATED RESULTS OF OPERATIONS
Years ended December 31, 2014, 2013, and 2012
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, 2014.
Interest and dividend income
Interest expense
Net interest income
Loan loss provision
Non-interest income
Non-interest expense
INCOME BEFORE PROVISION FOR INCOME T AXES
PROVISION FOR INCOME T AXES
NET INCOME
INCOME PER COMMON SHARE:
BASIC (1)
DILUT ED (2)
For the T welve
Months Ended
December 31, 2014
For the T welve
Months Ended
December 31, 2013
2014 to 2013
%
Change
$ Change
For the T welve
Months Ended
December 31, 2012
2013 to 2012
%
Change
$ Change
$
29,158
$
26,290
$
2,125
27,033
300
8,079
28,155
6,657
1,730
2,490
23,800
(450)
9,955
29,502
4,703
972
2,868
(365)
3,233
750
(1,876)
(1,347)
1,954
758
11% $
27,495
$
(1,205)
-15%
14%
-167%
-19%
-5%
42%
78%
3,484
24,011
(1,100)
9,391
28,417
6,085
1,300
(994)
(211)
650
564
1,085
(1,382)
(328)
-4%
-29%
-1%
-59%
6%
4%
-23%
-25%
$
$
$
4,927
$
3,731
$
1,196
32% $
4,785
$
(1,054)
-22%
0.48
0.48
$
$
0.37
0.37
$
$
0.11
0.11
30% $
30% $
0.47
0.47
$
$
(0.10)
(0.10)
-21%
-21%
Average common shares outstanding - basic (1)
Average common shares outstanding - diluted (2)
10,256,242
10,347,338
10,121,738
10,189,888
134,504
157,450
1%
2%
10,121,853
10,126,244
(115)
63,644
0%
1%
Net income. For the year ended December 31, 2014, net income was $4.9 million compared to $3.7 million in 2013. The increase in net
income for 2014 was primarily related to increases in net interest income due to growth in loans and a reduction in interest expense paid
on deposits. The decline in data processing and other conversion expenses relates to expenses associated with the acquisition of three
Sterling branches in 2013 and a reduction in expenses associated with the disposition of OREO. These expense reductions were partially
offset by a decline in gain on sale of loans due to the slowdown in mortgage refinance activity caused by an increase in interest rates
beginning in the latter half of 2013.
24
Net income of $3.7 million for 2013 was down from net income of $4.8 million for the year ended December 31, 2012. This was
primarily due to an increase in noninterest expenses associated with the expansion of loan production offices and integration of the
branches purchased from Sterling. This was offset partially by an increase in non-interest income from gain on sale of loans, ATM/Debit
card and annuity commission fee income. Net income in 2013 was also impacted by a reduction in recapture of provision for loan losses
as compared to the prior period.
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 70% of the Company's loan portfolio is tied to short-term rates, and therefore, re-price 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 2015.
25
The following tables set forth information with regard to average balances of interest earning assets and interest bearing liabilities and the
resultant yields or cost, net interest income, and the net interest margin on a tax equivalent basis. Non-accrual loans are included in gross
loans.
Average Inte re st Earning Balance s:
For the Twelve Months Ended
December 31, 2014
December 31, 2013
December 31, 2012
Average
Balance
Interest
Income or
Expense
Average
Yields or
Rates
Average
Balance
Interest
Income or
Expense
Average
Yields or
Rates
Average
Balance
Interest
Income or
Expense
Average
Yields or
Rates
(Dollars in Thousands)
ASSETS:
Interest bearing certificate of deposit
Interest bearing deposits in banks
Investments - taxable
Investments - nontaxable
Federal home loan bank stock
Pacific coast bankers bank stock
Gross loans (1)
Loans held for sale
Deferred fees
Total interest earning assets
Cash and due from banks
Bank premises and equipment (net)
Other real estate owned
Allowance for loan losses
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing deposits
Time deposits
Long term borrowings
Short term borrowings
Secured borrowings
Junior subordinated debentures
Total interest bearing liabilities
Non-interest-bearing deposits
Other liabilities
Equity
Total liabilities and shareholders' equity
Net interest income (3)
Net interest spread
Average yield on investments
Average yield on earning assets (2) (3)
Interest expense to earning assets
Net interest income to earning assets (2) (3)
Re conciliation of Non-GAAP me asure:
Tax Equivale nt Ne t Inte re st Income
$
$
$
$
42
47
1,269
1,258
3
30
26,871
255
-
29,775
581
1,087
215
1
-
241
2,125
2,727 $
20,326
63,312
29,514
2,962
266
536,971
7,026
(1,123)
661,981
13,201
16,633
1,658
(8,327)
40,679
725,825
344,084 $
122,002
10,591
150
-
13,403
490,230
158,697
5,710
71,188
725,825
1.54% $
0.23%
2.00%
4.26%
0.10%
11.28%
5.00%
3.63%
0.00%
4.50%
$
0.17% $
0.89%
2.03%
0.67%
0.00%
1.80%
0.43%
$
29
85
778
1,508
2
-
24,302
312
-
27,016
699
1,321
214
9
-
247
2,490
2,309 $
36,539
53,505
32,650
3,078
-
477,356
9,302
(1,034)
613,705
11,637
15,831
4,030
(9,065)
40,908
677,046
316,184 $
135,447
9,745
304
-
13,403
475,083
129,218
4,688
68,057
677,046
1.26% $
0.23%
1.45%
4.62%
0.06%
0.00%
5.09%
3.35%
0.00%
4.40%
$
0.22% $
0.98%
2.20%
0.00%
0.00%
1.84%
0.52%
$
2,985 $
29,104
29,993
27,590
3,173
-
466,943
12,950
(857)
571,881
10,751
14,753
6,880
(11,022)
42,427
635,670
288,984
144,486
7,803
2,697
448
13,403
457,821
107,048
5,058
65,743
635,670
12
72
770
1,525
-
-
25,461
492
-
28,332
1,084
1,798
217
79
20
286
3,484
$
27,650
$
24,526
$
24,848
4.07%
2.72%
4.50%
0.33%
4.18%
3.88%
2.65%
4.40%
0.42%
4.00%
0.40%
0.25%
2.57%
5.53%
0.00%
0.00%
5.45%
3.80%
0.00%
4.95%
0.38%
1.24%
2.78%
2.93%
4.46%
2.13%
0.76%
4.19%
3.99%
4.95%
0.61%
4.34%
Net interest income
Tax equivalent adjustment for municipal loan interest
Tax equivalent adjustment for municipal bond interest
Tax equivalent net interest income
$
$
27,033
189
428
27,650
$
$
23,800
213
513
24,526
$
$
24,011
318
519
24,848
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited.
Management believes that presentation of this non-GAAP measure provides useful information frequently used by shareholders in the evaluation of a company.
Non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.
(1) Non-accrual loans of approximately $8.7 million at 12/31/14, $7.2 million for 12/31/13, and $15.1 million for 12/31/2012 are included in the average loan balances.
(2) Loan interest income includes loan fee income of $679,000, $547,000, and $569,000 for the twelve months ended 12/31/2014, 12/31/2013, and 12/31/12, respectively.
(3) T ax-exempt income has been adjusted to a tax equivalent basis at a 34% effective rate. T he amount of such adjustment was an addition to recorded pre-tax income
of $617,000, $726,000, $837,000 for the twelve months ended December 31, 2014, 2013, and 2012, respectively.
Net interest income for the twelve months ended December 31, 2014 increased from the twelve months ended December 31, 2013. This
increase was primarily due to the growth in earning assets, along with changes in the balance sheet mix. Loan balances increased due to
the production generated predominately in our Washington and Oregon markets. Investment securities and interest bearing deposits in
banks decreased as a proportion of the balance sheet, due to the strong loan demand during the current year. Funding costs have declined
over the year due to the shift in mix toward non-interest bearing demand and lower-cost deposits, and continued historically low interest
rates.
As a result, net interest margin improved for the year ended December 31, 2014 as compared to the prior year, primarily due to the
improvement in the yield on earning assets and a decline in the cost of liabilities. This was because higher-yielding loans increased as a
proportion of earning assets during 2014. The improvement in yields on investment securities also enhanced net interest margin for the
26
twelve months ending December 31, 2014 as compared to the same period in 2013. This was primarily the result of redeploying lower
yielding cash-equivalents into higher-yielding federal government guaranteed mortgage-backed securities.
In addition, a decline in the rate paid for interest-bearing liabilities and an increase of the proportion of funding coming from non-interest
bearing deposits contributed to a decline in the cost of liabilities, thus resulting in an improvement of net interest margin in 2014 as
compared to 2013.
Net interest income for the twelve months ended December 31, 2013 decreased from the twelve months ended December 31, 2012.
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 during the 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.
As a result, net interest margin declined for the year ended December 31, 2013 as compared to the prior year, primarily due to the
decrease in the yield on earning assets, despite the decline in the cost of liabilities. This was because lower-yielding investment securities
increased as a proportion of earning assets during 2013. The additional deposits obtained via the purchase of three branches from Sterling
Savings Bank in June 2013 were deployed directly into investment securities initially and then used to fund loan growth over time.
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)
ASSETS:
For the Twelve Months Ended
December 31, 2014 vs. December 31, 2013
Increase (Decrease) Due To
For the Twelve Months Ended
December 31, 2013 vs. December 31, 2012
Increase (Decrease) Due To
Volume
Rate
Net
Change
Volume
Rate
Net
Change
Interest bearing certificate of deposit
$
5 $
8 $
13 $
(3) $
20 $
Interest bearing deposits in banks
Investments - taxable
Investments - nontaxable
Federal home loan bank stock
Pacific coast bankers bank stock
Gross loans (1)
Loans held for sale
Deferred fees
Total interest earning assets
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing deposits
Time deposits
Long term borrowings
Short term borrowings
Secured borrowings
Junior subordinated debentures
Total interest bearing liabilities (increase) decrease
Net increase (decrease) in net
interest income
(37)
142
(145)
-
-
3,034
(76)
-
(1)
349
(105)
1
30
(465)
19
-
(38)
491
(250)
1
30
2,569
(57)
-
19
604
280
-
-
568
(139)
-
(6)
(596)
(297)
-
-
(1,727)
(41)
-
17
13
8
(17)
-
-
(1,159)
(180)
-
$
$
2,923 $
(164) $
2,759 $
1,329 $
(2,647) $
(1,318)
61 $
(132)
19
-
-
-
(52)
(179) $
(102)
(18)
(8)
-
(6)
(313)
(118) $
(234)
1
(8)
-
(6)
(365)
103 $
(112)
54
(70)
(20)
-
(45)
(488) $
(365)
(57)
-
-
(39)
(949)
(385)
(477)
(3)
(70)
(20)
(39)
(994)
$
2,975 $
149 $
3,124 $
1,374 $
(1,698) $
(324)
Non-Interest Income. Noninterest income for 2014 was down from 2013, reflecting the declines in gains on sale of residential mortgage
loans due to the reduction in refinancing activity beginning in the latter half of 2013, declines in gains on sale of securities and higher
losses on sale of OREO due to a more aggressive approach to reducing these assets. This was partially offset by an increase in annuity
commission fee income.
27
Non-interest income was up in 2013 as compared to 2012. Categories contributing to this were increases in service charges on deposits
and ATM/debit card fee income due to growth in core deposits, primarily from the acquisition of the Sterling Savings Bank branches.
Also contributing were growth in annuity commission fee income as more employees became licensed to offer these products and a
reduction in OTTI losses due to a reduction in the securities incurring such write-downs. This was partially offset by a decrease in gain
on sale of OREO as a result of a declining volume of such properties.
The following table represents the principal categories of non-interest income for each of the years in the three-year period ended
December 31, 2014.
For The Twelve Months Ended
2014 to 2013
2013 to 2012
December
31, 2014
December
31, 2013
$ Change
% Change
December
31, 2012
$ Change
% Change
Service charges on deposit accounts
$
1,809
$
1,731 $
78
5%
$
1,686
$
Net gain (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
Earnings on bank owned life insurance
Other operating income
Fee income
Annuity sales income
Other non-interest income
Total non-interest income
(207)
3,686
88
(48)
505
1,709
464
73
40
5,171
405
(37)
452
1,811
320
62
(247)
(1,485)
(317)
(11)
53
(102)
144
11
-618%
-29%
-78%
30%
12%
-6%
45%
18%
331
5,058
303
(333)
510
1,673
17
146
$
8,079
$
9,955 $
(1,876)
-19%
$
9,391
$
45
(291)
113
102
296
(58)
138
303
(84)
564
3%
-88%
2%
34%
-89%
-11%
8%
1782%
-58%
6%
Non-Interest Expense. Noninterest expense for 2014 was down as compared to 2013. Increases in personnel expense related to the
addition of loan production personnel and branch staff for a new branch that opened in the fourth quarter of 2013 were partially offset by
$471,000 savings generated from reduction in mortgage lending staff initiated in first quarter 2014 prompted by the decline in residential
mortgage loan refinance activity. Total costs associated with OREO and related third-party loan expenses decreased due to the decline in
OREO balances and stabilization of collateral valuations. Also, data processing and other conversion expenses totaling $615,000 related
to the acquisition of three branches from Sterling in 2013 did not recur in 2014.
Total non-interest expense in 2013 was up compared to 2012. Contributing to this increase were costs associated with acquisition and
operation of the three branches acquired from Sterling, as previously noted. The increase in salary and benefits costs 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. The effect of
these increases was partially mitigated by decreases in FDIC insurance assessments, expenses related to OREO and other related costs.
28
The following table shows the principal categories of non-interest expense for each of the years in the three-year period ended December
31, 2014.
For The Twe lve Months Ende d
2014 to 2013
2013 to 2012
December
31, 2014
December
31, 2013
$ Change
% Change
December
31, 2012
$ Change
% Change
Salaries and employee benefits
$
17,118
$
17,013 $
Occupancy
Equipment
Data processing
Professional services
Other real estate owned write-downs
Other real estate owned operating costs
State taxes
FDIC and state assessments
Other non-interest expense:
Director fees
Communication
Advertising
Professional liability insurance
Amortization
Other non-interest expense
Total non-inte re st e xpe nse
2,006
1,050
2,009
745
67
238
417
491
287
209
331
85
385
1,839
860
2,268
935
946
408
458
535
224
172
316
90
415
2,717
3,023
105
167
190
(259)
(190)
(879)
(170)
(41)
(44)
63
37
15
(5)
(30)
(306)
1% $
16,215
$
9%
22%
-11%
-20%
-93%
-42%
-9%
-8%
28%
22%
5%
-6%
-7%
-10%
1,673
801
1,607
750
1,314
550
518
610
236
170
366
113
381
3,113
798
166
59
661
185
(368)
(142)
(60)
(75)
(12)
2
(50)
(23)
34
(90)
$
28,155
$
29,502 $
(1,347)
-5% $
28,417
$
1,085
5%
10%
7%
41%
25%
-28%
-26%
-12%
-12%
-5%
1%
-14%
-20%
9%
-3%
4%
Income Taxes. For the years ended December 31, 2014, 2013 and 2012 income taxes totaled $1.7 million, $972,000 and $1.3 million,
respectively, representing effective tax rates of 26.0%, 20.7% and 21.4%, 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.
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, 2014 and
2013, the Company had a net deferred tax asset of $3.2 million and $4.5 million, respectively.
See “Critical Accounting Policies” in this section above.
FINANCIAL CONDITION
At December 31, 2014 and 2013
Cash and Cash Equivalents
Total cash and cash equivalents, including interest bearing deposits in banks, decreased to $33,764,000 at December 31, 2014, from
$38,675,000 at December 31, 2013, due to increased lending through new loan production offices.
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 decreased $9,007,000, or 9.2%, during 2014 to $89,269,000 as funds were redeployed to support loan growth during
the period. 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.
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, 2014, the Company owned 38 securities in a continuous unrealized loss position for
29
twelve months or longer, with an amortized cost of $31,748,000 and fair value of $31,195,000. These securities that have been in a
continuous unrealized loss position for twelve months or longer at December 31, 2014, 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, 2014. For more information
regarding our investment securities and analysis of the value of securities in our investment portfolio, see Note 3 - "Securities" and Note
17 – "Fair Value Measurements" to the Company's audited consolidated financial statements included in Item 15 of this report. See also
“Critical Accounting Policies” in this section above.
The carrying values of investment securities at December 31 in each of the last three years are as follows:
(Dollars in T housands)
Available-for-sale:
2014
2013
2012
Collateralized mortgage obligations: agency issued
$
38,767 $
38,791 $
17,066
Collateralized mortgage obligations: non agency
Mortgage-backed securities: agency issued
U.S. Government agency securities
State and municipal securities
Corporate bonds
T otal available-for-sale
Held-to-maturity:
Mortgage-backed securities: agency issued
State and municipal securities
T otal held-to-maturity
T otal investments
527
12,199
8,056
27,891
-
2,011
13,389
8,811
32,160
982
87,440 $
96,144 $
123 $
1,706
159 $
1,973
1,829 $
2,132 $
2,544
5,093
5,952
26,906
3,545
61,106
221
6,716
6,937
89,269 $
98,276 $
68,043
$
$
$
$
The following table presents the maturities of investment securities at December 31, 2014.
At December 31, 2014
(Dollars in T housands)
Held-to-maturity
Available-for-sale
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Declining Balance Securities
T otal investment securities
$
$
$
-
-
889
817
123
-
-
899
818
135
$
325 $
8,636
12,903
13,234
51,809
329
8,662
13,160
13,796
51,493
1,829 $
1,852
$
86,907 $
87,440
Loan Portfolio
General. Total loans at December 31, 2014 were up as compared to December 31, 2013 and 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 consumer
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 2015, 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 at December 31 in each of the past five years.
30
Loans as of December 31, 2014, 2013, 2012, 2011 and 2010 consisted of the following:
(Dollars in T housands)
December
31, 2014
December
31, 2013
December
31, 2012
December
31, 2011
December
31, 2010
Commercial and agricultural
$
120,517
$
104,111
$
87,278
$
90,731
$
84,575
Real estate:
Construction and development
Residential 1-4 family
Multi-family
Commercial real estate -- owner occupied
Commercial real estate -- non owner occupied
Farmland
Consumer
Gross loans
Less: deferred fees
26,711
92,965
18,541
125,632
117,137
22,245
40,565
564,313
(1,214)
29,096
87,762
17,520
105,594
117,294
23,698
20,728
505,803
(1,137)
31,411
77,497
7,744
109,783
103,014
24,544
7,782
449,053
(857)
47,156
76,011
7,682
118,469
103,005
23,752
8,928
475,734
(841)
46,256
79,068
9,113
109,936
106,079
22,354
9,128
466,509
(828)
Portfolio Loans
$
563,099
$
504,666
$
448,196
$
474,893
$
465,681
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. 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. In addition, the loan portfolio contains $30.8 million and $11.2 million, as of December 31, 2014 and 2013, respectively, in
indirect consumer loans to individuals to finance luxury and classic cars as a part of a strategy begun in 2013 to diversify the loan
portfolio.
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 in owner occupied commercial real estate loans.
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, 2014, loans secured by real estate totaled $403.2 million, which represents
71.4% of the total loan portfolio. 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. See "Risk Factors" under Item 1A of this report.
We remain active in managing our existing construction loan and land development portfolios, the balances of which have declined over
the last three years. Construction and land development loans represented 4.8% and 5.7% of total loans outstanding at December 31,
2014 and 2013, respectively. We believe this segment will remain challenged into 2015, although to a lesser extent than in previous
years.
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, 2014, concentration in land
and residential construction as a percentage of risk based capital was 36.0% and total concentration in non-owner occupied commercial
real estate plus land and residential construction as a percentage of risk-based capital stood at 216.4%. In addition, the Company manages
new loan origination volume using concentration limits that establish maximum exposure levels by designated industry segment, real
estate product types, geography, and single borrower limits.
31
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,
2014.
(dollars in thousands)
Due in one
ye ar or le ss
Due afte r
one through
five ye ars
Due afte r
five ye ars
Total
Commercial
$
68,734 $
27,140 $
5,583 $
101,457
Construction, land development, other land loans
Residential real estate 1-4 family
Multi-family
Farmland
Commercial real estate
Consumer
Credit cards and overdrafts
Total
Less unearned income
Total loans
13,364
45,924
-
9,336
74,892
4,313
2,520
219,083 $
19,071
51,090
6,163
8,492
173,455
15,106
-
300,517 $
$
40
5,686
12,378
551
2,948
17,527
-
44,713 $
32,475
102,700
18,541
18,379
251,295
36,946
2,520
564,313
(1,214)
563,099
Total loans maturing afte r one ye ar with
Predetermined interest rates (fixed)
Floating or adjustable rates (variable)
Total
$
$
78,793 $
221,724
300,517 $
30,032 $
14,681
44,713 $
108,825
236,405
345,230
At December 31, 2014, 81% of the total loan portfolio was either due in one year or less or maturing after one year, but with a variable
rate. This compares to 82% as of December 31, 2013. Management seeks to maintain a significant proportion of its loan portfolio subject
to near term changes in interest rates to mitigate interest rate risk.
Asset Quality. The Company continues to aggressively identify and monitor adversely classified assets and take action based upon
available information. Levels of adversely classified assets increased primarily due to a $4.6 million commercial loan relationship and a
$2.0 million commercial real estate loan. Delinquencies continue to be well-managed and no significant adverse trends have been
identified.
Adve rse ly classifie d loans and se curitie s
(Dollars in T housands)
Rated substandard or worse, but not impaired
Impaired
T otal adversely classified loans¹
T otal investment securities²
Gross loans (excluding deferred loan fees)
Adversely classified loans to gross loans
Allowance for loan losses
Allowance for loan losses as a percentage of adversely classified loans
Allowance for loan losses to total impaired loans
Adversely classified loans and securities to total assets
December
31, 2014
December
31, 2013
$
$
$
$
$
$
$
$
$
$
7,368
11,311
18,679
199
564,313
3.31%
8,353
44.72%
73.85%
2.53%
$
$
$
$
$
2,842
9,922
12,764
1,834
505,803
2.52%
8,359
65.49%
84.25%
2.07%
2014 to 2013
$
Change
%
Change
December
31, 2012
2013 to 2012
$
%
Change
Change
4,526
1,389
5,915
159% $
14%
46% $
6,909 $
14,784
21,693 $
(4,067)
(4,862)
(8,929)
-59%
-33%
-41%
(1,635)
-89% $
2,245 $
(411)
-18%
58,510
12% $
(6)
0% $
56,750
13%
(999)
-11%
449,053 $
4.83%
9,358 $
43.14%
63.30%
3.72%
¹Adversely classified loans are defined as loans having a well-defined weakness or weaknesses related to the borrower's financial capacity or to pledged collateral that may
jeopardize the repayment of the debt. T hey are characterized by the possibility that the Bank may sustain some loss if the deficiencies giving rise to the substandard
classification are not corrected. Note that any loans internally rated worse than substandard are included in the impaired loan totals.
²Adversely classified investment securities consist of one private label collateralized mortgage obligation (CMO) as of 12/31/2014 and four private label CMOs as of
12/31/2013 and 12/31/2012.
32
The following table presents information related to the Company's delinquent loans, not on non-accrual status, as of December 31 in each
of the last three years.
30-89 Days Past Due by type
(Dollars in T housands)
December
31, 2014
% of
Category
December
31, 2013
% of
Category
$ Change
% Change
December
31, 2012
% of
Category
$ Change
% Change
2014 to 2013
2013 to 2012
Commercial and agricultural
$
-
0.0% $
14
1.0% $
(14)
-100% $
134
5.3% $
(120)
-90%
Real estate:
Construction and development
Residential 1-4 family
Multi-family
Commercial real estate -- owner occupied
Commercial real estate -- non owner occupied
Farmland
Total real estate
Consumer
T otal loans 30-89 days past due, not in
nonaccrual status
$
$
2.1%
71.9%
0.0%
0.0%
0.0%
5.5%
18
605
-
-
-
46
669
-
0.0%
333
24.0%
-
-
-
0.0%
0.0%
0.0%
875
62.9%
$
1,208
$
18
272
-
-
-
(829)
(539)
100%
82%
0%
0%
0%
-95%
-
1,595
-
-
652
133
0.0%
63.2%
0.0%
0.0%
25.9%
5.3%
-
(1,262)
-
-
(652)
742
0%
-79%
0%
0%
-100%
558%
-45% $
2,380
$
-1,172
172
20.5%
168
12.1%
4
2%
8
0.3%
160
2000%
841
100.0% $
1,390
100.0% $
(549)
-39% $
2,522
100.0% $
(1,132)
-45%
Delinquent loans to total loans, not in
nonaccrual status
0.23%
0.28%
0.57%
Non-performing Assets. Non-performing 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.
33
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.
Non-pe rforming asse ts
(Dollars in T housands)
Loans on nonaccrual status
December
31, 2014
December
31, 2013
December
31, 2012
December
31, 2011
December
31, 2010
Commercial and agricultural
$
96 $
286
$
1,901
$
530
$
1,251
Real estate:
Construction and development
Residential 1-4 family
Commercial real estate -- owner occupied(cid:2)(cid:4)(cid:3)
Commercial real estate -- non owner occupied
Farmland
Total real estate
Consumer
T otal loans on non accrual status(cid:2)¹(cid:3)
Loans past due greater than 90 days but
not on nonaccrual status
T otal non-performing loans
Other real estate owned
Construction, Land Dev & Other Land
1-4 Family Residential Properties
Nonfarm Nonresidential Properties
965
848
1,325
5,482
-
8,620
-
8,716
409
9,125
35
-
964
999
1,408
400
1,659
2,482
955
6,904
53
7,243
-
7,243
237
672
1,862
2,771
1,792
800
3,847
5,795
976
13,210
1
5,510
528
629
6,539
-
13,206
-
15,112
13,736
-
15,112
299
14,035
1,860
507
2,312
4,679
4,150
1,427
2,148
7,725
5,529
2,246
470
333
170
8,748
-
9,999
-
9,999
4,043
540
1,997
6,580
T otal nonperforming assets(cid:2)²(cid:3)
$
10,124 $
10,014
$
19,791
$
21,760
$
16,579
T roubled debt restructured loans on accrual status
Allowance for loan losses
Allowance to non-performing loans
Allowance to non-performing assets
Non-performing loans to total loans(cid:2)³(cid:3)
Non-performing assets to total assets
2,595
8,353
91.54%
82.51%
1.62%
1.36%
2,680
8,359
115.41%
83.47%
1.44%
1.42%
444
9,358
61.92%
47.28%
3.37%
3.08%
398
11,127
79.28%
51.14%
2.96%
3.39%
-
10,617
106.18%
64.04%
2.15%
2.57%
(cid:2)¹(cid:3) Includes $965,000, $1,408,000, $3,930,000, $7,734,000, and $932,000 in non-accrual troubled debt restructured loans ("T DRs") as of December
31, 2014, 2013, 2012, 2011, and 2010, respectively, which are also considered impaired loans.
(cid:2)²(cid:3) Does not include T DR's on accrual status.
(cid:2)³(cid:3) Excludes loans held for sale.
(cid:2)(cid:4)(cid:3) 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.
At December 31, 2014, total non-performing assets remained virtually unchanged in dollars from the prior year-end, with an increase in
non-performing loans being offset by a similar decrease in OREO. Approximately one-half, or $4.3 million, is represented by two
commercial real estate loan relationships. The collateral value supporting these loans is considered sufficient to mitigate any potential
losses, for which specific reserves have already been established. One of these relationships, a $1.7 million loan secured by income-
producing commercial real estate, is now paid current as to principal and interest.
Non-performing loans decreased at December 31, 2013, from the balance at December 31, 2012, due to decreases in all non-accrual loan
categories except consumer loans. The decline in non-accrual commercial real estate is primarily the result of partial or full payoffs
34
totaling $3.4 million from six borrowing relationships. The decrease in non-accrual commercial loans is made up primarily of a partial
payoff of one relationship totaling $1.4 million.
The Company continues to aggressively identify and monitor non-performing assets and take action based upon available information.
Troubled debt restructures (“TDRs”) declined as of December 31, 2014, as compared to December 31, 2013. TDRs are loans for which
the terms have been modified in order to grant a concession to a borrower that is experiencing financial difficulty. TDRs 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
$679,000, $1,130,000 and $1,213,000 for 2014, 2013 and 2012, respectively. Interest income recognized on impaired loans was
$404,000, $177,000 and $226,000 for 2014, 2013 and 2012, 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 its review of the appraisal, 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 loan losses or by designating a
specific reserve. Generally, the Company will record the charge-off rather than designate a specific reserve.
OREO at December 31, 2014 was down from the previous year-end primarily due to a decline in transfers into OREO from outstanding
loans during the current year. In addition, impairment charges declined due to improvement in real estate prices and reduced levels of
these assets. Management continues to market its OREO properties through an orderly liquidation process rather than engaging in
immediate liquidation that it believes may result in discounts greater than the projected carrying costs. Most of the properties held as
OREO are commercial real estate.
(Unaudited)
(Dollars in T housands)
For the T welve Months Ended
Other real estate owned, beginning of period
$
T ransfers from outstanding loans
Proceeds from sales
Net gain (loss) on sales
Impairment charges
T otal other real estate owned
$
December
31, 2014
% of
Category
December
31, 2013
% of
Category
2014 to 2013
$ Change
% Change
December
31, 2012
% of
Category
2013 to 2012
$ Change
% Change
2,771
842
(2,340)
(207)
(67)
999
277% $
84%
-234%
-21%
-6%
100% $
4,679
1,756
(2,758)
40
(946)
2,771
169% $
(1,908)
-41% $
63%
-100%
1%
-34%
(914)
418
(247)
879
-52%
-15%
-618%
-93%
100% $
(1,772)
-64% $
7,725
3,082
(5,145)
331
(1,314)
4,679
165% $
66%
-110%
7%
-28%
(3,046)
(1,326)
2,387
(291)
368
100% $
(1,908)
-39%
-43%
-46%
-88%
-28%
-41%
O ther real estate owned and foreclosed assets by type
(Unaudited)
(Dollars in T housands)
December
# of
December
# of
2014 to 2013
December
# of
2013 to 2012
31, 2014
Properties
31, 2013
Properties
$ Change
% Change
31, 2012
Properties
$ Change
% Change
Construction, Land Dev & Other Land
1-4 Family Residential Properties
Nonfarm Nonresidential Properties
T otal OREO by type
$
$
35
-
964
999
-
1
$
3
4
$
237
672
1,862
2,771
$
5
4
8
(202)
(672)
(898)
-85% $
-100%
-48%
17
$
(1,772)
-64% $
1,860
507
2,312
4,679
13
$
(1,623)
4
9
165
(450)
26
$
(1,908)
-87%
33%
-19%
-41%
Allowance and Provision for Credit Losses. The allowance for loan 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 loan 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 loan 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, 2014, based upon charge-off experience
and other factors considered by management, the loss factors used in the allowance for loan losses were updated from 0.40% to 0.30% on
pass rated commercial loans, from 0.40% to 0.35% on non owner-occupied commercial real estate loans, from 0.55% to 0.35% on owner-
occupied commercial real estate and from 0.65% to 0.60% on residential real estate. Loss factors for land and land development loans,
speculative residential construction, personal lines of credit and other consumer loans remained unchanged. As a result, the estimate for
35
the allowance for loan losses decreased. See “Critical Accounting Policies” in this section above, as well as “Risk Factors” under Item
1A. above.
Transactions in the allowance for loan losses for the years ended December 31 are as follows:
Al lowance for Loan Losse s
(Dollars in T housands)
For t he T welve Months Ended
December
31, 2014
December
31, 2013
December
31, 2012
December
31, 2011
December
31, 2010
Gross loans outst anding at end of period
Average loans outst anding, gross
Allowance for loan losses, beginning of period
$
$
$
564,313 $
505,803 $
449,053 $
475,734 $
536,971 $
477,356 $
466,086 $
483,974 $
8,359 $
9,358 $
11,127 $
10,617 $
Charge-offs
Commercial
Commercial Real Est ate
Residential Real Est ate
Consumer
T ot al charge-offs
Recoveries
Commercial
Commercial Real Est ate
Residential Real Est ate
Consumer
T ot al recoveries
Net charge-offs
Provision for (recapt ure of) loan losses
(26)
(533)
(129)
(79)
(767)
11
425
22
3
461
(306)
300
(131)
(90)
(453)
(154)
(828)
36
226
14
3
279
(549)
(450)
(67)
(827)
(576)
(309)
(1,779)
23
917
162
8
1,110
(669)
(1,100)
(161)
(2,005)
(665)
(93)
(2,924)
69
750
107
8
934
(1,990)
2,500
Allowance for loan losses, end of period
$
8,353 $
8,359 $
9,358 $
11,127 $
Ratio of net loans charged-off t o average
466,509
485,872
11,092
(469)
(2,055)
(1,518)
(119)
(4,161)
13
19
48
6
86
(4,075)
3,600
10,617
gross loans out standing, annualized
0.06%
0.12%
0.14%
0.41%
0.84%
Ratio of allowance for loan losses to
gross loans out standing
1.48%
1.65%
2.08%
2.34%
2.28%
The allowance for loan losses continues to decline in relation to total loans in concert with the general trend of improvement in charge
offs and delinquencies after incorporating loss potential of adversely classified loans. As such, loss factors used in estimates to establish
reserve levels have declined. A provision was made to the allowance for loan losses in the current year, corresponding to recent growth in
the loan portfolio.
The recapture of provision in the prior year was 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.
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 $32.8 million and $37.8 million at December 31, 2014 and 2013, respectively.
The ratio of the allowance for loan losses to total loans outstanding excluding the government guaranteed loans was 1.56% and 1.76%,
respectively.
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 loan 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
36
management quarterly and is reviewed by the Board of Directors. Based on this analysis and applicable accounting standards,
management considers the allowance for loan losses to be adequate at December 31, 2014.
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 T housands)
T otal impaired loans
T otal impaired loans with valuation allowance
$
Valuation allowance related to impaired loans
11,311 $
249
-
9,922 $
14,784 $
-
-
-
-
14,432 $
4,498
2,032
14,673
508
142
2014
2013
2012
2011
2010
No valuation allowance was considered necessary for the remaining impaired loans. The balance of the allowance for loan 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 loan losses is available
to absorb such charge-offs.
The Company allocates its allowance for loan 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 loan 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.
(Dollars in T housands)
For the T welve Months Ended
Commercial loans
Real estate loans
Consumer loans
Unallocated
T otal allowance
Ratio of allowance for loan losses to
December
31, 2014
% of total
loans*
December
31, 2013
% of total
loans*
December
31, 2012
% of total
loans*
December
31, 2011
% of total
loans*
December
31, 2010
% of total
loans*
$
$
1,022
4,120
979
2,232
8,353
20% $
74%
6%
0%
100% $
775
4,181
744
2,659
8,359
19% $
79%
2%
0%
100% $
923
4,927
531
2,977
9,358
19% $
79%
2%
0%
1,012
7,849
642
1,624
18% $
80%
2%
0%
816
7,139
690
1,972
19%
79%
2%
0%
100% $
11,127
100% $
10,617
100%
gross loans outstanding
1.48%
1.66%
2.09%
2.34%
2.28%
* Represents the total of all outstanding loans in each category as a percent of total loans outstanding
The table indicates decreases during 2014 in the portion of the allowance related to real estate loans, respectively, which were partially
offset by an increase in the portion related to commercial and consumer loans. The significant decline in 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 commercial and consumer loans resulted from an increase in
classified loans in this sector, as previously noted. The increase in the allowance related to consumer loans resulted from growth in this
sector. The unallocated portion of the allowance declined due to a reduction in qualitative risk factors corresponding to improving trends
in economic conditions.
The table indicates decreases 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.
37
Deposits
Total deposits were up at December 31, 2014, compared to the previous two years. Non-interest bearing demand and interest-bearing
demand deposits increased due to recent success in acquiring business deposit relationships in conjunction with the growth in lending
achieved over the past year. The combination of our efforts to reduce higher-cost time deposits through lowering interest rates paid and
offering non-insured deposit products continued to impact the balances of these types of deposits. 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. Growth in all categories in 2013 was also the result of the acquisition of three Sterling branches in second quarter 2013,
representing $37.6 million in deposits.
Total brokered deposits were $22.4 million at December 31, 2014, which included $2.3 million via reciprocal deposit arrangements. This
compares to $21.6 million at December 31, 2013, which included $3.9 million via reciprocal deposit arrangements. Brokered deposits
have been acquired over the past several years at historically low rates for extended maturities to help insulate the Bank in a rising rate
environment. The weighted average term of these brokered deposits is 50 months. Longer term CDs are generally not available in the
retail market as customers generally desire to keep funds more liquid and accessible. The Company views the prudent use of brokered
deposits and borrowings to be an appropriate funding tool to support interest rate risk mitigation strategies.
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, 2014, 2013 and 2012, respectively, follows:
De posits
(Dollars in T housands)
2014
2013
2012
December 31,
December 31,
December 31,
Interest-bearing demand (NOW)
Money market deposits
$
151,130 $
123,484
Savings deposits
T ime, interest deposits (CD's)
T otal interest-bearing deposits
Non-interest bearing demand
79,997
118,683
473,294
165,760
$
144,221
118,627
73,412
126,059
462,319
145,028
125,758
106,849
62,493
138,005
433,105
115,138
T otal deposits
$
639,054 $
607,347
$
548,243
38
The ratio of non-interest bearing deposits to total deposits is displayed in the table below.
Deposits
(Unaudited)
2014 to 2013
2013 to 2012
(Dollars in T housands)
2014
Total
2013
Total
$ Change
% Change
31, 2012
Total
$ Change
% Change
December 31,
Percent of
December 31,
Percent of
December
Percent of
Interest-bearing demand and
money market
Savings
Time deposits
Total interest-bearing deposits
Non-interest bearing demand
Total deposits
$
$
274,614
79,997
118,683
473,294
165,760
639,054
42% $
13%
19%
74%
26%
100% $
262,848
73,412
126,059
462,319
145,028
607,347
43% $
12%
21%
76%
24%
100% $
11,766
6,585
(7,376)
10,975
20,732
31,707
4% $
9%
-6%
2%
14%
5% $
232,607
62,493
138,005
433,105
115,138
548,243
43% $
11%
25%
79%
21%
100% $
30,241
10,919
(11,946)
29,214
29,890
59,104
13%
17%
-9%
7%
26%
11%
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.
De posi ts
(Dollars in T housands)
2014
Rat e
2013
Rat e
2012
Rat e
December 31,
December 31,
December 31,
Int erest -bearing demand (NOW)
Money market and savings deposit s
T ime, int erest deposit s (CD's)
T ot al int erest -bearing deposit s
Non-int erest bearing demand
T ot al deposit s
$
$
147,225 0.23% $
196,859 0.12%
122,002 0.89%
131,179 0.30% $
185,005 0.27%
135,447 0.98%
120,472 0.48%
168,512 0.30%
144,486 1.24%
466,086
451,631
433,470
158,697 0.00%
129,218 0.00%
107,048 0.00%
624,783 0.27% $
580,849 0.35% $
540,518 0.53%
Maturities of time certificates of deposit as of December 31, 2014 are summarized as follows:
(Dollars in T housands)
3 months or less
Over 3 through 6 months
Over 6 through 12 months
Over 12 months
Total time ce rtificate s
Under
$100,000
Over
$100,000
T otal
$
$
9,636 $
7,939
10,662
14,798
20,202 $
4,683
14,516
36,247
29,838
12,622
25,178
51,045
43,035 $
75,648 $
118,683
Short-Term Borrowings
The following is information regarding the Company's short-term borrowings for the years ended December 31, 2014, 2013 and 2012.
2014
2013
2012
Amount outstanding at end of period
Weighted average interest rate thereon
Maximum month-end balance during year
Average balance during the year
Average interest rate during the year
$
$
$
$
-
0.28%
-
$
153 $
0.28%
$
-
-
3,000 $
303 $
2.94%
3,000
2.94%
3,000
2,697
2.94%
39
CONTRACTUAL OBLIGATIONS
The Company is party to many contractual financial obligations at December 31, 2014, 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 for such obligations are due.
Less than
1 year
1-2
years
3-5
years
More than
5 years
Operating leases
T otal deposits
Federal home loan bank borrowings
Junior subordinated debentures
$
491 $
567 $
462 $
422,249
-
-
40,104
5,000
-
10,879
5,000
-
412 $
62
1,453
13,403
T otal
1,932
473,294
11,453
13,403
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 instruments. A summary of the Bank's
commitments at December 31 is as follows:
(Dollars in T housands)
December 31,
2014
December 31,
2013
Commitments to extend credit
Standby letters of credit
$
$
109,545
1,351
$
$
106,017
1,733
KEY FINANCIAL RATIOS
FINANCIAL PERFORMANCE OVERVIEW
For The Twe lve Months Ende d
Se le ctive pe rformance ratios
Return on average assets, annualized
Return on average equity, annualized
Dividend payout ratio
December
31, 2014
December
31, 2013
December
31, 2012
December
31, 2011
December
31, 2010
0.68%
6.92%
44%
0.55%
5.48%
55%
0.75%
7.28%
42%
0.44%
4.45%
0%
0.25%
2.77%
0%
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, 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.
40
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.
At December 31, 2014, the Bank had $11.5 million in outstanding borrowings against its $149.7 million in established borrowing capacity
with the FHLB, as compared to $10.0 million outstanding against a borrowing capacity of $143.1 million at December 31, 2013. The
Bank’s borrowing facility with the FHLB is subject to collateral and stock ownership requirements. The Bank also had an available
discount window primary credit line with the Federal Reserve Bank of San Francisco of approximately $52.9 million, subject to collateral
requirements, and $16.0 million from correspondent banks with no balance outstanding on any of these facilities.
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. In addition, the exercise of outstanding
warrants during 2013 provided a nonrecurring source of additional funds during that year. 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.
At December 31, 2014, two wholly-owned subsidiary grantor trusts established by the Company had issued and outstanding $13.4 million
of trust preferred securities (“TRUPs”). As of December 31, 2014 and 2013, interest payable on TRUPs totaled $40,000 and $40,000 in
each year, and is included in accrued interest payable on the balance sheet. For more information regarding the Company's issuance of
TRUPs, 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. 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 Company and its Bank subsidiary continue to satisfy the requirements to qualify as “well-capitalized” under regulatory guidelines.
Capital growth is provided primarily through earnings retention. Also, $1.2 million of additional capital was supplied in the current year
via the exercise at a price of $6.50 per share of warrants to purchase 185,000 shares of common stock originally issued in conjunction
with a private capital raise conducted in 2009. In general, capital ratios declined from December 31, 2013 due to the successful execution
of the Company’s growth strategy and shift in the balance sheet mix to higher risk-weighted loan assets.
The Board of Governors of the Federal Reserve System (“Federal Reserve”) and the FDIC have established minimum requirements for
capital adequacy for bank holding companies and state non-member banks. For more information on these topics, see the discussions
under the subheading “Capital Adequacy” in the section “Business” included in Item 1 of this Form 10-K for the year ended December
31, 2014.
The total risk based capital ratios of the Company include $13.4 million of junior subordinated debentures, all of which qualified as Tier 1
capital at December 31, 2014 and 2013, under guidance issued by the Federal Reserve. The Company expects to continue to rely on these
junior subordinated debentures as part of its regulatory capital.
41
The following table sets forth the minimum required capital ratios and actual ratios for December 31, 2014 and 2013.
(Dollars in T housands)
December
31, 2014
December
31, 2013
Change
Regulatory
Minimum to
be "Well
Capitalized"
greater than or equal to
Pacific Financial C orporation
Actual amount
T otal risk-based capital ratio
T ier 1 risk-based capital ratio
Leverage ratio
T angible common equity ratio
Bank of the Pacific
T otal risk-based capital ratio
T ier 1 risk-based capital ratio
Leverage ratio
13.61%
12.36%
9.80%
8.05%
13.52%
12.27%
9.73%
14.11%
12.85%
9.83%
7.74%
14.03%
12.78%
9.77%
(0.50)
(0.49)
(0.03)
0.31
(0.51)
(0.51)
(0.04)
10%
6%
5%
n/a
10%
6%
5%
Goodwill Valuation. Goodwill is assigned to reporting units for purposes of impairment 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, 2014,
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.
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 12.0%. 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 net income growth rate that approximated 23%; an asset growth of 4.4% in years
one through five; net interest margin ranging from 4.02% in the base year to 4.24% in year five; and a return on assets that ranged from
0.62% to 1.24%.
42
In applying the market approach method, the Company considered all banks that announced a sale between January 1, 2013 and June 30,
2014, with total assets under $5 billion and a return on assets greater than zero. This resulted in selecting 24 institutions which fit these
criteria. After selecting these 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.
The Company concluded its reporting unit had a fair value of $8.50 per share, or $86.6 million, after giving similar consideration to the
values derived from 1) the market approach of $8.20 per share weighted at 80%, and 2) the income approach of $9.67 per share million
weighted at 20%. This estimate compares to a carrying value of its reporting unit of $70.9 million. Accordingly, following step one of
the Company’s 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, a future impairment charge may be necessary if our stock
price declines, market values of others in the financial industry decrease, the Bank’s revenue falls, or there are significant adverse changes
in the operating environment for the financial industry.
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.
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.
43
The following table shows the dollar amount of interest sensitive assets and interest sensitive liabilities at December 31, 2014 and
differences between them for the maturity or repricing periods indicated.
At December 31, 2014
(Dollars in T housands)
Inte re st e arning asse ts
Loans, including loans held for sale
Investments and bank owned life insurance
Fed funds sold and interest bearing balances
with bank and interest bearing cd's
Federal home loan bank stock
Pacific coast bankers bank stock
Total inte re st e arnings asse ts
Inte re st be aring liabilitie s
Interest bearing demand deposits
Savings and money market deposits
T ime deposits
Borrowings
Junior subordinated debentures
Total inte re st be aring liabilitie s
Net interest rate sensitivity GAP
Cumulative interest rate sensitivity GAP
Cumulative interest rate sensitivity GAP
as a % of earnings assets
$
$
$
$
$
Due in one
year or less
Due after
one through
five years
Due after
five years
T otal
223,655 $
30,477
300,517 $
42,039
44,713 $
34,961
18,982
-
-
-
-
-
-
2,896
1,000
568,885
107,477
18,982
2,896
1,000
273,114 $
342,556 $
83,570 $
699,240
151,131 $
203,480
67,638
-
-
$
-
-
50,983
10,000
-
$
-
-
62
1,453
13,403
151,131
203,480
118,683
11,453
13,403
422,249 $
60,983 $
14,918 $
498,150
(149,135) $
281,573 $
132,438
68,652 $
201,090
201,090
21.51%
28.76%
Effects of Changing Prices. The results of operations and financial condition presented in this report are based on historical cost
information, and are not adjusted 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.
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
44
(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,
2014. 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, 2014, 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, 2014 that have materially affected, or are reasonable likely to materially affect, the Company's internal control over
financial reporting.
ITEM 9B. Other Information
None.
Part III
ITEM 10. Directors and Executive Officers of the Registrant
Information concerning directors and executive officers requested by this item is contained in the Company's Proxy Statement for its 2015
annual meeting of shareholders to be held on April 29, 2015 (“2015 Proxy Statement”), in the sections entitled "CURRENT EXECUTIVE
OFFICERS," "PROPOSAL NO. 1 – ELECTION OF DIRECTORS," and "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE" and is incorporated into this report by reference.
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.
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, Dan J. Tupper, Randy Rust, and Dwayne Carter. Messrs. Forcum,
Tupper, Rust and Carter are independent applying the definition of independence for audit committee members found in the Nasdaq
listing standards. Director John Van Dijk is considered independent per the Exchange Act rules, but as a former executive, 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 2015 Proxy Statement in the sections entitled "DIRECTOR
COMPENSATION FOR 2014" 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 2015 Proxy Statement in the section entitled "SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" and under the caption "Equity Compensation Plan Information" in the
section entitled "EXECUTIVE COMPENSATION."
45
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 2015 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 2014, are Douglas
Schermer (Chair), John Van Dijk, Gary Forcum and Randy Rognlin.
Information concerning director independence requested by this item is contained in the registrant's 2015 Proxy Statement in the section
entitled "PROPOSAL NO. 1 – ELECTION OF DIRECTORS" and is 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 2015 Proxy Statement and is incorporated into this report by reference.
Part IV
ITEM 15. Exhibits and Financial Statement Schedules
(a) (1) The following financial statements are filed below:
Report of Independent Registered Public Accounting Firm – BDO USA LLP
Report of Independent Registered Public Accounting Firm – Deloitte & Touche LLP
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Changes in Cash Flows
Notes to Consolidated Financial Statements
(a) (2) Schedules: None
(a) (3) Exhibits: See Exhibit Index immediately following the signature page.
46
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Pacific Financial Corporation
Aberdeen, Washington
We have audited the accompanying consolidated balance sheet of Pacific Financial Corporation as of December 31, 2014 and the related
consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for the period ended December 31,
2014. 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 audit.
We conducted our audit 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 audit 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 presentation of the financial statements. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Pacific Financial Corporation at December 31, 2014, and the results of its operations and its cash flows for the period ended December
31, 2014, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA LLP
Spokane, Washington
March 26, 2015
47
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 sheet of Pacific Financial Corporation and subsidiary (the “Company”) as of
December 31, 2013, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for
each of the two 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 the results of their operations and their cash flows for each of the two 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
48
PACIFIC FINANCIAL CORPORAT ION
CONSOLIDAT ED BALANCE SHEET S
(Dollars in T housands, except per share data)
ASSETS
Cash and cash equivalents:
Cash and due from banks
Interest-bearing deposits in banks
T otal cash and cash equivalents
Interest-bearing certificates of deposit (original maturities greater than 90 days)
Federal Home Loan Bank stock, at cost
Pacific Coast Bankers' Bank stock, at cost
Investment securities:
Investment securities available-for-sale, at fair market value
(amortized cost of $86,907 and $97,536)
Investment securities held-to-maturity, at amortized cost
(fair value of $1,852 and $2,158)
T otal invest ment securities
Loans held-for-sale
Loans, net of deferred loan fees
Allowance for loan losses
Loans, net
Premises and equipment, net of accumulated depreciation and amortization
Other real estate owned and foreclosed assets
Accrued interest receivable
Cash surrender value of life insurance
Goodwill
Other intangible assets
Other asset s
TO TAL ASSETS
LIABILITIES AND SHAREHO LDERS' EQ UITY
LIABILITIES
Deposits:
Demand
Interest-bearing demand and savings
T ime deposits
T otal deposits
Accrued interest payable
Short-t erm borrowings
Long-t erm borrowings
Junior subordinated debentures
Other liabilities
T otal liabilit ies
Preferred Stock, par value none
5,000,000 shares authorized, none outstanding
Common Stock, par value $1
25,000,000 shares authorized, 10,371,460 shares issued
and outstanding at 12/31/2014 and 10,182,083 at 12/31/2013
Additional paid-in-capital
Retained earnings
Accumulated other comprehensive loss
T otal shareholders' equity
December 31,
2014
December 31,
2013
$
14,782
$
16,255
31,037
2,727
2,896
1,000
12,214
23,734
35,948
2,727
3,013
-
87,440
96,144
$
$
1,829
89,269
5,786
563,099
(8,353)
554,746
16,303
999
2,348
18,742
12,168
1,439
5,347
2,132
98,276
7,765
504,666
(8,359)
496,307
16,790
2,771
2,307
18,237
12,168
1,481
7,249
744,807
$
705,039
$
165,760
354,611
118,683
639,054
145
-
11,453
13,403
8,269
672,324
145,028
336,260
126,059
607,347
167
-
10,000
13,403
6,985
637,902
-
-
10,371
42,991
19,256
(135)
72,483
10,182
41,817
16,507
(1,369)
67,137
TO TAL LIABILITIES AND SHAREHO LDERS' EQ UITY
$
744,807
$
705,039
See accompanying notes.
49
P ACIFIC FINANCIAL CORPORAT ION
CONSOLIDAT ED ST AT EMENT S OF INCOME
(Dollars in T housands, Except per Share Dat a)
INTERES T AND DIVIDEND INC O ME
Loans
Deposit s in banks and federal funds sold
Securit ies available for sale:
T axable
T ax-exempt
Securit ies held t o mat urit y:
T axable
T ax-exempt
FHLB & PCBB dividends
For t he Year Ended
December 31,
December 31,
December 31,
2014
2013
2012
$
26,937 $
24,401 $
89
1,261
749
8
81
33
114
769
798
10
198
-
25,635
84
756
711
14
295
-
T ot al int erest and dividend income
29,158
26,290
27,495
INTERES T EXPENSE
Deposit s:
Int erest -bearing demand and savings
T ime
Short -t erm borrowings
Long-t erm borrowings
Secured borrowings
Junior subordinat ed debent ures
T ot al int erest expense
Net int erest income
LO AN LO SS PRO VIS IO N (REC APTURE)
Net int erest income aft er loan loss provision (recapt ure)
NO N-INTERES T INC O ME
Service charges on deposit account s
Net (loss) gain on sale of ot her real est at e owned
Net gains from sales of loans
Net gains on sales of securit ies available for sale
Net ot her-than-t emporary impairment
Earnings on bank owned life insurance
Ot her operat ing income
T ot al non-int erest income
NO N-INTERES T EXPENSE
Salaries and employee benefit s
Occupancy
Equipment
Dat a processing
P rofessional services
Ot her real est at e owned writ e-downs
Ot her real est at e owned operat ing cost s
St at e t axes
FDIC and st at e assessment s
Ot her non-int erest expense
T ot al non-int erest expense
INC O ME BEFO RE PRO VISIO N FO R INC O ME TAXES
PRO VISIO N FO R INC O ME TAXES
Effe cti ve Tax Rate
NET INC O ME APPLIC ABLE TO C O MMO N SHAREHO LDERS
EARNINGS PER C O MMO N SHARE:
BAS IC
DILUTED
W EIGHTED AVERAGE S HARES O UTSTANDING:
BAS IC
DILUTED
581
1,087
1
215
-
241
2,125
27,033
300
26,733
1,809
(207)
3,686
88
(48)
505
2,246
8,079
17,118
2,006
1,050
2,009
745
67
238
417
491
4,014
28,155
6,657
1,730
25.99%
700
1,320
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
2,268
935
946
408
458
535
4,240
29,502
4,703
972
20.67%
1,084
1,798
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
1,607
750
1,314
550
518
610
4,379
28,417
6,085
1,300
21.36%
$
$
$
4,927 $
3,731 $
4,785
0.48
0.48
$
$
0.37
0.37
$
$
0.47
0.47
10,256,242
10,347,338
10,121,738
10,189,888
10,121,853
10,126,244
See accompanying notes.
50
PACIFIC FINANCIAL CORPORAT ION
CONSOLIDAT ED ST AT EMENT S OF COMPREHENSIVE INCOME
(Dollars in T housands)
For the Year Ended
December 31,
December 31,
December 31,
2014
2013
2012
NET INC O ME
O THER CO MPREHENSIVE INCO ME (LO SS), NET O F TAX:
Change in fair value of securities available-for-sale
Defined benefit plan
T otal other comprehensive income (loss), net of tax
CO MPREHENSIVE INCO ME
$
$
4,927
$
3,731
$
4,785
1,269
(35)
1,234
(1,875)
85
(1,790)
536
130
666
6,161
$
1,941
$
5,451
See accompanying notes.
51
PACIFIC FINANCIAL CORPORAT ION
CONSOLIDAT ED ST AT EMENT S OF CHANGES IN SHAREHOLDERS' EQUIT Y
(Dollars in T housands, Except Share Amounts)
Common Stock
Shares
Amount
Additional
Paid-in Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income/(Loss)
BALANC E - Dece mbe r 31, 2011
10,121,853
$
10,122 $
41,342 $
12,051 $
(245) $
Net income
Other comprehensive income, net of tax
Unrealized holding gain on securities less reclassification
adjustments for net gains included in net income
Amortization of unrecognized prior service costs and
net gains
Dividend paid ($0.20 per share)
Stock-based compensation expense
BALANC E - Dece mbe r 31, 2012
Net income
Other comprehensive income, net of tax
Unrealized holding loss on securities less reclassification
adjustments for net gains included in net income
Amortization of unrecognized prior service costs and
net gains
Issuance of common stock
Dividend declared ($0.20 per share)
Stock-based compensation expense
BALANC E - Dece mbe r 31, 2013
Net income
Other comprehensive income, net of tax
Unrealized holding gain on securities less reclassification
adjustments for net gains included in net income
Amortization of unrecognized prior service costs and
net gains
Issuance of common stock
Dividend declared ($0.21 per share)
Stock-based compensation expense
BALANC E - Dece mbe r 31, 2014
T otal
Shareholders'
Equity
63,270
4,785
536
130
(2,024)
24
66,721
-
-
-
-
-
-
-
-
-
-
-
-
-
10,121,853
$
-
10,122 $
24
41,366 $
4,785
-
-
(2,024)
-
14,812 $
-
536
130
-
-
421 $
-
-
-
60,230
-
-
-
-
60
-
-
-
-
334
-
-
10,182,083
$
-
10,182 $
117
41,817 $
-
-
-
189,377
-
-
-
-
189
-
-
10,371,460
$
-
10,371 $
-
-
-
1,035
-
139
42,991 $
3,731
-
3,731
-
-
-
(2,036)
-
16,507 $
(1,875)
(1,875)
85
-
-
-
(1,369) $
85
394
(2,036)
117
67,137
4,927
-
4,927
-
-
-
(2,178)
-
19,256 $
1,269
1,269
(35)
-
-
-
(135) $
(35)
1,224
(2,178)
139
72,483
See accompanying notes.
52
PACIFIC FINANCIAL CORPORAT ION AND SUBSIDIARY
CONSOLIDAT ED ST AT EMENT S OF CASH FLOWS
(Dollars in T housands)
C ASH FLO W S FRO M O PERATING AC TIVITIES
Net Income
Adjust ment s t o reconcile net income t o net cash from operat ing act ivit ies
December 31,
2014
For t he Year Ended
December 31,
2013
December 31,
2012
$
4,927
$
3,731
$
4,785
Provision for (recapt ure of) credit losses
Depreciat ion and amort izat ion
Deferred income t axes
Originat ions of loans held for sale
Proceeds from sales of loans held for sale
Net gain on sales of loans
Net gain on sales of securit ies available for sale
Net OT T I recognized in earnings
Loss (gain) on sales of ot her real est at e owned
(Gain) loss on sale of premises and equipment
Earnings on bank owned life insurance
(Increase) decrease in accrued int erest receivable
Decrease in accrued int erest payable
Ot her real est at e owned writ e-downs
Addit ions t o ot her real est at e owned
Decrease in prepaid expenses
Ot her operat ing act ivit ies
300
2,538
727
(150,899)
155,846
(3,546)
(88)
48
207
(2)
(505)
(41)
(22)
67
-
12
1,791
(450)
2,328
386
(225,068)
234,194
(5,171)
(405)
37
(40)
36
(452)
(228)
(48)
946
-
2,157
1,003
Net cash provided by operat ing act ivit ies
11,360
12,956
C ASH FLO W S FRO M INVESTING AC TIVITIES
Net decrease (increase) in int erest bearing balances wit h banks
Net decrease (increase) in cert ificat es of deposit s held for invest ment
Act ivit y in securit ies available for sale:
Sales
Mat urit ies, prepayment s and calls
Purchases
Act ivit y in securit ies held t o mat urit y:
Mat urit ies, prepayment s and calls
Purchases
P roceeds from sales of government loan pools
(Increase) decrease in loans made t o cust omers, net of principal collect ions
P urchases of premises and equipment
P roceeds from sales of ot her real est at e owned
Cash received in acquisit ion, net of cash paid
7,479
-
17,755
8,623
(17,711)
303
-
2,541
(60,809)
(848)
1,527
-
18,953
258
7,832
11,265
(57,521)
4,804
-
6,266
(60,004)
(2,728)
2,660
31,941
(1,100)
1,491
63
(251,435)
256,720
(5,058)
(303)
333
(331)
(6)
(510)
77
(1,277)
1,314
(185)
374
288
5,240
(14,162)
(2,985)
10,917
10,451
(34,194)
286
(200)
1,296
24,105
(844)
4,223
-
Net cash used in invest ing act ivit ies
(41,140)
(36,274)
(1,107)
C ASH FLO W S FRO M FINANC ING AC TIVITIES
Net increase in deposit s
Net decrease in short -t erm borrowings
Decrease in secured borrowings
P roceeds from issuance of long-t erm debt
Repayment s of long-t erm debt
Issuance of common st ock
Cash dividends paid
Net cash provided by (used in) financing act ivit ies
NET (DEC REASE) INC REAS E IN C AS H AND C ASH EQ UIVALENTS
C ASH AND DUE FRO M BANKS - BEGINNING O F THE PERIO D
C ASH AND DUE FRO M BANKS - END O F THE PERIO D
S UPPLEMENTAL DIS C LO S URES O F C ASH FLO W INFO RMATIO N
Cash paid for int erest
Cash paid for t axes
S UPPLEMENTAL S C HEDULE O F NO N C ASH INVESTING AND
FINANC ING AC TIVITIES
Change in fair value of securit ies available-for-sale, net of t ax
T ransfer of loans held for sale t o loans held for invest ment
Ot her real est at e owned acquired in set t lement of loans
Reclass of current port ion of long-t erm borrowings t o short -t erm borrowings
Financed sale of ot her real est at e owned
31,707
-
-
1,500
(47)
1,224
(2,036)
32,348
2,568
12,214
14,782
2,147
643
920
578
(842)
-
813
$
$
$
$
$
$
$
$
21,470
(3,000)
-
2,500
-
394
-
21,364
(1,954)
14,168
12,214
2,536
690
(1,875)
986
(1,756)
-
98
$
$
$
$
$
$
$
$
193
-
(741)
2,500
(2,500)
-
(2,024)
(2,572)
1,561
12,607
14,168
4,761
1,998
536
1,295
(2,897)
3,000
922
$
$
$
$
$
$
$
$
See accompanying notes.
53
Pacific Financial Corporation and Subsidiary
December 31, 2014 and 2013 and for the three years ended December 31, 2014, 2013 and 2012
Notes to Consolidated Financial Statements, Dollars in Thousands Except Per Share Amounts
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization – Pacific Financial Corporation (the “Company” or “Pacific”) is a bank holding company headquartered in Aberdeen,
Washington. The Company owns one banking subsidiary, Bank of the Pacific (the “Bank”), which is also headquartered in Washington.
The Company was incorporated in the State of Washington in February, 1997, pursuant to a holding company reorganization of the Bank.
The Company 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.
The Company conducts its banking business through the Bank, which operates 17 branches located in communities in Grays Harbor,
Pacific, Whatcom, Clark, Skagit and Wahkiakum counties in the state of Washington and three in Clatsop County, Oregon. In addition,
the Bank operates two loan production offices in Burlington and Dupont, 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 $37.6 million and loans acquired totaled $4.0 million. 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.
Basis of presentation – The consolidated financial statements include the accounts of Pacific Financial Corporation and its wholly-
owned subsidiary. All intercompany accounts and transactions have been eliminated in consolidation.
The interim consolidated financial statements are not audited, but include all adjustments that Management considers necessary for a fair
presentation of consolidated financial condition and results of operations for the interim periods presented.
Method of accounting and use of estimates – The Company prepares its consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. This
requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses
during the reporting periods. Actual results could differ from those estimates. Significant estimates made by Management involve the
calculation of the allowance for loan losses, impaired loans, the fair value of available-for-sale investment securities, deferred tax assets,
and the value of other real estate owned and foreclosed assets.
The Company utilizes the accrual method of accounting, which recognizes income when earned and expenses when incurred.
In preparing these financial statements, the Company has evaluated events and transactions subsequent to December 31, 2014, for
potential recognition or disclosure in the financial statements. In Management’s opinion, all accounting adjustments necessary to
accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These
adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation.
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
income (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.
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 component. Noncredit component 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.
54
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, 2014, future deterioration of the FHLB’s financial condition may result in
future impairment losses.
Pacific Coast Bankers Bank Stock -- The Company’s investment in Pacific Coast Bankers Bank (“PCBB”) stock is carried at cost.
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 loan 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.
Allowance for loan losses -- The allowance for loan 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 loan 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
loan 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.
For all portfolio segments, a restructuring of a debt constitutes a troubled debt restructuring (“TDR”) if the Company grants a concession
to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider.
Restructured workout loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the
55
original contractual terms. Loans or leases that are reported as TDRs are considered impaired and measured for impairment as described
above.
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 loan 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.
Goodwill and other intangible assets -- At December 31, 2014 the Company had $13,607 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, 2014 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 $171 and $213 at December 31, 2014 and 2013, respectively. Amortization expense related to core deposit intangible
totaled $43 and $28 during the years ended December 31, 2014 and 2013, respectively.
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.
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
56
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, 2014, 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 income. There were no amounts related to interest and
penalties recognized for the year ended December 31, 2014. The tax years that remain subject to examination by federal and state taxing
authorities are the years ended December 31, 2013, 2012 and 2011.
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 15.
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 361,545, 436,495, and 532,106 in 2014, 2013 and 2012, respectively. Outstanding
warrants also excluded were 0, 638,920, and 699,642 for the years ended 2014, 2013, and 2012, respectively.
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, 2014,
2013 and 2012.
Recent Accounting Pronouncements -- 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 disclosures required from
adoption of this ASU have been included in these financial statements.
In January 2014, FASB issued ASU 2014-04, “Receivables – Troubled Debt Restructurings by Creditors – Reclassification of Residential
Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure”. ASU 2014-04 clarifies when banks and similar institutions
(creditors) should reclassify mortgage loans collateralized by residential real estate properties from the loan portfolio to other real estate
owned (OREO). The ASU also requires certain interim and annual disclosures. ASU 2014-04 is effective for interim and annual periods
beginning after December 15, 2014. The Company does not anticipate that the adoption of this standard will have a material effect on its
financial statements.
In May 2014, FASB issued ASU 2014-09, “Revenue from Contracts with Customers”. Under this Update, FASB created a new Topic
606 which is in response to a joint initiative of FASB and the International Accounting Standards Board to clarify the principles for
57
recognizing revenue and to develop a common revenue standard for U.S. GAAP and international financial reporting standards that
would:
1. Remove inconsistencies and weaknesses in revenue requirements.
2. Provide a more robust framework for addressing revenue issues.
3. Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.
4. Provide more useful information to users of financial statements through improved disclosure requirements.
5. Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The amendments in this Update are effective for annual reporting periods beginning after December 15, 2016, including interim periods
within that reporting period. Early application is not permitted. The Company is currently evaluating the impact that this Update will
have on its consolidated financial position, results of operations or cash flows.
In August 2014, FASB issued ASU 2014-14, “Receivables- Troubled Debt Restructurings by Creditors; Classification of Certain
Government-Guaranteed Mortgage Loans Upon Foreclosure”. This ASU will require creditors to derecognize certain foreclosed
government-guaranteed mortgage loans and to recognize a separate other receivable that is measured at the amount the creditor expects to
recover from the guarantor, and to treat the guarantee and the receivable as a single unit of account. ASU 2014-14 is effective for interim
and annual periods beginning after December 15, 2014. The Company does not anticipate that the adoption of this standard will have a
material effect on its 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,
2014 and 2013 was approximately $1,031 and $953, respectively.
58
NOTE 3 - SECURITIES
Investment securities consist principally of short and intermediate term debt instruments issued by the U.S. Treasury, other U.S.
government agencies, state and local 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:
Investment securities at December 31, 2014 and December 31, 2013 consisted of the following:
(Dollars in T housands)
Available-for-sale:
Collateralized mortgage obligations: agency issued
Collateralized mortgage obligations: non-agency
Mortgage-backed securities: agency issued
U.S. Government and agency securities
State and municipal securities
T otal available-for-sale
Held-to-maturity:
Mortgage-backed securities: agency issued
State and municipal securities
T otal held-to-maturity
Available-for-sale:
Collateralized mortgage obligations: agency issued
Collateralized mortgage obligations: non agency
Mortgage-backed securities: agency issued
U.S. Government agency securities
State and municipal securities
Corporate bonds
T otal available-for-sale
Held-to-maturity:
Mortgage-backed securities: agency issued
State and municipal securities
T otal held-to-maturity
Amortized
cost
December 31, 2014
Gross
unrealized
gains
Gross
unrealized
losses
Fair
value
$
$
$
$
$
$
$
$
$
38,949
535
12,325
7,977
27,121
$
236
-
39
111
850
$
418
8
165
32
80
86,907
$
1,236
$
703
$
123
$
1,706
1,829
$
12
11
23
$
$
-
-
-
Amortized
cost
December 31, 2013
Gross
unrealized
gains
Gross
unrealized
losses
$
39,791
2,251
13,671
8,859
31,973
991
$
246
3
21
34
774
-
1,246
243
303
82
587
9
$
$
$
97,536
$
1,078
$
2,470
$
159
$
1,973
2,132
$
13
13
26
$
$
-
-
-
$
$
38,767
527
12,199
8,056
27,891
87,440
135
1,717
1,852
Fair
value
38,791
2,011
13,389
8,811
32,160
982
96,144
172
1,986
2,158
59
Unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in continuous
unrealized loss position, as of December 31, 2014, and December 31, 2013, are summarized as follows:
(Dollars in T housands)
At December 31, 2014
Available-for-sale:
Less than 12 months
12 months or more
T otal
Fair Value
Unrealized
Losses
Unrealized
Fair Value
Losses
Fair Value
Unrealized
Losses
Collateralized mortgage obligations: agency issued
$
5,836 $
27 $
17,446 $
391 $
23,282 $
Collateralized mortgage obligations: non agency
Mortgage-backed securities: agency issued
U.S. Government agency securities
State and municipal securities
T otal
335
2,883
-
2
80
-
192
6,888
3,615
6
85
32
527
9,771
3,615
5,123
14,177 $
$
41
150 $
3,054
31,195 $
39
553 $
8,177
45,372 $
418
8
165
32
80
703
At December 31, 2013
Available-for-sale:
Less than 12 months
12 months or more
T otal
Fair Value
Unrealized
Losses
Unrealized
Fair Value
Losses
Fair Value
Unrealized
Losses
Collateralized mortgage obligations: agency issued
$
21,043
$
778
$
6,265
$
Collateralized mortgage obligations: non agency
Mortgage-backed securities: agency issued
U.S. Government agency securities
State and municipal securities
Corporate bonds
T otal
389
7,752
5,550
11,551
982
27
218
82
485
9
1,619
2,643
-
1,821
-
468
216
85
-
102
-
$
27,308
$
1,246
2,008
10,395
5,550
13,372
982
243
303
82
587
9
$
47,267
$
1,599
$
12,348
$
871
$
59,615
$
2,470
At December 31, 2014, there were 56 investment securities in an unrealized loss position, of which 38 were in a continuous loss position
for 12 months or more. The unrealized losses on these securities were caused by changes in interest rates, widening pricing spreads and
market illiquidity, leading to a decline in the fair value subsequent to their purchase. The Company has evaluated the securities shown
above and anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable
market environment. Based on management’s evaluation, and because the Company does not have the intent to sell these securities and it
is not more likely than not that it will have to sell the securities before recovery of cost basis, the Company does not consider these
investments to be other-than-temporarily impaired at December 31, 2014.
For collateralized mortgage obligations (“CMO”) the Company estimates expected future cash flows of the underlying collateral, together
with any credit enhancements. The expected future cash flows of the underlying collateral are determined using the remaining contractual
cash flows adjusted for future expected credit losses (which considers current delinquencies, future expected default rates and collateral
value by vintage) and prepayments. The expected cash flows of the security are then discounted to arrive at a present value amount. For
the twelve months ended December 31, 2014, no CMO was determined to be other-than-temporarily-impaired. For the twelve months
ended December 31, 2013, one CMO was determined to be other-than-temporarily-impaired. This security was sold in second quarter
2014, incurring a loss of $69,000. The Company recorded $48,000, $37,000, and $333,000 in impairments related to credit losses through
earnings for the twelve months ended December 31, 2014, 2013, and 2012 respectively.
The following table presents the cash proceeds from the sales of securities and their associated gross realized gains and gross realized
losses that are included in earnings for the twelve months ended December 31, 2014, 2013, and 2012:
Investment securities gross gains and losses
(Dollars in T housands)
Gross realized gain on sale of securities
Gross realized loss on sale of securities
Net realized gain on sale of securities
Proceeds from sale of securities
$
$
$
December 31,
2014
For the Year Ended
December 31,
2013
December 31,
2012
315 $
(227)
88 $
448 $
(43)
405 $
332
(29)
303
17,755 $
7,832 $
10,917
60
The Company did not engage in originating subprime mortgage loans, and it does not believe that it has material exposure to subprime
mortgage loans or subprime mortgage backed securities. Additionally, the Company does not own any sovereign debt of Eurozone
nations or structured financial products, such as collateralized debt obligations or structured investment vehicles, which are known by the
Company to have elevated risk characteristics.
The amortized cost and estimated fair value of investment securities at December 31, 2014, by maturity are shown below. The amortized
cost and fair value of collateralized mortgage obligations and mortgage-backed securities are presented by expected average life, rather
than contractual maturity. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay
underlying loans without prepayment penalties.
At December 31, 2014
(Dollars in T housands)
Held-to-maturity
Available-for-sale
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Declining Balance Securities
T otal investment securities
$
$
$
-
-
889
817
123
-
-
899
818
135
$
325 $
8,636
12,903
13,234
51,809
329
8,662
13,160
13,796
51,493
1,829 $
1,852
$
86,907 $
87,440
At December 31, 2014 and 2013, investment securities with an estimated fair value of $84.1 million and $57.4 million, respectively, were
pledged to secure public deposits, certain nonpublic deposits and borrowings.
As required of all members of the Federal Home Loan Bank (“FHLB”) system, the Company maintains an investment in the capital stock
of the FHLB in an amount equal to the greater of $500,000 or 0.5% of home mortgage loans and pass-through securities plus 5.0% of the
outstanding balance of mortgage home loans sold to FHLB under the Mortgage Purchase Program. The FHLB system, the largest
government sponsored entity in the United States, is made up of 12 regional banks, including the FHLB of Seattle. Participating banks
record the value of FHLB stock equal to its par value at $100 per share. At December 31, 2014 and 2013, the Company held
approximately $2.9 million and 3.0 million, respectively, in FHLB stock.
The Company is required to hold FHLB’s stock in order to receive advances and views this investment as long-term. Thus, when
evaluating it for impairment, the value is determined based on the recovery of the par value through redemption by the FHLB or from the
sale to another member, rather than by recognizing temporary declines in value. The FHLB of Seattle disclosed that it reported net income
for the twelve month period ended December 31, 2014, at which time it declared a cash dividend. On November 22, 2013, the FHLB of
Seattle entered into an amended Stipulation and Consent to the Issuance of a Consent Order with the Federal Housing Finance Agency
(“Finance Agency”), modifying the previous order issued on October 25, 2010. The Finance Agency now deems the FHLB of Seattle to
be “adequately capitalized” under the Finance Agency’s Prompt Corrective Action rule. The Company has concluded that its investment
in FHLB is not impaired as of December 31, 2014, and believes that it will ultimately recover the par value of its investment in this stock.
The Company owns $1.0 million in common stock in Pacific Coast Bankers’ Bancshares (PCBB), from which the Company receives a
variety of corresponding banking services through its banking subsidiary Pacific Coast Bankers Bank. An investment by the Company in
such an entity is permissible under 12 CFR 362.3(a)(2)(iv). When evaluating this investment for impairment, the value is determined
based on the recovery of the par value through any redemption by PCBB or from the sale to another eligible purchaser, rather than by
recognizing temporary declines in value. PCBB disclosed that it reported net income for the twelve month period ended December 31,
2014 and maintains capital ratios that exceed “well capitalized” standards for regulatory purposes.
61
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY
Loans
Loans held in the portfolio at December 31, 2014 and December 31, 2013, are as follows:
(Dollars in T housands)
December
31, 2014
December
31, 2013
Commercial and agricultural
$
120,517
$
104,111
Real estate:
Construction and development
Residential 1-4 family
Multi-family
Commercial real estate -- owner occupied
Commercial real estate -- non owner occupied
Farmland
Consumer
Gross loans
Less: deferred fees
26,711
92,965
18,541
125,632
117,137
22,245
40,565
564,313
(1,214)
29,096
87,762
17,520
105,594
117,294
23,698
20,728
505,803
(1,137)
Portfolio Loans
$
563,099
$
504,666
Allowance for loan losses and credit quality
The allowance for loan losses represents the Company’s estimate as to the probable credit losses inherent in its loan portfolio. The
allowance for loan losses is increased through periodic charges to earnings through provision for loan losses and represents the aggregate
amount, net of loans charged-off and recoveries on previously charged-off loans, that is needed to establish an appropriate reserve for
credit losses. The allowance is estimated based on a variety of factors and using a methodology as described below:
(cid:2) The Company classifies loans into relatively homogeneous pools by loan type in accordance with regulatory guidelines for
regulatory reporting purposes. The Company regularly reviews all loans within each loan category to establish risk ratings
for them that include Pass, Watch, Special Mention, Substandard, Doubtful and Loss. Pursuant to ASC 310 “Accounting by
Creditors for Impairment of a Loan”, the impaired portion of collateral dependent loans is charged-off. Other risk-related
loans not considered impaired have loss factors applied to the various loan pool balances to establish loss potential for
provisioning purposes.
(cid:2) Analyses are performed to establish the loss factors based on historical experience, as well as expected losses based on
qualitative evaluations of such factors as the economic trends and conditions, industry conditions, levels and trends in
delinquencies and impaired loans, levels and trends in charge-offs and recoveries, among others. The loss factors are applied
to loan category pools segregated by risk classification to estimate the loss inherent in the Company’s loan portfolio
pursuant to ASC 450 “Accounting for Contingencies.”
(cid:2) Additionally, impaired loans are evaluated for loss potential on an individual basis in accordance with ASC 310
“Accounting by Creditors for Impairment of a Loan,” and specific reserves are established based on thorough analysis of
collateral values where loss potential exists. When an impaired loan is collateral dependent and a deficiency exists in the fair
value of collateral securing the loan in comparison to the associated loan balance, the deficiency is charged-off at that time
or a specific reserve is established. Impaired loans are reviewed no less frequently than quarterly.
(cid:2)
In the event that a current appraisal to support the fair value of the real estate collateral underlying an impaired loan has not
yet been received, but the Company believes that the collateral value is insufficient to support the loan amount, an
impairment reserve is recorded. In these instances, the receipt of a current appraisal triggers an updated review of the
collateral support for the loan and any deficiency is charged-off or reserved at that time. In those instances where a current
appraisal is not available in a timely manner in relation to a financial reporting cut-off date, the Company discounts the most
recent third-party appraisal depending on a number of factors including, but not limited to, property location, local price
volatility, local economic conditions, and recent comparable sales. In all cases, the costs to sell the subject property are
deducted in arriving at the fair value of the collateral.
62
Changes in the allowance for loan losses for the twelve months ended December, 2014 and 2013 were as follows:
Allowance for Loan Losses
Dollars in Thousands
Commercial Real
Residential
Commercial
Estate ("CRE")
Real Estate
Consumer
Unallocated
Total
For the twelve months ended December 31, 2014
Beginning balance
Charge-offs and concessions
Recoveries
Provision / (recapture)
Ending balance
$
$
775 $
(26)
11
262
3,506 $
(533)
425
21
675 $
(129)
22
133
744 $
(79)
3
311
2,659 $
-
-
(427)
1,022 $
3,419 $
701 $
979 $
2,232 $
8,359
(767)
461
300
8,353
Allowance for Loan Losses
Dollars in Thousands
Commercial
Commercial Real
Estate ("CRE")
Residential
Real Estate
Consumer
Unallocated
Total
For the twelve months ended December 31, 2013
Beginning balance
Charge-offs and concessions
Recoveries
Provision / (recapture)
Ending balance
$
$
923 $
(131)
36
(53)
775 $
4,098 $
(90)
226
(728)
829 $
(453)
14
285
531 $
(154)
3
364
2,977 $
-
-
(318)
3,506 $
675 $
744 $
2,659 $
9,358
(828)
279
(450)
8,359
Recorded investment in loans as of December 31, 2014 and 2013 are as follows:
Schedule of Loan Losses Related to Financing Receivables Current and Noncurrent
Dollars in Thousands
As of December 31, 2014
Allowance for Loan Losses:
Ending balance: individually evaluated
for impairment
Ending balance: collectively evaluated
for impairment
Total allowance for loan losses
Loans:
Ending balance: individually evaluated
for impairment
Ending balance: collectively evaluated
for impairment
Ending balance
Less deferred fees
Ending balance total loans
$
$
$
$
$
Commercial
Commercial Real
Estate ("CRE")
Residential
Real Estate
Consumer
Unallocated
Total
-
$
1,022
1,022 $
249 $
-
$
-
$
-
$
3,170
3,419 $
701
701 $
979
979 $
2,232
2,232 $
380 $
9,864 $
1,067 $
-
$
120,137 $
281,861 $
110,439 $
40,565 $
120,517 $
291,725 $
111,506 $
40,565 $
-
-
-
$
$
$
$
$
63
249
8,104
8,353
11,311
553,002
564,313
(1,214)
563,099
Schedule of Loan Losses Related to Financing Receivables Current and Noncurrent
Dollars in Thousands
As of December 31, 2013
Allowance for Loan Losses:
Ending balance: individually evaluated
for impairment
Ending balance: collectively evaluated
for impairment
Total allowance for loan losses
Loans:
Ending balance: individually evaluated
for impairment
Ending balance: collectively evaluated
for impairment
Ending balance
Less deferred fees
Ending balance total loans
Credit Quality Indicators
$
$
$
$
$
$
Commercial
Commercial Real
Estate ("CRE")
Residential
Real Estate
Consumer
Unallocated
Total
-
$
775 $
775 $
-
$
-
$
-
$
-
$
-
3,506 $
3,506 $
675 $
675 $
744 $
744 $
2,659 $
2,659 $
8,359
8,359
587 $
8,656 $
626 $
53 $
103,524 $
267,026 $
104,656 $
20,675 $
104,111 $
275,682 $
105,282 $
20,728 $
-
-
-
$
$
$
$
$
9,922
495,881
505,803
(1,137)
504,666
Federal regulations require that the Bank periodically evaluate the risks inherent in its loan portfolios. In addition, the Washington
Division of Banks and the Federal Deposit Insurance Corporation (“FDIC”) have authority to identify problem loans and, if appropriate,
require them to be reclassified. There are three classifications for problem loans: Substandard, Doubtful, and Loss. These terms are used
as follows:
(cid:2) “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.
(cid:2) “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."
(cid:2) “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 loan losses, thereby reducing that reserve.
The Bank also classifies some loans as “Pass” or Other Loans Especially Mentioned (“OLEM”). Within the Pass classification certain
loans are “Watch” rated because they have elements of risk that require more monitoring than other performing loans. Pass grade loans
include a range of loans from very high credit quality to acceptable credit quality. These borrowers generally have strong to acceptable
capital levels and consistent earnings and debt service capacity. Loans with higher grades within the Pass category may include
borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Overall, loans with a
Pass grade show no immediate loss exposure. Loans classified as OLEM continue to perform but have shown deterioration in credit
quality and require close monitoring.
64
Credit quality indicators as of December 31, 2014 and December 31, 2013 were as follows:
(Dollars in T housands)
December 31, 2014
Other Loans
Especially
Mentioned
Pass
Substandard
Doubtful
T otal
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
T otal real estate
Consumer
Less deferred fees
$
111,800 $
6,354 $
2,363 $
$
-
120,517
25,696
89,183
18,274
117,444
94,068
20,130
364,795
40,436
-
50
684
267
1,717
17,587
1,862
22,167
82
-
965
3,098
-
6,471
5,233
253
16,020
47
-
-
-
-
-
249
-
249
-
-
26,711
92,965
18,541
125,632
117,137
22,245
403,231
40,565
(1,214)
T otal loans
$
517,031 $
28,603 $
18,430 $
249 $
563,099
December 31, 2013
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
T otal real estate
Consumer
Less deferred fees
Other Loans
Especially
Mentioned
Pass
Substandard
Doubtful
T otal
$
100,262 $
2,858 $
991 $
$
-
104,111
26,587
84,407
17,520
100,612
98,044
20,228
347,398
20,570
-
1,101
554
-
1,019
16,752
2,464
21,890
62
-
1,408
2,801
-
3,963
2,498
1,006
11,676
96
-
-
-
-
-
-
-
-
-
-
29,096
87,762
17,520
105,594
117,294
23,698
380,964
20,728
(1,137)
T otal loans
$
468,230 $
24,810 $
12,763 $
$
-
504,666
65
Impaired Loans
Impaired loans by type as of December 31, 2014, and interest income recognized for the twelve months ended December 31, 2014, were
as follows:
(Dollars in T housands)
December 31, 2014
With no Related Allowance:
Commercial
Consumer
Residential real estate
Commercial real estate:
CRE -- owner occupied
CRE -- non owner occupied
Farmland
Construction and development
T otal
With a Related Allowance:
Consumer
Residential real estate
CRE -- non owner occupied
T otal
T otal Impaired Loans:
Commercial
Consumer
Residential real estate
Commercial real estate:
CRE -- owner occupied
CRE -- non owner occupied
Farmland
Construction and development
T otal Impaired Loans
Unpaid
Principal
Balance
Recorded
Investment
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$
$
$
$
$
$
418 $
-
1,359
1,381
7,642
-
3,023
13,823 $
$
-
-
249
249 $
418 $
-
1,359
1,381
7,891
-
3,023
14,072 $
380 $
-
1,067
1,379
7,271
-
965
11,062 $
$
-
-
249
249 $
380 $
-
1,067
1,379
7,520
-
965
11,311 $
$
$
$
-
-
-
-
-
-
-
-
-
-
249
249 $
$
-
-
249
-
-
-
-
249 $
439 $
53
866
1,662
4,705
716
1,201
9,642 $
$
-
-
83
83 $
439 $
53
866
1,662
4,788
716
1,201
9,725 $
19
58
-
-
45
225
57
404
-
-
-
-
19
-
58
-
45
225
57
404
66
Impaired loans by type as of December 31, 2013, and interest income recognized for the twelve months ended December 31, 2013, were
as follows:
(Dollars in T housands)
December 31, 2013
With no Related Allowance:
Commercial
Consumer
Residential real estate
Commercial real estate:
CRE -- owner occupied
CRE -- non owner occupied
Farmland
Construction and development
T otal
With a Related Allowance:
Consumer
Residential real estate
CRE -- non owner occupied
T otal
T otal Impaired Loans:
Commercial
Consumer
Residential real estate
Commercial real estate:
CRE -- owner occupied
CRE -- non owner occupied
Farmland
Construction and development
T otal Impaired Loans
Insider Loans
Unpaid
Principal
Balance
Recorded
Investment
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$
$
$
$
$
$
608 $
53
815
1,714
6,776
955
3,685
14,606 $
-
-
-
-
$
$
608 $
53
815
1,714
6,776
955
3,685
14,606 $
587 $
53
626
1,714
4,579
955
1,408
9,922 $
-
-
-
-
$
$
587 $
53
626
1,714
4,579
955
1,408
9,922 $
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
$
$
$
$
$
1,270 $
11
1,045
2,482
5,195
959
1,582
12,544 $
2 $
40
42 $
-
1,270 $
13
1,085
2,482
5,195
959
1,582
12,586 $
9
1
25
24
40
-
78
177
-
-
-
-
9
1
25
24
40
-
78
177
Certain related parties of the Company, principally directors and their affiliates, were loan customers of the Bank in the ordinary course of
business during 2014 and 2013. Total related party loans outstanding at December 31, 2014 and 2013 to executive officers and directors
were $2,374 and $66, respectively. During 2014 and 2013, new loans of $3,758 and $5, respectively, were made, and repayments totaled
$1,450 and $324, 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,
2014.
67
Aging Analysis
The following tables summarize the Company’s loans past due, both accruing and nonaccruing, by type as of December 31, 2014 and
December 31, 2013:
(Dollars in T housands)
December 31, 2014:
30-59 Days
Past Due
60-89 Days
Past Due
Greater
Than
90 Days
Total Past
Due
Non-accrual
Loans
Current
Total
Loans
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
Total real estate
Consumer
Less deferred fees
Total
December 31, 2013:
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
Total real estate
Consumer
Less deferred fees
Total
$
$
18
537
-
-
-
46
601
170
-
771 $
14 $
-
333
-
-
-
875
1,208
165
-
$
1,387 $
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
-
$
-
$
96 $
120,421 $
120,517
68
68
2
70 $
$
3
3 $
-
-
-
409
-
-
409
-
18
605
-
409
-
46
1,078
172
965
848
-
1,325
5,482
-
8,620
-
-
409 $
-
1,250 $
-
8,716 $
25,728
91,512
18,541
123,898
111,655
22,199
393,533
40,393
(1,214)
553,133 $
26,711
92,965
18,541
125,632
117,137
22,245
403,231
40,565
(1,214)
563,099
-
-
-
-
-
-
-
-
-
-
-
$
14 $
286 $
103,811 $
104,111
-
333
-
-
-
875
1,208
168
-
1,408
400
-
1,659
2,482
955
6,904
53
-
27,688
87,029
17,520
103,935
114,812
21,868
372,852
20,507
(1,137)
$
1,390 $
7,243 $
496,033 $
29,096
87,762
17,520
105,594
117,294
23,698
380,964
20,728
(1,137)
504,666
Interest income on non-accrual loans that would have been recorded had those loans performed in accordance with their initial terms was
$679, $1,130, and $1,213 for 2014, 2013, and 2012, respectively.
Modifications
A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the
modification constitutes a concession. There are various types of concessions when modifying a loan, however, forgiveness of principal
is rarely granted by the Company. Commercial and industrial loans modified in a TDR may involve term extensions, below market
interest rates and/or interest-only payments wherein the delay in the repayment of principal is determined to be significant when all
elements of the loan and circumstances are considered. Additional collateral, a co-borrower, or a guarantor is often required.
Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the
loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or
adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment
period. Residential mortgage loans modified in a TDR are primarily comprised of loans where monthly payments are lowered to
accommodate the borrowers’ financial needs. Land loans are typically structured as interest-only monthly payments with a balloon
payment due at maturity. Land loans modified in a TDR typically involve extending the balloon payment by one to three years, and
providing an interest rate concession. Home equity modifications are made infrequently and are uniquely designed to meet the specific
needs of each borrower.
Loans modified in a TDR are considered impaired loans and typically already on non-accrual status. Partial charge-offs have in some
cases already been taken against the outstanding loan balance. Loans modified in a TDR for the Company may have the financial effect
of increasing the specific allowance associated with the loan. An allowance for impaired loans that have been modified in a TDR is
measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable
market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. The Company’s
practice is to re-appraise collateral dependent loans every six to nine months. During the twelve months ended December 31, 2014, there
was no impact on the allowance from TDRs during the period, as the loans classified as TDRs during the period did not have a specific
68
reserve and were already considered impaired loans at the time of modification and no further impairment was required upon
modification. The Company had no commitments to lend additional funds for loans classified as TDRs at December 31, 2014.
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 table presents TDRs as of December 31, 2014 and 2013, all of which were modified due to financial stress of the borrower.
There were not any subsequent defaulted TDRs as of December 31, 2014 and 2013. There were no loans modified or recorded as TDRs
during the years ended December 31, 2014 and 2013.
Restructured loans by type current and subsequently defaulted
(Dollars in T housands)
December 31, 2014
Current Restructured Loans
Pre-T DR
Outstanding
Recorded
Investment
Post-T DR
Outstanding
Recorded
Investment
Number of Loans
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
CRE -- non owner occupied
T otal restructured loans (1)
1 $
2
2
1
1
7 $
335 $
2,764
272
59
2,180
5,610 $
284
965
219
54
2,038
3,560
December 31, 2013
Current Restructured Loans
Pre-T DR
Outstanding
Recorded
Investment
Post-T DR
Outstanding
Recorded
Investment
Number of Loans
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
CRE -- non owner occupied
T otal restructured loans (1)
1 $
3
2
1
1
8 $
335 $
2,972
272
59
2,180
5,818 $
302
1,408
227
55
2,096
4,088
(1) T he period end balances are inclusive of all partial paydowns and charge-offs since the modification date.
The following table summarizes the Company’s troubled debt restructured loans by type and geographic region as of December 31, 2014:
Restructured loans by type and geographic region
(Dollars in T housands)
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
CRE -- non owner occupied
T otal restructured loans
Central Western
Washington
Southwestern
Washington
$
$
$
-
-
-
54
-
54 $
December 31, 2014
Restructured Loans
Northern
Washington
Oregon
T otals
Number of
Loans
-
-
-
-
-
-
$
$
284 $
841
-
-
2,038
3,163 $
$
-
124
219
-
-
343 $
284
965
219
54
2,038
3,560
1
2
2
1
1
7
69
The following table presents troubled debt restructurings by accrual or nonaccrual status as of December 31, 2014 and 2013:
Restructured loans by accrual or nonaccrual status
(Dollars in T housands)
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
CRE -- non owner occupied
T otal restructured loans
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
CRE -- non owner occupied
T otal restructured loans
$
$
$
$
December 31, 2014
Restructured loans
Non-accrual
Status
Accrual Status
284 $
-
219
54
2,038
2,595 $
T otal
Modifications
284
965
219
54
2,038
$
-
965
-
-
-
965 $
3,560
December 31, 2013
Restructured loans
Non-accrual
Status
Accrual Status
302 $
-
227
55
2,096
2,680 $
$
-
1,408
-
-
-
1,408 $
T otal
Modifications
302
1,408
227
55
2,096
4,088
NOTE 5 – ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS)
The following table presents the changes in each component of accumulated other comprehensive income/(loss), net of tax, for the twelve
months ended December 31, 2014 and 2013:
(Dollars in T housands)
Balance, January 1, 2014
Other comprehensive gain (loss) before reclassifications
Amounts reclassified from AOCI
Net Current period other comprehensive income (loss)
Balance, December 31, 2014
Balance, January 1, 2013
Other comprehensive gain (loss) before reclassifications
Amounts reclassified from AOCI
Net Current period other comprehensive income (loss)
Balance, December 31, 2013
Net Unrealized
Gains and Losses
On Investment
Securities
Defined Benefit
Plans
T otal
(919) $
(450) $
(1,369)
1,295
(26)
1,269
(35)
-
(35)
1,260
(26)
1,234
350 $
(485) $
(135)
Net Unrealized
Gains and Losses
On Investment
Securities
Defined Benefit
Plans
T otal
956 $
(535) $
421
(1,632)
(243)
(1,875)
-
85
85
(1,547)
(243)
(1,790)
(919) $
(450) $
(1,369)
$
$
$
$
70
The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (“AOCI”) for
the twelve months ended December 31, 2014 and 2013:
(Dollars in T housands)
Details about Accumulated Other
Comprehensive Income Components
Affected Line Item in the Statement Where Net
Income is Presented
For the Year
Ended December
31, 2014
Net Unrealized Gains and Losses
on Investment Securities
(Dollars in T housands)
Details about Accumulated Other
Comprehensive Income Components
Net Unrealized Gains and Losses
on Investment Securities
$
$
$
$
(88)
48
14
(26)
(Gain) on sales of investments available for sale
Net OT T I losses
Income tax expense
Unrealized gain on investment securities net of tax
Affected Line Item in the Statement Where Net
Income is Presented
For the Year
Ended December
31, 2013
(405)
37
125
(243)
(Gain) on sales of investments available for sale
Net OT T I losses
Income tax expense
Unrealized gain on investment securities net of tax
71
The following table presents the components of other comprehensive income (loss) for the twelve months ended December
31, 2014 and 2013:
(Dollars in T housands)
Twe lve months e nde d De ce mbe r 31, 2014
Net unrealized losses on investment securities:
Net unrealized gains arising during the period
Less: reclassification adjustments for net gains realized in net income
Net unrealized losses on investment securities
Defined benefit plans:
Amortization of unrecognized prior service costs and net
actuarial gains/losses
Other Comprehensive Income
(Dollars in T housands)
Twe lve months e nde d De ce mbe r 31, 2013
Net unrealized losses on investment securities:
Net unrealized losses arising during the period
Less: reclassification adjustments for net gains realized in net income
Net unrealized losses on investment securities
Defined benefit plans:
Amortization of unrecognized prior service costs and net
actuarial gains/losses
Other Comprehensive Loss
$
$
$
$
$
$
$
$
Before T ax
T ax Effect
Net of T ax
1,962 $
(40) $
1,922 $
667 $
(14)
653 $
(53) $
(18) $
1,869 $
635 $
1,295
(26)
1,269
(35)
1,234
Before T ax
T ax Effect
Net of T ax
(2,473) $
(368) $
(2,841) $
(841) $
(125)
(966) $
(1,632)
(243)
(1,875)
129 $
44 $
85
(2,712) $
(922) $
(1,790)
NOTE 6 – PREMISES AND EQUIPMENT
The components of premises and equipment at December 31 are as follows:
Premises and equipment
Land and premises
Equipment, furniture and fixtures
Construction in progress
Less accumulated deprecation and amortization
T otal premises and equipment
2014
2013
19,875 $
7,698
84
27,657
(11,354)
19,859
8,142
167
28,168
(11,378)
16,303 $
16,790
$
$
Depreciation expense
Rental expense
2014
2013
2012
1,242 $
1,013 $
574 $
544 $
989
442
$
$
72
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:
2015 $
2016
2017
2018
2019
491
331
236
233
229
$
1,520
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:
For the T welve Months Ended
December
31, 2014
December
31, 2013
$ Change
Other real estate owned, beginning of period
$
2,771 $
4,679 $
(1,908)
T ransfers from outstanding loans
Proceeds from sales
Net gain (loss) on sales
Impairment charges
842
1,756
(2,340)
(2,758)
(207)
(67)
40
(946)
(914)
418
(247)
879
T otal other real estate owned
$
999 $
2,771 $
(1,772)
At December 31, 2014 and 2013, OREO consisted of properties as follows:
O the r re al e state owne d and fore close d asse ts by type
(Unaudited)
(Dollars in T housands)
December
31, 2014
# of
Properties
December
31, 2013
# of
Properties
Construction, Land Dev & Other Land
1-4 Family Residential Properties
Nonfarm Nonresidential Properties
T otal OREO by type
$
$
35
-
964
999
-
1
3
4
237
672
1,862
2,771
5
4
8
17
Net (loss) gain on sales of OREO totaled $(207), $40 and $331 for the years ended December 31, 2014, 2013 and 2012, respectively.
73
NOTE 8 – DEPOSITS
The composition of deposits at December 31 is as follows:
De posits
(Dollars in T housands)
2014
2013
December 31,
December 31,
NOW and money market accounts
$
274,614 $
262,848
Savings deposits
T ime certificates, $100,000 or more
Other time certificates
T otal interest-bearing deposits
Non-interest bearing demand
79,997
75,648
43,035
473,294
165,760
73,412
76,628
49,431
462,319
145,028
T otal deposits
$
639,054 $
607,347
Scheduled maturities of time certificates of deposit are as follows for future years ending December 31:
At December 31, 2014
(Dollars in T housands)
$
2015
2016
2017
2018
2019
T hereafter
Maturities
67,642
25,656
14,342
5,724
5,160
159
Total
$
118,683
NOTE 9 – BORROWINGS
Long-term borrowings at December 31, 2014 and 2013 represent advances from the Federal Home Loan Bank of Seattle (“FHLB”).
Advances at December 31, 2014 bear interest at 0.47% to 2.54% and mature in various years as follows: 2016 - $5,000, 2019 - $5,000 and
$1,453 in 2024. The Bank has pledged $140,773 in loans as collateral for these borrowings at December 31, 2014.
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, 2014, and 2013. The following is a summary of short-term borrowings for the years ended:
(Dollars in T housands)
2014
2013
Amount outstanding at end of period
Weighted average interest rate thereon
Maximum month-end balance during year
Average balance during the year
Average interest rate during the year
$
$
$
$
-
0.28%
-
$
153 $
0.28%
-
-
3,000
303
2.94%
74
NOTE 10 – JUNIOR SUBORDINATED DEBENTURES
At December 31, 2014, two wholly-owned subsidiary grantor trusts established by the Company had outstanding $13.0 million of Trust
Preferred Securities (“trust preferred securities”). Trust preferred securities accrue and pay distributions periodically at specified annual
rates as provided in the indentures. The trusts used the net proceeds from the offering of trust preferred securities to purchase a like
amount of Junior Subordinated Debentures (the “Debentures”) of the Company. The Debentures are the sole assets of the trusts. The
Company’s obligations under the Debentures and the related documents, taken together, constitute a full and unconditional guarantee by
the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon the maturity of the
Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole or
in part, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date.
The Debentures issued by the Company to the grantor trusts totaling $13.0 million are reflected in the consolidated balance sheet in the
liabilities section under the caption “junior subordinated debentures.” The Company records interest expense on the corresponding junior
subordinated debentures in the consolidated statements of income. The Company recorded $403,000 in the consolidated balance sheet at
December 31, 2014 and 2013, respectively, for the common capital securities issued by the issuer trusts.
As of December 31, 2014 and 2013, regular accrued interest on junior subordinated debentures totaled $40,000 for both years and is
included in accrued interest payable on the balance sheet. Following are the terms of the junior subordinated debentures as of December
31, 2014.
(Dollars in T housands)
T rust Name
Issue Date
Issued
Amount
Rate
Pacific Financial Corporation
Statutory T rust I
December
2005
$
5,000
LIBOR + 1.45% (1)
Pacific Financial Corporation
Statutory T rust II
June
2006
$
8,000
13,000
LIBOR + 1.60% (2)
Maturity
Date
March
2036
July
2036
(1) Pacific Financial Corporation Statutory T rust I securities incurred interest at the fixed rate of 6.39% until mid March
2011, at which the rate changed to a variable rate of 3-month LIBOR (0.24% at December 15, 2014) plus 1.45%
or 1.69%, adjusted quarterly, through the final maturity date in March 2036.
(2) Pacific Financial Corporation Statutory T rust II securities incur interest at a variable rate of 3-month LIBOR (0.253%
at January 1, 2015) plus 1.60% or 1.85%, adjusted quarterly, through the final maturity date in July 2036.
NOTE 11 – INCOME TAXES
The Company recorded an income tax provision for the twelve months ended December 31, 2014, 2013, and 2012. The amount of the
provision for each period was commensurate with the estimated tax liability associated with the net income earned during the period. As
of December 31, 2014, the Company maintained a deferred tax asset balance of $3.2 million. The Company believes it will be fully
utilized in the normal course of business, thus no valuation allowance is maintained against this asset.
The Company's provision for income taxes includes both federal and state income taxes and reflects the application of federal and state
statutory rates to the Company's income before taxes. The principal difference between statutory tax rates and the Company's effective tax
rate is the benefit derived from investing in tax-exempt securities and bank owned life insurance.
Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset or liability is determined based
on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of
existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in
tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce the net
carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax
asset will not be realized.
The Company applies the provisions of FASB ASC 740, Income Taxes, relating to the accounting for uncertainty in income taxes. The
Company periodically reviews its income tax positions based on tax laws and regulations, and financial reporting considerations, and
records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations of the
Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment.
The Company’s uncertain tax positions were nominal in amount as of December 31, 2014.
75
Income taxes for the years ended December 31 is as follows:
Current
Deferred
Total income tax be ne fit
2014
2013
2012
$
$
1,003 $
727
586 $
386
1,237
63
1,730 $
972 $
1,300
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities and net deferred tax
assets are recorded in other assets in the consolidated financial statements at December 31 are:
$
$
$
De fe rre d Tax Asse ts
Allowance for loan losses
Deferred compensation
Supplemental executive retirement plan
Unrealized loss on securities available for sale
Loan fees/costs
OREO write-downs
OREO operating expenses
T ax credit carry-forwards
Non-accrual loan interest
Other
Total de fe rre d tax asse ts
De fe rre d Tax Liabilitie s
Depreciation
Loan fees/costs
Unrealized gain on securities available for sale
Prepaid expenses
FHLB dividends
Other
Total de fe rre d tax liabilitie s
2014
2013
2,863 $
102
1,151
-
416
11
-
-
73
445
2,892
111
1,039
473
393
305
174
534
108
170
5,061 $
6,199
100 $
1,290
181
128
130
67
1,896
172
1,185
-
108
137
51
1,653
The following is a reconciliation between the statutory and effective federal income tax rate for the years ended December 31:
Ne t de fe rre d tax asse ts
$
3,165 $
4,546
2014
Amount
Pe rce nt
of Pre -tax
Income
2013
Amount
Pe rce nt
of Pre -tax
Income
2012
Amount
Pe rce nt
of Pre -tax
Income
Income tax at statutory rate
Adjustments resulting from:
T ax-exempt income
Net earnings on life insurance policies
Low income housing tax credit
Other
Total income tax e xpe nse
$
$
2,330
35.0% $
1,646
35.0% $
2,130
35.0%
(412)
(169)
(82)
63
-6.2%
-2.5%
-1.2%
1.0%
(483)
(152)
(101)
62
-10.3%
-3.2%
-2.1%
1.3%
(542)
(178)
(109)
(1)
-8.9%
-2.9%
-1.8%
0.0%
1,730
25.9% $
972
20.7% $
1,300
21.4%
As of December 31, 2014, the Company believes that it is more likely than not that it will be able to fully realize its deferred tax asset
(“DTA”) and therefore has not recorded a valuation allowance.
76
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 $609, $272, and $400 in 2014, 2013 and 2012,
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 $180, $161 and $152 for 2014, 2013 and 2012, 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.
There were no deferrals or ongoing expense to the Company for these plans in 2014, 2013, and 2012.
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 $4,020 and $3,911 at
December 31, 2014 and 2013, respectively. In 2014, 2013 and 2012, the net benefit recorded from these plans, including the cost of the
related life insurance, was $380, $354 and $396, 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 $311 and $322 at December 31, 2014 and 2013, 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 $137, $107 and $95 in 2014, 2013 and 2012, 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 accumulate 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 $5,945 and $5,817 at December 31, 2014 and 2013,
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:
(cid:2)
(Dollars in Thousands)
2014
2013
2012
Net periodic pension cost:
Service cost
Interest cost
Amortization of prior service cost
Amortization of net (gain)/loss
$
$
153
111
90
26
$
145
104
90
22
Net periodic pension cost
$
380
$
361
$
167
106
90
27
390
Weighted average assumptions:
Discount rate
Rate of compensation increase
3.57%
n/a
4.37%
n/a
4.47%
n/a
77
The following table sets forth the change in benefit obligation at December 31:
(cid:2)
(Dollars in Thousands)
Change in benefit obligation:
Benefit obligation at the beginning of year
$
Service cost
Interest cost
Benefits paid
Actuarial gain/(loss)
2014
2013
$
2,573
153
111
(45)
152
2,342
145
104
(45)
27
Benefit obligation at end of year
$
2,944
$
2,573
Amounts recognized in accumulated other comprehensive income (AOCI) at December 31 are as follows:
(cid:2)
(Dollars in Thousands)
2014
2013
Loss
Prior service cost
Total recognized in AOCI
$
$
$
334
152
486
$
179
271
450
The following table summarizes the projected and accumulated benefit obligations at December 31:
(cid:2)
(Dollars in Thousands)
2014
2013
Projected benefit obligation
Accumulated benefit obligation
$
$
2,944
2,944
2,573
2,573
Estimated future benefit payments as of December 31, 2014 are as follows:
(Dollars in T housands)
2015 $
2016
2017
2018
2019
2020-2024
149,743
149,743
149,743
242,175
242,175
1,210,875
NOTE 13 – 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.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to
extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit
policies in making commitments and conditional obligations as they do for on-balance-sheet instruments. A summary of the Bank’s off-
balance sheet commitments at December 31, 2014 and December 31, 2013 is as follows:
(Dollars in T housands)
December 31,
2014
December 31,
2013
Commitments to extend credit
Standby letters of credit
$
$
109,545
1,351
$
$
106,017
1,733
78
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the
contract. Many of the commitments expire without being drawn upon; therefore total commitment amounts do not necessarily represent
future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held
varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial
properties.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The
credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
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 condensed consolidated financial statements.
At December 31, 2014, the Bank had $11,500 in outstanding borrowings against its $149,700 in established borrowing capacity with the
FHLB, as compared to $10,000 outstanding against a borrowing capacity of $143,100 at December 31, 2013. The Bank’s borrowing
facility with the FHLB is subject to collateral and stock ownership requirements. The Bank also had an available discount window
primary credit line with the Federal Reserve Bank of San Francisco of approximately $52,900, subject to collateral requirements, and
$16,000 from correspondent banks with no balance outstanding on any of these facilities.
The Company is currently not party to any material pending litigation. However, because of the nature of its activities, the Company may
be subject to or threatened with legal actions in the ordinary course of business. In the opinion of management, liabilities arising from
these claims, if any, will not have a material effect on the results of operations or financial condition of the Company.
NOTE 14 – SIGNIFICANT CONCENTRATION 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 $8,500.
NOTE 15 – STOCK BASED COMPENSATION
The Company’s 2011 Equity Incentive Plan, as amended (the “2011 Plan”), provides for the issuance of up to 900,000 shares in
connection with incentive and nonqualified stock options, restricted stock, restricted stock units and other equity-based awards. Prior to
adoption of the 2011 Plan, the Company made equity-based awards under the Company’s 2000 Stock Incentive Plan, which expired
January 1, 2011.
Stock Options
The 2011 Plan authorizes the issuance of incentive and non-qualified stock options, as defined under current tax laws, to key personnel.
Options granted under the 2011 Plan either become exercisable ratably over five years or in a single installment five years from the date
of grant.
The Company uses the Black-Scholes option pricing model to calculate the fair value of stock option awards based on assumptions in the
following table. Expected volatility is based on historical volatility of the Company’s common stock. The expected term of stock options
granted is based on the simplified method, which is the simple average between contractual term and vesting period. The risk-free rate is
based on the expected term of stock options and the applicable U.S. Treasury yield in effect at the time of grant.
Grant period ended
Expected
Life
Risk Free
Interest Rate
Expected
Volatility
Dividend
Yield
Average
Fair Value
December 31, 2014
December 31, 2013
December 31, 2012
6.5 years
6.5 years
6.5 years
2.11%
1.36%
1.34%
23.23%
23.05%
22.43%
3.27% $
4.13% $
0.00% $
1.02
0.58
0.77
79
A summary of stock option activity as of December 31, 2014, 2013 and 2012, and changes during the twelve months then
ended are presented below:
December 31, 2014
December 31, 2013
December 31, 2012
Weighted
Average
Exercise
Price
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Shares
Shares
Outstanding beginning of period
625,495
$
9.53
537,107
$
11.28
586,448
$
11.32
Granted
Exercised
Forfeited
Expired
23,500
(4,000)
(7,650)
(70,400)
6.13
5.00
6.89
15.17
186,000
-
(64,337)
(33,275)
5.05
-
11.36
9.25
10,500
-
(12,550)
(47,291)
O utstanding e nd of pe riod
566,945
Exe rcisable e nd of pe riod
388,345
$
$
8.75
625,495
10.39
328,845
$
$
9.53
537,107
12.95
389,827
$
$
5.00
-
10.44
10.57
11.28
12.98
A summary of the status of the Company’s non-vested options as of December 31, 2014 and 2013 and changes during the twelve months
then ended, are presented below:
December 31, 2014
December 31, 2013
Weighted
Average
Fair Value
Shares
Weighted
Average
Fair Value
Shares
Non-vested beginning of period
296,650
$
0.47
147,280
$
0.31
Granted
Vested
Forfeited
23,500
(136,650)
(4,900)
1.02
0.34
0.34
186,000
(17,875)
(18,755)
0.57
0.32
0.40
Non-ve ste d e nd of pe riod
178,600
$
0.65
296,650
$
0.47
The following information summarizes information about stock options outstanding and exercisable at December 31, 2014:
Options Outstanding
Weighted
Average
Remaining
Contractual
T erm
(Years)
Weighted
Average
Exercise
Price
Range of e xe rcise prices
Number
0.00 - 5.00
5.01 - 10.00
10.01 - 14.74
14.75 - 16.00
175,900
197,500
111,650
81,895
$
7.95
5.54
2.16
0.28
4.97
6.83
13.69
14.80
Options Exercisable
Weighted
Average
Remaining
Contractual
T erm
(Years)
Weighted
Average
Exercise
Price
$
7.94
4.85
2.17
0.27
4.95
6.98
13.69
14.80
Number
32,800
162,000
111,650
81,895
566,945
4.86
$
8.74
388,345
3.37
$
10.39
80
December
31, 2014
December
31, 2013
Aggre gate intrinsic value
outstanding e nd of pe riod
$
306,710
$
303,450
Aggre gate intrinsic value
e xe rcisable e nd of pe riod
$
55,390
$
-
The Company accounts for stock based compensation in accordance with GAAP, which requires measurement of compensation cost for
all stock-based awards based on grant date fair value and recognition of compensation cost over the service period of each award.
Stock-based compensation expense
(Unaudited)
(Dollars in T housands)
T welve months ended December 31, 2014
Before T ax
T ax Effect
Net of T ax
Recognized compensation expense
T welve months ended December 31, 2013
Recognized compensation expense
Future compensation expense (1)
$
$
$
67 $
23 $
44
Before T ax
T ax Effect
Net of T ax
50 $
17 $
33
December
31, 2014
December
31, 2013
60 $
80
Weighted Average Remaining Contractual
T erm (Years)
1.8
1.8
(1) related to non-vested stock options
Restricted Stock Units
The Company grants restricted stock units (“RSU”) to employees qualifying for awards under the Company’s Annual Incentive
Compensation Plan. Recipients of RSUs will be issued a specified number of shares of common stock under the 2011 Plan upon the lapse
of applicable restrictions. Outstanding RSUs are subject to forfeiture if the recipient’s employment terminates prior to the expiration of
three years from the date of grant.
The following table summarizes RSU activity during the twelve months ended December 31, 2014 and 2013:
December 31, 2014
December 31, 2013
Weighted
Average
Grant Price
Shares
Weighted
Average
Remaining
Contractual
terms (in years)
Outstanding, January 1, 2014
50,024
Granted
Converted
Forfeited
$
5.43
13,624
(476)
(1,939)
Weighted
Average
Remaining
Contractual
terms (in
Weighted
Average
Grant Price
4.93
Shares
16,059
$
35,476
-
(1,511)
O utstanding e nd of pe riod
61,233
1.3
50,024
2.0
81
The following table summarizes RSU compensation expense during the twelve months ended December 31, 2014 and 2013:
RSU compensation expense
(Unaudited)
(Dollars in T housands)
T welve months ended December 31, 2014
Before T ax
T ax Effect
Net of T ax
RSU recognized compensation expense
T welve months ended December 31, 2013
RSU recognized compensation expense
$
$
148 $
50 $
98
Before T ax
T ax Effect
Net of T ax
66 $
22 $
44
December
31, 2014
December
31, 2013
Future compensation expense (1)
$
150 $
172
(1) related to non-vested RSU's
NOTE 16 – 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, 2014 and 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.
82
Actual capital amounts and ratios for December 31, 2014 and 2013 are presented in the table below.
(Dollars in T housands)
De ce mbe r 31, 2014
T otal risk-based capital ratio
Company
Bank
T ier 1 risk-based capital ratio
Company
Bank
T ier 1 leverage capital ratio
Company
Bank
(Dollars in T housands)
De ce mbe r 31, 2013
T otal risk-based capital ratio
Company
Bank
T ier 1 risk-based capital ratio
Company
Bank
T ier 1 leverage capital ratio
Company
Bank
$
$
Actual
Amount
Ratio
Capital
Adequacy
Purposes
Amount
Ratio
T o be well
capitalized under
prompt corrective
action provisions
amount
Ratio
79,308
78,681
72,011
71,392
72,011
71,392
13.61% $
13.52%
12.36%
12.27%
9.80%
9.73%
46,616
46,563
23,308
23,282
27,604
27,591
8.00% $
8.00%
4.00%
4.00%
4.00%
4.00%
n/a
58,204
n/a
34,922
n/a
34,489
n/a
10%
n/a
6%
n/a
5%
Actual
Amount
Ratio
Capital
Adequacy
Purposes
Amount
Ratio
T o be well
capitalized under
prompt corrective
action provisions
amount
Ratio
74,477
74,036
67,856
67,420
67,856
67,420
14.11% $
14.03%
12.85%
12.78%
9.83%
9.77%
42,237
42,202
21,119
21,101
27,604
27,591
8.00% $
8.00%
4.00%
4.00%
4.00%
4.00%
n/a
52,753
n/a
31,652
n/a
34,489
n/a
10%
n/a
6%
n/a
5%
NOTE 17 – FAIR VALUE MEASUREMENTS
Fair Value Hierarchy
The Company uses an established hierarchy for measuring fair value that is intended to maximize the use of observable inputs and
minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as
follows:
Level 1 – Valuations based on quoted prices in active exchange markets for identical assets or liabilities; also includes certain corporate
debt securities actively traded in over-the-counter markets.
Level 2 – Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar
assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and
model–derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained
from, or corroborated by, third-party pricing services. This category generally includes certain U.S. Government, agency and non-agency
securities, state and municipal securities, mortgage-backed securities, corporate securities, and residential mortgage loans held for sale.
Level 3 – Valuation based on unobservable inputs supported by little or no market activity for financial instruments whose value is
determined using pricing models, discounted cash flow methodologies, yield curves and similar techniques, as well as instruments for
which the determination of fair value requires significant management judgment or estimation. Level 3 valuations incorporate certain
assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external
data, which may include third-party pricing services.
83
Investment Securities Available-for-Sale
The Company uses an independent pricing service to assist management in determining fair values of investment securities available-for-
sale. This service provides pricing information by utilizing evaluated pricing models supported with market based information. Standard
inputs include benchmark yields, reported trades, broker/dealer quotes, credit ratings, bids and offers, relative credit information and
reference data from market research publications. Investment securities that are deemed to have been trading in illiquid or inactive
markets may require the use of significant unobservable inputs.
The pricing service provides quoted market prices when available. Quoted prices are not always available due to bond market inactivity.
For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash
flows. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities,
volatility, credit spread and optionality. Additionally, the pricing service may obtain a broker quote when sufficient information is not
available to produce a valuation. Valuations and broker quotes are non-binding and do not represent quotes on which one may execute
the disposition of the assets.
The Company generally obtains one value from its primary external third-party pricing service. The Company’s third-party pricing
service has established processes for us to submit inquiries regarding quoted prices. The Company’s third-party pricing service will
review the inputs to the evaluation in light of any new market data presented by us. The Company’s third-party pricing service may then
affirm the original quoted price or may update the evaluation on a going forward basis.
On a quarterly basis, management reviews the pricing information received from the third party-pricing service through a combination of
procedures that include an evaluation of methodologies used by the pricing service, analytical reviews and performance analyses of the
prices against statistics and trends and maintenance of an investment watch list. Based on this review, management determines whether
the current placement of the security in the fair value hierarchy is appropriate or whether transfers may be warranted. As necessary, the
Company compares prices received from the pricing service to discounted cash flow models or through performing independent
valuations of inputs and assumptions similar to those used by the pricing service in order to ensure prices represent a reasonable estimate
of fair value. Although the Company does identify differences from time to time as a result of these validation procedures, the Company
did not make any significant adjustments as of December 31, 2014 or December 31, 2013.
The following table presents the balances of assets measured at fair value on a recurring basis at December 31, 2014 and December 31,
2013.
(Dollars in T housands)
Description
Available-for-sale securities:
Fair Value Measure me nts
At De cember 31, 2014
Fair Value
12/31/2014
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Other Observable Inputs
(Level 2)
Significant
Unobservable Inputs
(Level 3)
Collateralized mortgage obligations: agency issued
$
38,767 $
Collateralized mortgage obligations: non agency
Mortgage-backed securities: agency issued
U.S. Government agency securities
State and municipal securities
527
12,199
8,056
27,891
Total assets measure d at fair value
$
87,440 $
-
-
-
-
-
-
$
$
38,767 $
527
12,199
8,056
25,741
85,290 $
-
-
-
-
2,150
2,150
Description
Available-for-sale securities:
Fair Value Measure me nts
At De cember 31, 2013
Fair Value
12/31/2013
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Other Observable Inputs
(Level 2)
Significant
Unobservable Inputs
(Level 3)
Collateralized mortgage obligations: agency issued
$
38,791 $
Collateralized mortgage obligations: non agency
Mortgage-backed securities: agency issued
U.S. Government agency securities
State and municipal securities
Corporate bonds
2,011
13,389
8,811
32,160
982
Total assets measure d at fair value
$
96,144 $
-
-
-
-
-
-
-
$
$
38,791 $
2,011
13,389
8,811
30,741
982
94,725 $
-
-
-
-
1,419
-
1,419
84
As of December 31, 2014 and December 31, 2013, the Company had four and two investments, respectively, classified as Level 3
investments which consist of non-rated municipal bonds for which the Company is the sole owner of the entire bond issue. The valuation
of these securities is supported by analysis prepared by an independent third party. Their approach to determining fair value involves
using recently executed transactions and market quotations for similar securities. As these securities are not rated by the rating agencies
and there is no trading volume, management determined that these securities should be classified as Level 3 within the fair value
hierarchy.
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 twelve months ended December 31, 2014 and 2013, respectively. Transfers between level categorizations may
occur due to changes in the availability of market observable inputs, which generally are caused by changes in market conditions such as
liquidity, trading volume or bid-ask spreads. Transfers between level categorizations may also occur due to changes in the valuation
source. For example, in situations where a fair value quote is not provided by the Company’s independent third-party valuation service
provider and as a result the price is stale, the security is transferred into Level 3. Transfers in and out of level categorizations are reported
as having occurred at December 31, 2014 and 2013.
(Dollars in T housands)
T welve months ended December 31,
2014
2013
Balance beginning of period
T ransfers in to level 3
Change in FV (included in other comprehensive income)
Balance end of period
$
$
1,419 $
810
(79)
2,150 $
1,099
464
(144)
1,419
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 consider third party appraisals by qualified licensed appraisers, less estimated costs to sell. These appraisals may utilize a single
valuation approach or a combination of approaches including comparable sales and the income approach.
Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and
income data available and include consideration for variations in location, size, and income production capacity of the property. The
income approach commonly utilizes a discount or cap rate to determine the present value of expected future cash flows. Additionally, the
appraisals are periodically further adjusted by the Company in consideration of charges that may be incurred in the event of foreclosure
and are based on management’s historical knowledge, changes in business factors and changes in market conditions. Such discounts are
typically significant, and may range from 10% to 30%.
Impaired loans are reviewed and evaluated quarterly for additional impairment and adjusted accordingly, based on the same factors
identified above. Because of the high degree of judgment required in estimating the fair value of collateral underlying impaired loans and
because of the relationship between fair value and general economic conditions, we consider the fair value of impaired loans to be highly
sensitive to changes in market conditions.
Other real estate owned – OREO is initially recorded at the fair value of the property less estimated costs to sell. This amount becomes
the property’s new basis. Management considers third party appraisals in determining the fair value of particular properties. These
appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.
Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and
income data available and include consideration for variations in location, size, and income production capacity of the property.
Additionally, the appraisals are periodically further adjusted by the Company based on management’s historical knowledge, changes in
business factors and changes in market conditions. Such adjustments are typically downward, and may range from 10% to 25%.
85
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
loan losses. Management periodically reviews OREO to ensure the property is carried at the lower of its new basis or fair value, net of
estimated costs to sell. Any additional write-downs based on re-evaluation of the property fair value are charged to non-interest expense.
Because of the high degree of judgment required in estimating the fair value of OREO and because of the relationship between fair value
and general economic conditions, we consider the fair value of OREO to be highly sensitive to changes in market conditions.
The following table presents the Company’s assets that were held at the end of each period that were measured at fair value on a
nonrecurring basis during the twelve months ended December 31, 2014 and year ended December 31, 2013:
(Dollars in T housands)
De scription
Other real estate owned and foreclosed assets
Loans measured for impairment, net of
specific reserves
Total impaire d asse ts me asure d at fair value $
$
Fair Value Me asure me nts
As of De ce mbe r 31, 2014
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
Other Observable
Inputs (Level 2)
Fair Value
12/31/2014
139 $
231
370 $
-
-
-
$
$
-
-
-
De scription
Other real estate owned and foreclosed assets
Loans measured for impairment, net of
specific reserves
Total impaire d asse ts me asure d at fair value $
$
Fair Value
12/31/2013
1,960 $
162
2,122 $
Fair Value Me asure me nts
As of De ce mbe r 31, 2013
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
Other Observable
Inputs (Level 2)
-
-
-
$
$
-
-
-
Significant
Unobservable
Inputs (Level 3)
139
231
370
Significant
Unobservable
Inputs (Level 3)
1,960
162
2,122
$
$
$
$
Other real estate owned with a pre-foreclosure loan balance of $969 was acquired during the twelve months ended December 31, 2014.
Upon foreclosure, write downs totaling $127 were applied to the allowance for loan losses during the period related to these assets.
The following table presents quantitative information about Level 3 inputs for financial instruments measured at fair value on a
nonrecurring basis at December 31, 2014:
(Dollars in T housands)
De scription
Other real estate owned and foreclosed assets
Loans measured for impairment, net of
specific reserves
$
$
Fair Value
12/31/2014
139
Valuation
T echnique
Appraised value
Significant
Unobservable
Inputs
Adjustment for
market conditions
Range
(Weighted
Average)
0-9% (2.5%)
231
Appraised value
Adjustment for
market conditions
0-20% (2.2%)
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, 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
86
discounted cash flows.
Federal Home Loan Bank Stock
FHLB stock is carried at cost which approximates fair value and equals its par value because the shares can only be redeemed
with the FHLB at par.
Pacific Coast Bankers’ Bancshares Stock
PCBB stock is carried at cost which approximates fair value and equals its par value based on the price per share paid at the
capital offering concluded during the current quarter.
Loans, net and loans held for sale
The fair value of loans is estimated based on comparable market statistics for loans with similar credit ratings. An additional
liquidity discount is also incorporated to more closely align the fair value with observed market prices. Fair values of loans held
for sale are based on a discounted cash flow calculation using interest rates currently available on similar loans. The fair value
was based on an aggregate loan basis.
Deposits
The fair value of deposits with no stated maturity date is included at the amount payable on demand. Fair values for fixed rate
certificates of deposit are estimated using a discounted cash flow calculation based on interest rates currently offered on similar
certificates.
Borrowings
The fair values of the Company’s long-term borrowings is estimated using discounted cash flow analysis based on the
Company’s incremental borrowing rates for similar types of borrowing arrangements.
Junior subordinated debentures
The fair value of the junior subordinated debentures and trust preferred securities is estimated using discounted cash flow
analysis based on interest rates currently available for junior subordinated debentures.
Off-Balance-Sheet Instruments
The fair value of commitments to extend credit and standby letters of credit was estimated using the rates currently charged to
enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the
customers. Since the majority of the Company’s off-balance-sheet instruments consist of non-fee producing, variable-rate
commitments, the Company has determined they do not have a material fair value.
87
The estimated fair value of the Company’s financial instruments at December 31, 2014 and December 31, 2013 is as follows:
(Dollars in T housands)
Financial assets:
Cash and cash equivalents
Interest-bearing certificates of deposit
(original maturities greater than 90 days)
Investment securities available-for-sale
Investment securities held-to-maturity
Federal Home Loan Bank stock
Pacific Coast Bankers Bank stock
Loans held-for-sale
Loans
Financial liabilities:
Deposits
Long-term borrowings
Junior subordinated debentures
As of December 31, 2014
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
Carrying Value
Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs (Level 3)
T otal Fair
Value
$
31,037 $
31,037
$
-
$
-
$
31,037
2,727
87,440
1,829
2,896
1,000
5,786
554,746
2,727
-
-
-
-
-
-
-
85,290
1,852
2,896
1,000
5,786
-
-
2,150
-
-
-
-
527,510
2,727
87,440
1,852
2,896
1,000
5,786
527,510
$
639,054 $
11,453
13,403
$
-
-
-
639,537 $
11,583
-
$
-
-
7,644
639,537
11,583
7,644
As of December 31, 2013
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
Carrying Value
Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs (Level 3)
T otal Fair
Value
Financial assets:
Cash and cash equivalents
Interest-bearing certificates of deposit
(original maturities greater than 90 days)
Investment securities available-for-sale
Investment securities held-to-maturity
Federal Home Loan Bank stock
Loans held-for-sale
Loans
Financial liabilities:
Deposits
Long-term borrowings
Junior subordinated debentures
$
35,948 $
35,948
$
-
$
-
$
35,948
2,727
96,144
2,132
3,013
7,765
496,307
2,727
-
-
-
-
-
-
94,725
2,158
3,013
7,765
-
-
1,419
-
-
-
473,224
2,727
96,144
2,158
3,013
7,765
473,224
$
607,347 $
10,000
13,403
$
-
-
606,654 $
10,195
-
$
-
-
7,646
606,654
10,195
7,646
88
NOTE 18 – EARNINGS PER SHARE
The Company’s basic earnings per common share is computed by dividing net income available to common shareholders (net income less
dividends declared by the weighted average number of common shares outstanding during the period). The Company’s diluted earnings
per common share is computed similar to basic earnings per common share except that the numerator is equal to net income available to
common shareholders and the denominator is increased to include the number of additional common shares that would have been
outstanding if dilutive potential common shares had been issued. Included in the denominator are the dilutive effects of stock options
computed under the treasury stock method and outstanding warrants as if converted to common stock.
The following table illustrates the computation of basic and diluted earnings per share.
Basic:
Net income (numerator)
Weighted average shares outstanding (denominator)
Basic e arnings pe r share
Diluted:
Net income (numerator)
Weighted average shares outstanding
Effect of dilutive stock options
Weighted average shares outstanding assuming dilution (denominator)
Dilute d e arnings pe r share
Shares subject to outstanding options
Shares subject to outstanding warrants
$
$
$
$
For the Year Ended
December 31,
2014
2013
2012
4,927 $
3,731
$
4,785
10,256,242
10,121,738
10,121,853
0.48 $
0.37
$
0.47
4,927 $
3,731
$
4,785
10,256,242
10,121,738
10,121,853
91,096
66,150
4,391
10,347,338
10,187,888
10,126,244
0.48 $
0.37
$
0.47
December 31,
2014
December 31,
2013
December 31,
2012
361,545
-
436,495
638,920
532,106
699,642
As of December 31, 2014 and 2013, the shares subject to outstanding options and for December 31, 2013, the shares subject to
outstanding warrants, included some options that had exercise prices in excess of the current market value. Those specific shares are not
included in the table above, as exercise of these options and warrants would not be dilutive to shareholders.
NOTE 19 – 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 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 purposes of the acquisition are 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.
89
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
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 were expensed as incurred in the year ended December 31, 2013. These acquisition and
integration expenses included salaries and benefits, technology and communications, occupancy and equipment, professional services and
other noninterest expenses. For the year ended December 31, 2013, the Company incurred $615 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.
Cash and cash equivalents
Investment securities
Loans receivable, net
Premises and equipment
Goodwill and intangible assets
Other assets
Total assets
Deposits and accrued interest payable
Borrowings
Other liabilities
Equity
Total liabilities and shareholders’ equity
$ 91,781
68,043
455,777
15,197
13,677
36,803
$681,278
$586,092
23,903
4,562
66,721
$681,278
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
90
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
Pro forma earnings per share
Basic
Diluted
$25,357
9,776
30,131
1,072
$3,930
$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, 2014 or 2013 for both the balance sheet and income statement.
91
NOTE 20 – CONDENSED FINANCIAL INFORMATION-PARENT COMPANY ONLY
PACIFIC FINANCIAL CORPORAT ION-PARENT COMPANY ONLY
CONDENSED CONSOLIDAT ED BALANCE SHEET S
(Dollars in T housands)
ASSETS
Cash and cash equivalents:
Investment in bank
Other assets
TO TAL ASSETS
LIABILITIES
Junior subordinated debentures
Dividends payable
Other liabilities
T otal liabilities
SHAREHO LDERS' EQ UITY
Shareholders' equity
LIABILITIES AND SHAREHO LDERS' EQ UITY
$
$
$
December 31,
2014
December 31,
2013
$
2,585
84,864
655
88,104
$
13,403
$
2,178
40
15,621
2,483
79,701
432
82,616
13,403
2,036
40
15,479
72,483
67,137
TO TAL LIABILITIES AND SHAREHO LDERS' EQ UITY
$
88,104
$
82,616
PACIFIC FINANCIAL CORPORAT ION-PARENT COMPANY ONLY
CONSOLIDAT ED ST AT EMENT S OF INCOME
(Dollars in T housands)
For the Year Ended
December 31,
December 31,
December 31,
2014
2013
2012
INCO ME
Dividend income from the bank
$
1,678 $
2,400 $
Other income
T otal interest and dividend income
EXPENSES
INCO ME BEFO RE PRO VISIO N FO R INCO ME TAXES
INCO ME TAX BENEFIT
INCO ME BEFO RE EQ UITY IN UNDISTRIBUTED
INCO ME O F THE BANK
EQ UITY IN UNDISTRIBUTED INC O ME O F THE BANK
7
1,685
902
783
215
998
3,929
7
2,407
608
1,799
124
1,923
1,808
NET INC O ME
$
4,927 $
3,731 $
3,500
10
3,510
517
2,993
101
3,094
1,691
4,785
92
PACIFIC FINANCIAL CORPORAT ION-PARENT COMPANY ONLY
CONSOLIDAT ED ST AT EMENT S OF COMPREHENSIVE INCOME
(Dollars in T housands)
For the Year Ended
December 31,
December 31,
December 31,
2014
2013
2012
NET INC O ME
O THER CO MPREHENSIVE INCO ME (LO SS), NET O F TAX:
Change in fair value of securities available-for-sale
Defined benefit plan
T otal other comprehensive income (loss), net of tax
CO MPREHENSIVE INCO ME
$
$
4,927
$
3,731
$
4,785
1,269
(35)
1,234
(1,875)
85
(1,790)
536
130
666
6,161
$
1,941
$
5,451
PACIFIC FINANCIAL CORPORAT ION AND SUBSIDIARY-PARENT COMPANY ONLY
CONSOLIDAT ED ST AT EMENT S OF CASH FLOWS
(Dollars in T housands)
December 31,
2014
For the Year Ended
December 31,
2013
December 31,
2012
4,927
$
3,731
$
4,785
(3,929)
(223)
-
-
775
-
1,366
(3)
(2,036)
(673)
102
2,483
2,585
(1,808)
(29)
(96)
117
1,915
394
-
-
-
394
2,309
173
2,483
$
$
(1,691)
35
(1,312)
24
1,841
-
-
-
(2,024)
(2,024)
(183)
356
173
CASH FLO WS FRO M O PERATING ACTIVITIES
Net Income
Adjustments to reconcile net income to net cash from operating activities
$
Equity in undistributed income of subsidiary
Net change in other assets
Net change in other liabilities
Other -- net
Net cash provided by operating activities
CASH FLO WS FRO M FINANCING ACTIVITIES
Common stock issued
Warrants exercised
Repurchase of stock (RSU)
Dividends paid
Net cash provided by (used in) financing activities
NET (DECREASE) INCREASE IN CASH
CASH - BEGINNING O F THE PERIO D
CASH - END O F THE PERIO D
$
93
Year Ended De ce mbe r 31, 2014
Interest income
Interest expense
Ne t interest income
Provision for credit losses
Non-interest income
Non-interest expense
Income be fore income taxes
Income taxes
Ne t income
Earnings per common share
Basic
Diluted
Year Ended De ce mbe r 31, 2013
Interest income
Interest expense
Ne t interest income
Recapture of credit losses
Non-interest income
Non-interest expense
Income be fore income taxes
Income taxes
Ne t income
Earnings per common share
Basic
Diluted
Year Ended De ce mbe r 31, 2012
Interest income
Interest expense
Ne t interest income
Provision for (recapture of) credit losses
Non-interest income
Non-interest expense
Income be fore income taxes
Income taxes
Ne t income
Earnings per common share
Basic
Diluted
QUART ERLY DAT A (UNAUDIT ED)
(Dollars in T housands, Except per Share Data)
First Quarter
Second Quarter
T hird Quarter
Fourth Quarter
7,336
536
6,800
100
2,021
7,127
1,594
473
1,121
0.11
0.11
6,814
563
6,251
-
1,922
7,122
1,051
262
789
0.08
0.08
6,673
764
5,909
(1,500)
2,691
7,838
2,262
583
1,679
0.16
0.16
$
7,085 $
7,337 $
7,400 $
530
6,555
-
1,608
6,830
1,333
305
541
6,796
100
2,176
7,066
1,806
403
518
6,882
100
2,274
7,133
1,923
549
1,028 $
1,403 $
1,374 $
0.10 $
0.10 $
0.14 $
0.14 $
0.13 $
0.13 $
6,271 $
6,600 $
6,605 $
689
5,582
-
2,626
7,419
789
88
648
5,952
(450)
3,175
7,872
1,705
373
590
6,015
-
2,232
7,089
1,158
249
701 $
1,332 $
909 $
0.07 $
0.07 $
0.13 $
0.13 $
0.09 $
0.09 $
7,034 $
7,037 $
6,751 $
984
6,050
100
1,848
6,599
1,199
181
907
6,130
300
2,409
6,910
1,329
256
829
5,922
-
2,443
7,070
1,295
280
1,018 $
1,073 $
1,015 $
0.10 $
0.10 $
0.11 $
0.11 $
0.10 $
0.10 $
$
$
$
$
$
$
$
$
$
$
$
94
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized, on the 26th day of March, 2015.
PACIFIC FINANCIAL CORPORATION
(Registrant)
_______________________________________
Dennis A. Long, President and CEO
/s/ Dennis A. Long
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 26th day of March, 2015.
Principal Executive Officer and Director Principal Financial and Accounting Officer
/s/ Dennis A. Long
_______________________________________ _______________________________________
Dennis A. Long, President and CEO and Director Douglas N. Biddle, Chief Financial Officer
/s/ Douglas N. Biddle
Remaining Directors
/s/ Gary C. Forcum
_______________________________________ _______________________________________
Gary C. Forcum (Chairman of the Board) John Van Dijk
/s/ John Van Dijk
/s/ Randy W. Rognlin
_______________________________________ _______________________________________
Randy W. Rognlin Edwin Ketel
/s/ Edwin Ketel
/s/ Randy Rust /s/ Dwayne Carter
_______________________________________ _______________________________________
Randy Rust Dwayne Carter
/s/ Douglas M. Schermer /s/ Susan C. Freese
_______________________________________ _______________________________________
Douglas M. Schermer Susan C. Freese
/s/ Denise Portmann
_______________________________________ _______________________________________
Denise Portmann, Secretary
/s/ Dan J. Tupper
Dan J. Tupper
/s/ Kristi Gundersen
_______________________________________
Kristi Gundersen
95
Exhibit Index
EXHIBIT NO.
EXHIBIT
3.1
3.2
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
10.15
21
31.1
31.2
32
Restated Articles of Incorporation. Incorporated by reference to Exhibit 3.2 to the Company's Current Report on
Form 8-K dated April 23, 2014 (the "April 2014 8-K").
Amended and Restated Bylaws. Incorporated by reference to Exhibit 3.3 to the April 2014 8-K.
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.
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.*
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.
Incorporated by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the year ended December
31, 2013.*
Subsidiaries of the Registrant
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.
96
EXHIBIT 21
SCHEDULE OF SUBSIDIARIES
The following is a list of registrant's subsidiaries at March 26, 2015.
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
97
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
UNDER RULE 13a-14(a)
I, Dennis A. Long, certify that:
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 26, 2015
/s/ Dennis A. Long
Dennis A. Long, President and Chief Executive Officer
98
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;
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 26, 2015
/s/ Douglas N. Biddle
Douglas N. Biddle, Chief Financial Officer
99
Exhibit 32
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.
/s/ Dennis A. Long /s/ Douglas N. Biddle
Dennis A. Long,
President and Executive Vice President and
Chief Executive Officer Chief Financial Officer
March 26, 2015 March 26, 2015
Douglas N. Biddle,
100
GENERAL CORPORATE AND SHAREHOLDER INFORMATION
Administrative Headquarters
1101 S. Boone Street
Aberdeen, WA 98520
(360) 533-8870
Independent Accountants
BDO USA, LLP
Spokane, Washington
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 account
directly through Investor Center at www.computershare.com/investor.
Annual Meeting
The annual meeting of shareholders will be held on April 29, 2015 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
Kristi Gundersen
Partner & CFO
Knutz en Farms, LP
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
Dan Tupper
Vice President & General Manager
Crown Distributing Co. of Aberdeen, Inc.
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
Chief Financial Officer
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.
[This page intentionally left blank.]
Pacific Financial Corporation
1101 S. Boone Street
Aberdeen, WA 98520
360.533.8873
BankofthePacific.com
Cover photo of
Mt. Hood in Oregon