March 23, 2016
Dear Fellow Shareholders:
Denise Portmann
President & CEO
We are very proud of the exceptional financial performance Pacific Financial has delivered to its
shareholders in 2015. We grew earnings by 13% to $5.6 million for the year, or $0.54 per share, and
achieved our sixth consecutive year of profitability. In addition, for the second consecutive year we raised
our annual cash dividend by 5% to $0.22 per share for 2015, equating to a yield of approximately 3.3% at
current market levels.
Our company is emerging as an outstanding franchise, as we continue to make progress in executing on our
growth strategies, strengthening our balance sheet, and prudently managing our operations. The loan
portfolio increased 11% during the year, while total deposits increased 12%, substantially outpacing the
median state and national averages, as displayed below.
Loan Growth Rate (%)
Deposit Growth Rate (%)
15
10
5
0
15
10
5
0
Bank of the
Pacific
State
Median
National
Median
Bank of the
Pacific
State
Median
National
Median
Source: SNL Financial, LC
Core deposits remained strong at 93% of total deposits. Our capital ratios continue to exceed regulatory
requirements with total risk-based capital at 12.78%. Credit quality metrics continue to improve, now at
levels we have not seen since 2007. Nonperforming loans were 0.62% of total assets at year end, less than
half the level of a year ago. Our net interest margin also remains above average at 4.10% for the full year.
We expect to sustain our loan and deposit growth momentum into 2016, as we continue to focus on our
customer’s financial needs to deliver real value and real solutions. With our strong capital and liquidity, we
are well positioned to build upon our performance in 2016. The accompanying Selected Financial Data
demonstrates our improvement in financial performance in 2015. Some of those highlights are displayed as
follows:
(cid:2) Earnings grew to $5.6 million, or $0.54 per share, an increase of 13%;
(cid:2) Non-interest bearing deposits increased 12%;
(cid:2) Gross loans grew 11%;
(cid:2) Net interest income increased 8% to $29.1 million;
(cid:2) Net overhead ratio improved to 2.67% from 2.77%;
(cid:2) Tangible book value per share grew to $6.03 at December 31, 2015, an increase of 6%.
In addition, we accomplished the following initiatives to improve operating performance and efficiency:
(cid:2) Completed SEC deregistration of common stock, reducing expenses by approximately $200,000;
(cid:2) Renegotiated our core processing contract to achieve 10% savings;
(cid:2) Closed two underperforming branches in WA, while enhancing electronic banking channels in
the first quarter of 2016.
Additionally, in early 2015 we expanded our presence in the high-growth market of Salem, OR by adding a
seasoned commercial lending team. These high-quality banking professionals have focused on commercial
lending, generated solid core deposits and built deep relationships with the business owners in that
community. This initiative has proven to be a perfect fit for our strategic direction. As we go forward, we
expect our 2016 plans to further enhance our franchise and will include:
(cid:2) Creating a small business banking specialty unit to nurture deposit and loan relationships in this
segment, while adding technology-assisted underwriting to improve delivery of credit products.
(cid:2) Expanding our treasury management team with enhanced treasury management products set to
capture additional deposits and fee income from the commercial banking segment.
(cid:2) Creating a Small Business Administration (SBA) lending unit to generate and sell government-
guaranteed loans to boost non-interest income.
(cid:2) Pursuing in-market or adjacent market branch acquisitions to improve market share and enhance
branch operational economies of scale.
Community banks such as ours are critical to our communities, and we are deeply embedded in our
communities making a positive impact. We have intimate knowledge of our local economies and local small
businesses which allow us to effectively serve our clients providing them with many products and services
tailored to meet their needs.
We have an outstanding board of directors with an exceptional management team and a strong culture of
loyal employees. We thank you for your continued support and confidence. As always, we will continue to
search for ways to improve efficiencies while maintaining strong open communications with our
shareholders. Please join us for our annual shareholders’ meeting on Wednesday, April 27, 2016, at 4:00
p.m. at 1101 S. Boone Street, Aberdeen, WA 98520.
Sincerely,
Gary. C. Forcum
Chairman of the Board
Pacific Financial Corporation
Denise Portmann
President and Chief Executive Officer
Pacific Financial Corporation
Pacific Financial Corporation
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.
O pe rations Data
Net interest income
Loan loss provision (recapture)
Noninterest income
Noninterest expense
Provision for income taxes
Ne t income
Net income per share:
Basic
Diluted
Dividends declared
Dividends declared per share
Dividends payout ratio
Pe rformance Ratios
Interest rate spread
Net interest margin⁽¹⁾
Efficiency ratio⁽²⁾
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⁽³⁾
T angible book value per share⁽⁴⁾
Equity to assets ratio
$
$
$
$
$
$
$
$
2015
29,139 $
582
9,799
30,859
1,921
5,576 $
For the Ye ar Ende d De ce mbe r 31,
2013
2014
2012
(in thousands)
27,033 $
300
8,079
28,155
1,730
4,927 $
23,800 $
(450)
9,955
29,502
972
3,731 $
24,011 $
(1,100)
9,391
28,417
1,300
4,785 $
2015
$
0.54
0.53
2,287 $
0.22
$
41%
For the Ye ar Ende d De ce mbe r 31,
2014
2012
2013
(dollars in thousands, except per share data)
0.47
0.47
0.37
0.37
0.48
0.48
$
$
$
2,178 $
0.21
$
44%
2,036 $
0.20
$
55%
2,024 $
0.20
$
42%
3.99%
4.10%
79.25%
0.71%
7.35%
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%
824,613 $
617,019
714,499
24,706
76,285
7.34
6.03
9.25%
$
$
744,807 $
554,746
639,054
24,856
72,483
6.99
5.68
9.73%
$
$
705,039 $
496,307
607,347
23,403
67,137
6.59
5.25
9.52%
$
$
643,594 $
438,838
548,243
23,903
66,721
6.59
5.35
10.37%
$
$
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
0.24%
1.33%
1.62%
1.48%
1.98%
1.66%
547.89%
0.62%
91.54%
1.36%
115.41%
1.42%
3.37%
2.09%
61.92%
3.08%
⁽¹⁾ Net interest income divided by average earning assets
⁽²⁾ Noninterest expense divided by the sum of net interest income and noninterest income
⁽³⁾ Shareholder equity divided by shares outstanding
⁽⁴⁾ Shareholder equity less intangibles divided by shares outstanding
2011
23,685
2,500
7,614
25,648
333
2,818
2011
0.28
0.28
-
-
-
4.03%
4.22%
81.95%
0.44%
4.55%
641,254
463,766
548,050
24,644
63,270
6.25
5.01
9.87%
2.96%
2.34%
79.28%
3.39%
Tel: 509-747-8095
Fax: 509-747-0415
www.bdo.com
601 W. Riverside Ave., Suite 900
Spokane, WA 99201-0611
Independent Auditor’s Report
Board of Directors and Shareholders
Pacific Financial Corporation
Aberdeen, Washington
We have audited the accompanying consolidated financial statements of Pacific Financial
Corporation, which comprise the consolidated balance sheets as of December 31, 2015 and
2014, and the related consolidated statements of income and comprehensive income, changes
in stockholders’ equity, and cash flows for the years then ended, and the related notes to the
consolidated financial statements.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated
financial statements in accordance with accounting principles generally accepted in the United
States of America; this includes the design, implementation, and maintenance of internal
control relevant to the preparation and fair presentation of consolidated financial statements
that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on
our audits. We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements are free from
material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the consolidated financial statements. The procedures selected depend on the
auditor’s judgment, including the assessment of the risks of material misstatement of the
consolidated financial statements, whether due to fraud or error. In making those risk
assessments, the auditor considers internal control relevant to the entity’s preparation and fair
presentation of the consolidated financial statements in order to design audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit
also includes evaluating the appropriateness of accounting policies used and the reasonableness
of significant accounting estimates made by management, as well as evaluating the overall
presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our audit opinion.
BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of
the international BDO network of independent member firms.
BDO is the brand name for the BDO network and for each of the BDO Member Firms.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Pacific Financial Corporation as of December 31,
2015 and 2014, and the results of its operations and its cash flows for the years then ended in
accordance with accounting principles generally accepted in the United States of America.
Spokane, Washington
March 23, 2016
Pacific Financial Corporation
Consolidated Statements of Financial Condition
(Dollars in thousands, except per share data)
AS S ETS
December 31,
2015
December 31,
2014
Cash on hand and in banks
Interest bearing deposits
Cash and cash equivalents
Other interest earning deposits
Investment securities available for sale, at fair value
Investment securities held to maturity (fair value of $1,713 and $1,852, respectively)
Loans held for sale
Loans, net of deferred loan fees
Allowance for loan losses
Total Loans, net
Federal Home Loan Bank stock, at cost
Pacific Coast Bankers' Bank stock, at cost
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 assets
TOTAL AS S ETS
$
$
LIABILITIES AND S HAREHOLDERS ' EQUITY
LIABILITIES
Deposits
Demand
Interest bearing demand and savings
Time deposits
Total deposits
Federal Home Loan Bank Advances
Junior subordinated debentures
Accrued interest payable and other liabilities
Total liabilities
$
$
$
$
17,680
9,846
27,526
2,727
100,024
1,697
12,333
625,336
(8,317)
617,019
1,346
1,000
15,749
3,610
2,674
19,231
12,168
1,404
6,105
824,613
185,001
389,723
139,775
714,499
11,303
13,403
9,123
748,328
14,782
16,255
31,037
2,727
87,440
1,829
5,786
563,099
(8,353)
554,746
2,896
1,000
16,303
999
2,348
18,742
12,168
1,439
5,347
744,807
165,760
354,611
118,683
639,054
11,453
13,403
8,414
672,324
S HAREHOLDERS ' EQUITY
Preferred Stock, no par value; 5,000,000 shares authorized; no shares issued
or outstanding at December 31, 2015 and December 31, 2014
-
-
Common Stock, $1 par value; 25,000,000 shares authorized, 10,394,828 and 10,371,460
shares issued and outstanding at December 31, 2015 and 2014, respectively
Additional paid-in-capital
Retained earnings
Accumulated other comprehensive income (loss), net
Total shareholders' equity
TOTAL LIABILITIES AND S HAREHOLDERS ' EQUITY
$
10,395
43,245
22,545
100
76,285
824,613
$
10,371
42,991
19,256
(135)
72,483
744,807
See accompanying Notes to Consolidated Financial Statements.
Pacific Financial Corporation
Consolidated Statements of Income
(Dollars in thousands, except per share data)
Twelve Months Ended
December 31,
2015
2014
INTERES T AND DIVIDEND INCOME
Loans, including fees
Deposits in banks and federal funds sold
Taxable interest on investment securities
Tax-exempt interest on investment securities
FHLB & PCBB dividends
Total interest and dividend income
INTERES T EXPENS E
Deposits
Federal Funds Purchased
Federal Home Loan Bank Advances
Junior subordinated debentures
Total interest expense
Net interest income
LOAN LOS S PROVIS ION
Net interest income after loan loss provision
NONINTERES T INCOME
Service charges on deposits
Net gain (loss) on sale of other real estate owned
Gains on sales of loans, net
Gain on sales of securities available for sale, net
Other-than-temporary impairment, net
Earnings on bank owned life insurance
Other noninterest income
Total noninterest income
NONINTERES T EXPENS E
Salaries and employee benefits
Occupancy
Equipment
Data processing
Professional services
Other real estate owned write-downs
Other real estate owned operating costs
State and local taxes
FDIC and state assessments
Other noninterest expense
Total noninterest expense
INCOME BEFORE INCOME TAXES
INCOME TAX EXPENS E
NET INCOME APPLICABLE TO COMMON S HAREHOLDERS
EARNINGS PER COMMON S HARE:
BAS IC
DILUTED
WEIGHTED AVERAGE S HARES OUTS TANDING:
BAS IC
DILUTED
$
29,294 $
92
1,094
792
68
31,340
1,715
2
236
248
2,201
29,139
582
28,557
1,764
128
4,961
53
-
490
2,403
9,799
19,070
1,965
1,061
1,872
599
104
184
465
535
5,004
30,859
7,497
1,921
$
$
$
5,576 $
0.54
0.53
$
$
26,937
89
1,269
830
33
29,158
1,668
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
4,927
0.48
0.48
10,382,499
10,524,303
10,256,242
10,347,338
See accompanying Notes to Consolidated Financial Statements.
2
Pacific Financial Corporation
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
NET INCO ME
Change in fair value of securities available for sale
Defined benefit pension plan
Other comprehensive income, net of tax
CO MPREHENSIVE INCO ME
Twelve Months Ended
December 31,
2015
2014
$
$
5,576
$
4
231
235
5,811
$
4,927
1,269
(35)
1,234
6,161
See accompanying Notes to Consolidated Financial Statements.
3
Pacific Financial Corporation
Consolidated Statements of Shareholders’ Equity
(Dollars in thousands, except share amounts)
Number of
Common
Shares
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
O ther
Comprehensive
Income (Loss)
Total
Shareholders'
Equity
Balance at December 31, 2013
10,182,083
$
10,182 $
41,817 $
16,507 $
(1,369) $
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
Cash dividends declared ($0.21 per share)
Stock-based compensation expense
Balance at December 31, 2014
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
Cash dividends declared ($0.22 per share)
Stock-based compensation expense
Balance at December 31, 2015
-
-
-
189,377
-
-
-
-
-
189
-
-
-
-
-
1,035
-
139
4,927
-
-
-
-
(2,178)
-
1,269
(35)
-
-
-
10,371,460
$
10,371 $
42,991 $
19,256 $
(135) $
-
-
-
23,368
-
-
-
-
24
-
-
-
-
41
-
-
10,394,828
$
-
10,395 $
213
43,245 $
5,576
-
-
-
(2,287)
-
22,545 $
-
4
231
-
-
-
100 $
67,137
4,927
1,269
(35)
1,224
(2,178)
139
72,483
5,576
4
231
65
(2,287)
213
76,285
See accompanying Notes to Consolidated Financial Statements.
4
Pacific Financial Corporation
Consolidated Statements of Cash Flow
(Dollars in thousands)
Cash flows from operating activities:
Net Income
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses
Depreciation and amortization
Deferred income taxes
Originations of loans held for sale
Proceeds from sales of loans held for sale
Gain on sales of loans, net
Gain on sales of securities available for sale, net
Other-than-temporary impairment recognized in earnings
(Gain) loss on sales of other real estate owned
Gain on sale of premises and equipment
Earnings on bank owned life insurance
Increase in accrued interest receivable
Increase (decrease) in accrued interest payable
Other real estate owned write-downs
(Increase) decrease in prepaid expenses
Other operating activities
Net cash provided by operating activities
Cash flows from investing activities
Loans originated, net of principal payments
Net decrease in interest bearing balances with banks
Maturities of investment securities held to maturity
Maturities of investment securities available for sale
Purchase of investment securities available for sale
Purchases of premises and equipment
Proceeds from sales of investment securities available for sale
Proceeds from sales of government loan pools
Proceeds from sales of other real estate owned
Net cash used in investing activities
Cash flows from financing activities
Net increase in deposits
Proceeds from FHLB Advances
Repayments of FHLB Advances
Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosures of cash flow information:
Cash paid for interest
Cash paid for taxes
Supplemental non-cash disclosures of cash flow information:
T ransfer of loans held for sale to loans held for investment
Other real estate owned acquired in settlement of loans
Financed sale of other real estate owned
Twelve Months Ended
December 31,
2015
2014
$
5,576
$
4,927
582
2,861
29
(206,986)
205,400
(4,961)
(53)
-
(128)
(30)
(490)
(326)
7
104
(376)
644
1,853
(66,952)
6,409
131
10,262
(29,240)
(844)
6,808
-
1,289
(72,137)
75,445
-
(150)
65
(2,178)
73,182
2,898
14,782
17,680
2,194
2,306
-
(3,876)
448
$
$
$
$
$
$
300
2,538
727
(150,899)
155,846
(3,546)
(88)
48
207
(2)
(505)
(41)
(22)
67
12
1,791
11,360
(60,809)
7,479
303
8,623
(17,711)
(848)
17,755
2,541
1,527
(41,140)
31,707
1,500
(47)
1,224
(2,036)
32,348
2,568
12,214
14,782
2,147
643
578
(842)
813
$
$
$
$
$
$
See accompanying Notes to Consolidated Financial Statements.
5
check
17,680
14,782
Pacific Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2015 and December 31, 2014
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 Aberdeen,
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 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 three loan production offices in Burlington and DuPont, Washington and Salem Oregon and has a
residential real estate mortgage department.
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.
Certain prior year amounts have been reclassified to conform with the 2015 presentation. None of these reclassifications have an
effect on net income or net cash flows.
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.
Subsequent events –The Company performed an evaluation of subsequent events through March 23, 2016, the date these financial
statements were available to be issued. There were no significant subsequent events identified.
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 noninterest income.
Federal Home Loan Bank stock – The Company’s investment in Federal Home Loan Bank (FHLB) stock is carried at cost. The
Company is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding
mortgages, total assets or FHLB advances.
6
At December 31, 2015 the stock was that of FHLB of Des Moines and at December 31, 2014 the stock was that of FHLB of Seattle.
The FHLB of Seattle merger with and into the FHLB of Des Moines was effective in the second quarter of 2015.
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
payoff 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.
TDRs typically present an elevated level of credit risk as the borrowers are not able to perform according to the 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.
7
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, 2015 the Company had $13.6 million 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, 2015 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 noninterest expenses using an accelerated method over ten years. Net unamortized core
deposit intangible totaled $134,000 and $171,000 at December 31, 2015 and 2014, respectively. Amortization expense related to core
deposit intangible totaled $34,000 and $43,000 during the years ended December 31, 2015 and 2014, respectively.
In 2006, the Bank completed a deposit transfer and assumption transaction with an Oregon-based bank for a $1.3 million 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
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
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, 2015, 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
8
interest and penalties recognized for the year ended December 31, 2015. The tax years that remain subject to examination by federal
and state taxing authorities are the years ended December 31, 2014, 2013 and 2012.
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 260,350 and 361,545 in 2015 and 2014, respectively. There were no
outstanding warrants for the years ended 2015 and 2014.
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,
2015 and 2014.
Recent accounting pronouncements – In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting
Standards Update (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’s adoption of this standard did not 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
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, 2017, including interim
periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15,
2016, including interim reporting periods within that reporting period. The Company is currently evaluating the impact that this
Update will have on its consolidated financial position, results of operations or cash flows.
9
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’s adoption of this standard did not have a
material effect on its financial statements.
In January 2016, FASB issued ASU 2016-01, “'Financial Instruments─Overall (Subtopic 825-10): Recognition and Measurement of
Financial Assets and Financial Liabilities”. The amendments in ASU 2016-01:
- Requires equity investments (except those accounted for under the equity method of accounting, or those that result in
consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income.
-Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for
disclosure purposes.
-Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial
asset (i.e., securities or loans and receivables).
-Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to
estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost.
ASU 2016-01 is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within
those fiscal years. The Company is currently evaluating the impact that this Update will have on its consolidated financial position,
results of operations or cash flows.
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 required reserve balance at December 31, 2015 and 2014 was
met by holding cash.
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 were as follows:
10
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
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, 2015
Gross
Unrealized
Gains
Gross
Unrealized
Losses
$
39,445
434
12,256
8,588
38,765
(in thousands)
129
$
-
50
81
999
$
529
12
128
23
31
Fair
Value
39,045
422
12,178
8,646
39,733
99,488
$
1,259
$
723
$
100,024
65
$
1,632
1,697
$
5
11
16
$
$
-
-
-
Amortized
Cost
December 31, 2014
Gross
Unrealized
Gains
Gross
Unrealized
Losses
$
38,949
535
12,325
7,977
27,121
(in thousands)
236
$
39
111
850
418
8
165
32
80
$
$
$
86,907
$
1,236
$
703
$
123
$
1,706
1,829
$
12
11
23
$
$
-
-
-
$
$
70
1,643
1,713
Fair
Value
38,767
527
12,199
8,056
27,891
87,440
135
1,717
1,852
$
$
$
$
$
$
$
$
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, 2015 and December 31, 2014, were as follows:
De ce mbe r 31, 2015
Le ss Than 12 Months
12 Months or More
Total
Unre aliz e d
Unre aliz e d
Unre aliz e d
Fair Value
Losse s
Fair Value
Losse s
Fair Value
Losse s
Available for sale
(in thousands)
Collateralized mortgage obligations: agency issued
$
25,029 $
325 $
7,987 $
204 $
33,016 $
Collateralized mortgage obligations: non agency
Mortgage backed securities: agency issued
U.S. Government agency securities
State and municipal securities
T otal
-
6,240
5,595
5,133
41,997 $
$
-
64
23
31
443 $
422
3,273
-
-
11,682 $
12
64
-
422
9,513
5,595
-
280 $
5,133
53,679 $
529
12
128
23
31
723
De ce mbe r 31, 2014
Le ss Than 12 Months
12 Months or More
Total
Unre aliz e d
Unre aliz e d
Unre aliz e d
Fair Value
Losse s
Fair Value
Losse s
Fair Value
Losse s
Available for sale
(in thousands)
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
335
2,883
-
5,123
2
80
41
-
192
6,888
3,615
3,054
6
85
32
39
527
9,771
3,615
8,177
T otal
$
14,177 $
150 $
31,195 $
553 $
45,372 $
418
8
165
32
80
703
11
At December 31, 2015, there were 68 investment securities in an unrealized loss position. 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, 2015.
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 years ended December 31, 2015 and 2014, no CMO was determined to be other-than-temporarily-
impaired. The Company recorded $0 and $48,000 in impairments related to credit losses through earnings for the years ended
December 31, 2015 and 2014, respectively.
The following table presents the cash proceeds from the sales of securities and their associated gross realized gains and gross realized
losses that were included in earnings for the twelve months ended December 31, 2015 and 2014:
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
Twelve Months Ended
December 31,
2015
2014
(in thousands)
108 $
(55)
53 $
315
(227)
88
6,845 $
17,755
$
$
$
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 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.
The amortized cost and estimated fair value of investment securities at December 31, 2015, by maturity were as follows:
De ce mbe r 31, 2015
He ld to Maturity
Available for Sale
Amortiz e d
Cost
Fair Value
Amortiz e d
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
$
$
$
-
175
1,168
289
65
1,697 $
$
(in thousands)
-
178
1,176
289
70
1,713
$
2,594 $
14,885
23,929
5,945
52,135
99,488 $
2,602
14,982
24,633
6,162
51,645
100,024
At December 31, 2015 and 2014, investment securities with an estimated fair value of $84.4 million and $84.1 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. Participating banks
12
record the value of FHLB stock equal to its par value at $100 per share. At December 31, 2015 and 2014, the Company held
approximately $1.3 million and $2.9 million, respectively, in FHLB stock. The $1.6 million decrease was due to the repurchase of
stock by the FHLB of Seattle as a result of the FHLB of Seattle merger with FHLB of Des Moines which was effective during the
second quarter of 2015. Based on the FHLB of Des Moines structure, the amount of stock to be held by participating banks is
substantially less than that of the former FHLB of Seattle.
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, 2015 and maintains capital ratios that exceed “well capitalized” standards for regulatory purposes.
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY
Loans held in the portfolio at December 31, 2015 and December 31, 2014, were as follows:
Commercial and agricultural
Real estate:
Construction and development
Residential 1-4 family
Multi-family
Commercial real estate -- owner occupied
Commercial real estate -- non owner occupied
Farmland
Consumer
Gross loans
Less: deferred fees
Portfolio Loans
December 31,
2015
2014
(in thousands)
$
131,734 $
120,517
33,170
94,217
26,828
134,366
134,612
20,492
51,352
626,771
(1,435)
26,711
92,965
18,541
125,632
117,137
22,245
40,565
564,313
(1,214)
$
625,336 $
563,099
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
13
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.
Changes in the allowance for loan losses for the twelve months ended December 31, 2015 and December 31, 2014 were as follows:
Beginning balance
Charge-offs and concessions
Recoveries
Provision (recapture)
Ending balance
Beginning balance
Charge-offs and concessions
Recoveries
Provision (recapture)
Ending balance
Twelve Months Ended December 31, 2015
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Unallocated
Total
1,022 $
-
49
24
1,095 $
3,419 $
(806)
263
645
3,521 $
(in thousands)
701 $
(86)
86
202
903 $
979 $
(143)
19
(54)
801 $
2,232 $
-
-
(235)
1,997 $
8,353
(1,035)
417
582
8,317
Twelve Months Ended December 31, 2014
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Unallocated
Total
775 $
(26)
11
262
1,022 $
(in thousands)
3,506 $
(533)
425
21
3,419 $
675 $
(129)
22
133
701 $
744 $
(79)
3
311
979 $
2,659 $
-
-
(427)
2,232 $
8,359
(767)
461
300
8,353
$
$
$
$
The recorded investment in loans as of December 31, 2015 and December 31, 2014 were as follows:
14
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
Total
Less deferred fees
Total loans
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
Total
Less deferred fees
Total loans
Credit Quality Indicators
$
$
$
$
$
$
$
$
December 31, 2015
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Unallocated
Total
(in thousands)
-
$
-
$
-
$
-
$
-
$
-
1,095
1,095 $
3,521
3,521 $
903
903 $
801
801 $
1,997
1,997 $
8,317
8,317
430 $
1,210 $
284 $
57 $
N/A $
1,981
131,304
131,734 $
321,430
322,640 $
120,761
121,045 $
51,295
51,352 $
N/A
N/A
624,790
626,771
(1,435)
625,336
$
December 31, 2014
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Unallocated
Total
(in thousands)
-
$
249 $
-
$
-
$
-
$
249
1,022
1,022 $
3,170
3,419 $
701
701 $
979
979 $
2,232
2,232 $
8,104
8,353
380 $
9,864 $
1,067 $
-
$
N/A $
11,311
120,137
120,517 $
281,861
291,725 $
110,439
111,506 $
40,565
40,565 $
N/A
N/A
553,002
564,313
(1,214)
563,099
$
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.
15
Credit quality indicators as of December 31, 2015 and December 31, 2014 were as follows:
December 31, 2015
O ther Loans
Especially
Mentioned
Pass
Substandard
(in thousands)
Doubtful
Total
$
123,098 $
5,690 $
2,946 $
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
T otal loans
$
32,375
91,315
26,828
126,894
123,236
20,251
420,899
51,161
(1,435)
593,723 $
-
1,332
-
5,552
2,707
241
9,832
19
-
796
1,569
-
1,920
8,669
-
12,954
172
-
15,541 $
16,072 $
December 31, 2014
-
-
-
-
-
-
-
-
-
-
-
$
131,734
33,171
94,216
26,828
134,366
134,612
20,492
443,685
51,352
(1,435)
625,336
$
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
O ther Loans
Especially
Mentioned
Pass
Substandard
(in thousands)
Doubtful
Total
$
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
-
28,603 $
965
3,098
-
6,471
5,233
253
16,020
47
-
18,430 $
-
-
-
-
249
-
249
-
-
249 $
26,711
92,965
18,541
125,632
117,137
22,245
403,231
40,565
(1,214)
563,099
T otal loans
$
517,031 $
Impaired Loans
Impaired loans by type as of December 31, 2015 and 2014, and interest income recognized for the twelve months ended December 31,
2015 and 2014, were as follows:
16
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:
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
December 31, 2015
Unpaid
Principal
Balance
Recorded
Investment
430 $
57
700
56
217
-
1,109
2,569 $
-
-
$
$
430 $
57
700
56
217
-
1,109
2,569 $
430 $
57
425
56
217
-
796
1,981 $
-
-
$
$
430 $
57
425
56
217
-
796
1,981 $
$
$
$
$
$
$
Related
Allowance
(in thousands)
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
Average
Recorded
Investment
Interest
Income
Recognized
$
$
$
$
$
$
375 $
35
750
779
2,883
41
843
5,706 $
-
-
$
$
375 $
35
750
779
2,883
41
843
5,706 $
10
3
94
2
70
-
-
179
-
-
10
3
94
2
70
-
-
179
17
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:
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
December 31, 2014
Unpaid
Principal
Balance
Recorded
Investment
418 $
-
1,359
1,381
7,642
-
3,023
13,823 $
249
249 $
418 $
-
1,359
1,381
7,891
-
380 $
-
1,067
1,379
7,271
-
965
11,062 $
249
249 $
380 $
-
1,067
1,379
7,520
-
3,023
14,072 $
965
11,311 $
Related
Allowance
(in thousands)
-
-
-
-
-
-
-
-
$
$
249
249 $
$
-
-
249
-
-
-
-
249 $
$
$
$
$
$
Average
Recorded
Investment
Interest
Income
Recognized
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
Insider Loans
Certain related parties of the Company, principally directors and their affiliates, were loan customers of the Bank in the ordinary
course of business during 2015 and 2014. Total related party loans outstanding at December 31, 2015 and 2014 to executive officers
and directors were $2.1 million and $2.4 million, respectively. During 2015 and 2014, new loans of $401,000 and $3.8 million,
respectively, were made, and repayments totaled $679,000 and $1.4 million 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, 2015.
Aging Analysis
The following tables summarize the Company’s loans past due, both accruing and nonaccruing, by type as of December 31, 2015 and
December 31, 2014:
18
30-59 Days
Past Due
60-89 Days
Past Due
Gre ate r
Than
90 Days
Commercial and agricultural
Real estate:
$
76 $
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
14
100
-
-
-
-
114
114
-
$
-
-
-
-
857
66
-
923
-
-
T otal
$
304 $
923 $
-
-
-
-
-
-
-
-
-
-
-
De ce mbe r 31, 2015
Total Past
Due
Non-accrual
Loans
Loans Not
Past Due
Total
Loans
(in thousands)
$
76 $
164 $
131,494 $
131,734
14
100
-
857
66
-
1,037
114
-
796
284
-
-
217
-
1,297
57
-
32,360
93,833
26,828
133,509
134,329
20,492
441,351
51,181
(1,435)
33,170
94,217
26,828
134,366
134,612
20,492
443,685
51,352
(1,435)
$
1,227 $
1,518 $
622,591 $
625,336
De ce mbe r 31, 2014
30-59 Days
Past Due
60-89 Days
Past Due
Gre ate r
Than
90 Days
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
18
537
-
-
-
46
601
170
-
$
-
-
-
-
-
-
-
68
68
2
-
-
-
-
409
-
-
409
-
-
Total Past
Due
Non-accrual
Loans
Loans Not
Past Due
Total
Loans
(in thousands)
$
-
$
96 $
120,421 $
120,517
18
605
-
409
-
46
1,078
172
-
965
848
-
1,325
5,482
-
8,620
-
-
25,728
91,512
18,541
123,898
111,655
22,199
393,533
40,393
(1,214)
26,711
92,965
18,541
125,632
117,137
22,245
403,231
40,565
(1,214)
T otal
$
771 $
70 $
409 $
1,250 $
8,716 $
553,133 $
563,099
Troubled Debt Restructured Loans
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, 2015, there was no impact on the allowance from TDRs during the period, as the loans classified as TDRs during the period did
not have a specific reserve 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, 2015.
19
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, 2015 and 2014, all of which were modified due to financial stress of the
borrower. There were not any subsequent defaulted TDRs as of December 31, 2015 and 2014. There were no loans modified or
recorded as TDRs during the years ended December 31, 2015 and 2014.
The following tables summarize the Company’s TDRs by type as of December 31, 2015 and December 31, 2014:
Number
of Loans
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
T otal T DRs (1)
1
1
1
1
4
Number
of Loans
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
CRE -- non owner occupied
T otal T DRs (1)
1
2
2
1
1
7
December 31, 2015
Pre-TDR
O utstanding
Recorded
Investment
(dollars in thousands)
Post-TDR
O utstanding
Recorded
Investment
335 $
1,000
192
59
266
796
141
56
1,586 $
1,259
December 31, 2014
Pre-TDR
O utstanding
Recorded
Investment
(dollars in thousands)
Post-TDR
O utstanding
Recorded
Investment
335 $
2,764
272
59
2,180
5,610 $
284
965
219
54
2,038
3,560
$
$
$
$
(1) T he period end balances are inclusive of all partial pay-downs and charge-offs since the modification date.
The following tables present troubled debt restructurings by accrual or nonaccrual status as of December 31, 2015 and 2014:
20
December 31, 2015
Accrual
Status
Non-Accrual
Status
(in thousands)
Total
TDRs
266 $
-
141
56
463 $
$
-
796
-
-
266
796
141
56
796 $
1,259
December 31, 2014
Accrual
Status
Non-Accrual
Status
(in thousands)
Total
TDRs
284 $
-
219
54
2,038
2,595 $
$
-
965
-
-
-
965 $
284
965
219
54
2,038
3,560
$
$
$
$
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
T otal T DRs
Commercial and agriculture
Construction and development
Residential real estate
CRE -- owner occupied
CRE -- non owner occupied
T otal T DRs
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, 2015 and December 31, 2014:
Balance, January 1, 2015
Other comprehensive gain before reclassifications
Amounts reclassified from AOCI
Net current period other comprehensive income
Balance, December 31, 2015
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
Net
Unrealized
Gain (Loss)
on Investment
Securities
Defined
Benefit
Plans
(in thousands)
350 $
39
(35)
4
354 $
(485) $
231
-
231
(254) $
Net
Unrealized
Gain (Loss)
on Investment
Securities
Defined
Benefit
Plans
(in thousands)
(919) $
1,295
(26)
1,269
350 $
(450) $
(35)
-
(35)
(485) $
$
$
$
$
Total
(135)
270
(35)
235
100
Total
(1,369)
1,260
(26)
1,234
(135)
The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (loss) for
the twelve months ended December 31, 2015 and December 31, 2014:
21
Twelve Months Ended
December 31,
2015
2014
(in thousands)
Gain on sales of investments available for sale
Other-than-temporary impairment, net
Income tax expense
Unrealized gain on investment securities, net of tax
$
$
(53) $
-
18
(35) $
(88)
48
14
(26)
The following table presents the components of other comprehensive income (loss) for the twelve months ended December 31, 2015
and December 31, 2014:
Net unrealized gains on investment securities:
Net unrealized gains arising during the period
Less: reclassification adjustments for net gains realized in net income
Net unrealized gains on investment securities
Defined benefit plans:
Amortization of unrecognized prior service costs and net actuarial gains
Other Comprehensive Income
Net unrealized gains on investment securities:
Net unrealized gains arising during the period
Less: reclassification adjustments for net gains realized in net income
Net unrealized gains on investment securities
Defined benefit plans:
Amortization of unrecognized prior service costs and net actuarial losses
Other Comprehensive Income
Before Tax
Twelve Months Ended December 31, 2015
Tax Effect
Net of Tax
(in thousands)
59 $
(53)
6
350
356 $
20 $
(18)
2
119
121 $
39
(35)
4
231
235
Before Tax
Twelve Months Ended December 31, 2014
Tax Effect
Net of Tax
(in thousands)
1,962 $
(40)
1,922
(53)
1,869 $
667 $
(14)
653
(18)
635 $
1,295
(26)
1,269
(35)
1,234
$
$
$
$
NOTE 6 – PREMISES AND EQUIPMENT
The components of premises and equipment at December 31, 2015 and 2014 were as follows:
December 31,
2015
2014
(in thousands)
19,600 $
7,993
431
28,024
(12,275)
15,749 $
19,875
7,698
84
27,657
(11,354)
16,303
December 31,
2015
2014
(in thousands)
1,235 $
567 $
1,242
574
$
$
$
$
Land and premises
Equipment, furniture and fixtures
Construction in progress
Less accumulated deprecation and amortization
T otal premises and equipment
Depreciation expense
Rental expense
22
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 were as follows (in thousands):
2016 $
2017
2018
2019
2020
534
424
395
348
256
$
1,957
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 Other Real Estate Owned (OREO) for the years ended December 31, 2015 and
December 31, 2014:
Other real estate owned, beginning of period
$
999 $
2,771
De ce mbe r 31,
2015
2014
(in thousands)
T ransfers from outstanding loans
Proceeds from sales
Net gain (loss) on sales
Impairment charges
3,876
842
(1,289)
(2,340)
128
(104)
(207)
(67)
999
T otal other real estate owned
$
3,610 $
OREO property types were as follows for the years ended December 31, 2015 and December 31, 2014:
December 31,
2015
2014
Amount
Number of
Properties
Amount
Number of
Properties
Construction, Land Dev & Other Land
Nonfarm Nonresidential Properties
T otal OREO
$
$
-
3,610
3,610
(dollars in thousands)
-
4
4
$
$
35
964
999
1
3
4
NOTE 8 – DEPOSITS
Time deposits that meet or exceed the FDIC Insurance limit of $250,000 at December 31, 2015 and 2014 were $71.4 million and
$37.0 million, respectively.
The composition of deposits at December 31, 2015 and December 31, 2014 was as follows:
23
De ce mbe r 31,
2015
2014
(in thousands)
Interest-bearing demand (NOW)
Money market deposits
Savings deposits
T ime deposits (CDs)
T otal interest-bearing deposits
Non-interest bearing demand
T otal deposits
$
$
165,544 $
133,799
90,380
139,775
529,498
185,001
714,499 $
151,130
123,484
79,997
118,683
473,294
165,760
639,054
Scheduled maturities of CDs were as follows for future years ending December 31 (in thousands):
2016
2017
2018
2019
2020
T hereafter
T otal
Maturities
65,764
23,665
18,099
24,060
8,071
116
139,775
$
$
NOTE 9 – BORROWINGS
Federal funds purchased and short-term advances from the Federal Home Loan Bank generally mature within one to four days from
the transaction date. The following is a summary of these borrowings:
Amount outstanding at end of period
Average balance during the year
Average interest rate during the year
$
$
-
$
3,519 $
0.29%
-
153
0.28%
December 31,
2015
2014
(dollars in thousands)
Federal Home Loan Bank advances at December 31, 2015 and 2014 represent longer term advances from the Federal Home Loan
Bank of Des Moines (FHLB). Advances at December 31, 2015 bear interest from 0.47% to 2.54% with a weighted average rate of
1.98%. The advances mature in various years as follows (in thousands):
2016
2019
2020
2024
$
$
$
$
2,500
5,000
2,500
1,303
NOTE 10 – JUNIOR SUBORDINATED DEBENTURES
At December 31, 2015, two wholly-owned subsidiary grantor trusts established by the Company had outstanding $13.4 million of
Trust Preferred Securities (TPS). 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, 2015 and 2014, respectively, for the common capital securities issued by the issuer trusts.
24
As of December 31, 2015 and 2014, 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, 2015.
Trust Name
Issue Date
Issued
Amount
Rate
Maturity
Date
Pacific Financial Corporation
Statutory T rust I
December
2005
$
5,000
LIBOR + 1.45% (1)
(dollars in thousands)
Pacific Financial Corporation
Statutory T rust II
June
2006
8,000
13,000
$
LIBOR + 1.60% (2)
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 (0.51% at December 11, 2015) plus 1.45%
or 1.96%, 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 (0.32%
at October 13, 2015) plus 1.60% or 1.92%, 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, 2015 and 2014. The amount of the
provision for each period was commensurate with the estimated tax liability associated with the net income earned during the period.
As of December 31, 2015, the Company maintained a deferred tax asset balance of $3.1 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, 2015.
Income taxes for the years ended December 31 was as follows:
Current
Deferred
T otal income tax provision
December 31,
2015
2014
(in thousands)
1,866 $
55
1,921 $
1,003
727
1,730
$
$
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:
25
December 31,
2015
2014
Deferred Tax Assets
Allowance for loan losses
Deferred compensation
Supplemental executive retirement plan
Loan fees/costs
OREO write-downs
Compensation expense
Non-accrual loan interest
Other
T otal deferred tax assets
Deferred Tax Liabilities
Depreciation
Loan fees/costs
Unrealized gain on securities available for sale
Prepaid expenses
FHLB dividends
Other
T otal deferred tax liabilities
$
$
$
(in thousands)
2,855 $
92
1,286
493
118
196
-
239
5,279 $
115 $
1,658
183
144
20
70
2,190
Net deferred tax assets
$
3,089 $
2,863
102
1,151
416
11
-
73
445
5,061
100
1,290
181
128
130
67
1,896
3,165
The following is a reconciliation between the statutory and effective federal income tax rate for the years ended December 31:
2015
Amount
2,624
(395)
(167)
(66)
(75)
1,921
December 31,
2014
Percent
of Pre-tax
Income
Percent
of Pre-tax
Income
Amount
(dollars in thousands)
35.0% $
2,330
35.0%
-5.3%
-2.2%
0.9%
-1.0%
25.6% $
(412)
(169)
(82)
63
1,730
-6.2%
-2.5%
-1.2%
1.0%
25.9%
Income tax at statutory rate
Adjustments resulting from:
T ax-exempt income
Net earnings on life insurance policies
Low income housing tax credit
Other
T otal income tax expense
$
$
As of December 31, 2015, 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.
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 $671,000 and $609,000 in 2015 and
2014, 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 $205,000 and $180,000 for 2015 and 2014, 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 2015 and 2014.
26
The directors of a bank acquired by the Company in 1999 adopted two deferred compensation plans for directors. One plan provides
retirement income benefits for all directors and the other, a deferred compensation plan, covers 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 $4.1 million
and $4.0 million at December 31, 2015 and 2014, respectively. In 2015 and 2014, the net benefit recorded from these plans, including
the cost of the related life insurance, was $378,000 and $380,000, 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 $268,000 and $311,000 at December 31, 2015 and 2014,
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 $136,000 and $137,000 in 2015 and 2014, 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 $704,000. The Company has purchased bank
owned life insurance covering all participants in the SERP. The cash surrender value of these policies totaled $6.1 million and $5.9
million at December 31, 2015 and 2014, 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, 2015 and 2014:
Net periodic pension cost:
Service cost
Interest cost
Amortization of prior service cost
Amortization of net loss
Net periodic pension cost
Weighted average assumptions:
Discount rate
Rate of compensation increase
December 31,
2015
2014
(dollars in thousands)
$
$
134 $
103
90
51
378 $
153
111
90
26
380
3.57%
n/a
4.37%
n/a
The following table sets forth the change in benefit obligation at December 31, 2015 and December 31, 2014:
Change in benefit obligation:
Benefit obligation at the beginning of year
Service cost
Interest cost
Benefits paid
Actuarial (gain) loss
Benefit obligation at end of year
December 31,
2015
2014
(in thousands)
2,944 $
134
103
(45)
(91)
3,045 $
2,573
153
111
(45)
152
2,944
$
$
Amounts recognized in accumulated other comprehensive income at December 31 were as follows:
27
Loss
Prior service cost
T otal recognized in AOCI
December 31,
2015
2014
(in thousands)
164 $
90
254 $
334
152
486
$
$
The following table summarizes the projected and accumulated benefit obligations at December 31:
Projected benefit obligation
Accumulated benefit obligation
$
December 31,
2015
2014
(in thousands)
3,045 $
3,045
2,944
2,944
Estimated future benefit payments as of December 31, 2015 were as follows (in thousands):
2016 $
2017 $
2018 $
2019 $
2020 $
2021-2025 $
254
150
242
242
242
1,211
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, 2015 and December 31, 2014 is as follows:
De cember 31,
2015
2014
(in thousands)
Commitments to extend credit
Standby letters of credit
$
$
159,911
1,756
$
$
109,545
1,351
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the
contract. Many of the commitments expire without being drawn upon; therefore total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the customer.
Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-
producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.
The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
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.
28
At December 31, 2015, the Bank had $11.3 million in outstanding borrowings against its $294.2 million in established borrowing
capacity with the FHLB, as compared to $11.5 million outstanding against a borrowing capacity of $149.7 million at December 31,
2014. 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 $65.4 million,
subject to collateral requirements, and $16.0 million 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 $8.5 million.
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.
Expected
Life
6.5 years
6.5 years
Risk Free
Interest
Rate
1.85%
2.11%
Expected
Stock
Price
Volatility
22.82%
23.23%
Dividend
Yield
3.20%
3.27%
Grant period ended
December 31, 2015
December 31, 2014
Weighted
Average
Fair value
of
O ptions
Granted
$
1.05
$
1.02
The following tables summarize the stock option activity for the years ended December 31, 2015 and 2014:
29
Outstanding at December 31, 2013
Granted
Exercised
Forfeited
Expired
Outstanding at December 31, 2014
Granted
Exercised
Forfeited
Expired
Outstanding at December 31, 2015
Shares
625,495
23,500
(4,000)
(7,650)
(70,400)
566,945
7,500
(4,000)
(22,550)
(78,045)
469,850
Vested and expected to vest at December 31, 2015
469,850
Exercisable at December 31, 2015
330,700
Weighted
Average
Remaining
Contractual
Term
(in Years)
Weighted
Average
Exercise
Price
9.53
6.13
5.00
6.89
15.17
8.75
6.60
5.00
8.98
14.77
7.74
7.74
8.79
$
$
$
1.60
1.60
1.60
Information related to the stock option plan during each year follows:
Intrinsic value of options exercised
Cash received from option exercises
2015
2014
(in thousands)
$
$
8 $
20 $
6
20
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.
The following information summarizes information about stock expense for the years ended December 31, 2015 and 2014:
Compensation Expense
T ax Effect
Compensation Expense, net
Twe lve Months Ende d
De ce mbe r 31,
2015
2014
(in thousands)
$
$
31 $
11
20 $
67
23
44
As of December 31, 2015, there was $35,000 of total unrecognized compensation cost related to nonvested stock options. The cost is
expected to be recognized over a weighted-average period of 1.6 years.
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, 2015 and 2014:
30
We ighte d
Ave rage
Grant
Date Fair
Value
5.43
6.75
Share s
50,024
13,624
(476)
(1,939)
61,233
44,966
(19,368)
(3,127)
83,704
$
$
Outstanding at December 31, 2013
Granted
Vested
Forfeited
Outstanding at December 31, 2014
Granted
Vested
Forfeited
Outstanding at December 31, 2015
The following table summarizes RSU compensation expense during the twelve months ended December 31, 2015 and 2014:
Compensation Expense
T ax Effect
Compensation Expense, net
De cember 31,
2015
2014
(in thousands)
$
$
213 $
72
141 $
148
50
98
As of December 31, 2015, there was $245,000 of total unrecognized compensation cost related to nonvested RSUs. The cost is
expected to be recognized over a weighted-average period of 1.5 years.
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, 2015 and 2014, 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.
Actual capital amounts and ratios for December 31, 2015 and 2014 are presented in the table below.
31
Actual
Amount
Ratio
Required for Capital
Adequacy Purposes
Amount
Ratio
(dollars in thousands)
To be Well
Capitalized Under
Prompt Correction
Action Regulations*
Ratio
Amount
As of December 31, 2015
Company
Common equity T ier 1 capital to
risk-weighted assets
$
T ier 1 leverage capital to average assets
T ier 1 capital to risk-weighted assets
T otal capital to risk-weighted assets
Bank
Common equity T ier 1 capital to
risk-weighted assets
T ier 1 leverage capital to average assets
T ier 1 capital to risk-weighted assets
T otal capital to risk-weighted assets
As of December 31, 2014
Company
T ier 1 leverage capital to average assets $
T ier 1 capital to risk-weighted assets
T otal capital to risk-weighted assets
Bank
T ier 1 leverage capital to average assets
T ier 1 capital to risk-weighted assets
T otal capital to risk-weighted assets
63,456
76,456
76,456
84,742
75,725
75,725
75,725
84,001
72,011
72,011
79,308
71,392
71,392
78,681
9.57%
9.44%
11.53%
12.78%
11.44%
9.35%
11.44%
12.69%
9.80%
12.36%
13.61%
9.73%
12.27%
13.52%
29,838
32,397
39,786
53,047
27,801
32,396
39,716
52,956
27,604
23,308
46,616
27,591
23,282
46,563
4.50%
4.00%
6.00%
8.00%
4.20%
4.00%
6.00%
8.00%
4.00%
4.00%
8.00%
4.00%
4.00%
8.00%
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
43,026
40,495
52,955
66,195
6.50%
5.00%
8.00%
10.00%
N/A
N/A
N/A
N/A
N/A
N/A
34,489
34,922
58,204
5.00%
6.00%
10.00%
*includes Basel III Capital Conservation Buffer
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.
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
32
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, 2015 or December 31, 2014.
The following table presents the balances of assets measured at fair value on a recurring basis at December 31, 2015 and December
31, 2014.
At December 31, 2015
Q uoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
O ther
O bservable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Description
Fair Value
Available-for-sale securities:
(in thousands)
Collateralized mortgage obligations: agency issued
$
39,045 $
Collateralized mortgage obligations: non agency
Mortgage-backed securities: agency issued
U.S. Government agency securities
State and municipal securities
T otal assets measured at fair value
422
12,178
8,646
39,733
$
100,024 $
-
-
-
-
-
-
$
39,045 $
422
12,178
8,646
37,707
$
97,998 $
-
-
-
-
2,026
2,026
At December 31, 2014
Q uoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
O ther
O bservable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Description
Fair Value
Available-for-sale securities:
(in thousands)
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
T otal assets measured at fair value
527
12,199
8,056
27,891
$
87,440 $
33
-
-
-
-
-
-
$
38,767 $
527
12,199
8,056
25,741
$
85,290 $
-
-
-
-
2,150
2,150
As of December 31, 2015 and December 31, 2014, the Company had four securities 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, 2015 and 2014, 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. There were no transfers
in or out of Level 3 during the year ended December 31, 2015. Transfers in and out of Level 3 at December 31, 2014 are as follows:
Balance beginning of period
T ransfers in to level 3
Change in FV (included in other comprehensive income)
Balance end of period
$
$
Twelve Months Ended
December 31,
2015
2014
(in thousands)
2,150 $
-
(124)
2,026 $
1,419
810
(79)
2,150
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%.
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
34
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.
There were no assets held at the end of December 31, 2015 that were measured at fair value on a nonrecurring basis. Other real estate
owned with a pre-foreclosure loan balance of $2.6 million was acquired during the twelve months ended December 31, 2015. Upon
foreclosure, write downs totaling $684,000 were applied to the allowance for loan losses during the period related to these assets.
The following table presents the Company’s assets that were held at the end of December 31, 2014 that were measured at fair value on
a nonrecurring basis:
De scription
Fair Value
Other real estate owned and foreclosed assets
Loans measured for impairment, net of
specific reserves
T otal assets measured on a nonrecurring basis
$
$
139 $
231
370 $
At De ce mbe r 31, 2014
Q uote d Price s
in Active
Marke ts for
Ide ntical
Asse ts
(Le ve l 1)
O the r
O bse rvable
Inputs
(Le ve l 2)
Significant
Unobse rvable
Inputs
(Le ve l 3)
(in thousands)
-
-
-
$
$
-
-
-
$
$
139
231
370
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 thousands):
Other real estate owned and foreclosed assets
Description
Loans measured for impairment, net of specific reserves
$
$
Fair Value
139
Valuation
Technique
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 discounted cash flows.
Federal Home Loan Bank stock
FHLB stock is not publically traded; thus, it is not practicable to determine the fair value of FHLB stock due to restrictions
placed on its transferability. At December 31, 2015 the stock was stock of the FHLB of Des Moines and at December 31,
2014 was stock of the FHLB of Seattle. The FHLB of Seattle merged with and into the FHLB of Des Moines effective in the
second calendar quarter of 2015.
Pacific Coast Bankers’ Bank stock
PCBB stock is carried at cost which approximates fair value and equals its par value based on a third-party valuation opinion
as of December 31, 2015.
Loans, net and loans held for sale
35
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.
The estimated fair value of the Company’s financial instruments at December 31, 2015 and December 31, 2014 is as follows:
36
As of De ce mbe r 31, 2015
Q uote d Price s
in Active
Marke ts for
Ide ntical
Asse ts
(Le ve l 1)
Carrying
Value
$
27,526 $
27,526
O the r
O bse rvable
Inputs
(Le ve l 2)
(in thousands)
-
$
Significant
Unobse rvable
Inputs
(Le ve l 3)
Total Fair
Value
$
-
$
27,526
2,727
100,024
1,697
1,346
1,000
12,333
617,019
2,727
-
-
N/A
-
-
-
-
97,998
1,285
N/A
1,000
12,333
-
-
2,026
428
N/A
-
-
584,432
2,727
100,024
1,713
N/A
1,000
12,333
584,432
$
714,499 $
11,303
13,403
$
-
-
-
715,235 $
11,379
-
$
-
-
7,990
715,235
11,379
7,990
As of De ce mbe r 31, 2014
Q uote d Price s
in Active
Marke ts for
Ide ntical
Asse ts
(Le ve l 1)
Carrying
Value
O the r
O bse rvable
Inputs
(Le ve l 2)
(in thousands)
Significant
Unobse rvable
Inputs
(Le ve l 3)
Total Fair
Value
$
31,037 $
31,037
$
-
$
-
$
31,037
2,727
87,440
1,829
2,896
1,000
5,786
554,746
2,727
-
-
N/A
-
-
-
-
85,290
1,852
N/A
1,000
5,786
-
-
2,150
-
N/A
-
-
527,510
2,727
87,440
1,852
N/A
1,000
5,786
527,510
$
639,054 $
11,453
13,403
$
-
-
639,537 $
11,583
-
$
-
-
7,644
639,537
11,583
7,644
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
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
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:
37
Basic:
Net income (numerator)
Weighted average shares outstanding (denominator)
Basic earnings per share
Diluted:
Net income (numerator)
Weighted average shares outstanding
Effect of dilutive stock options
Weighted average shares outstanding assuming dilution (denominator)
Diluted earnings per share
Shares subject to outstanding options
Shares subject to outstanding warrants
$
$
$
$
For the Year Ended
December 31,
2015
2014
(dollars in thousands, except per
share amounts)
5,576 $
4,927
10,382,499
10,256,242
0.54 $
0.48
5,576 $
4,927
10,382,499
10,256,242
141,804
91,096
10,524,303
10,347,338
0.53 $
0.48
For the Year Ended
December 31,
2015
260,350
N/A
2014
361,545
N/A
As of December 31, 2015 and 2014, the shares subject to outstanding options 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 – CONDENSED FINANCIAL INFORMATION – PARENT COMPANY ONLY
Pacific Financial Corporation – Parent Company Only
Consolidated Statements of Financial Condition
(in thousands)
ASSETS
December 31,
2015
December 31,
2014
Cash and cash equivalents:
Investment in bank
Other assets
TO TAL ASSETS
LIABILITIES
$
$
2,602
88,458
957
92,017
$
$
LIABILITIES AND SHAREHO LDERS' EQ UITY
Junior subordinated debentures
$
13,403
$
Dividends payable
Other liabilities
T otal liabilities
SHAREHO LDERS' EQ UITY
Shareholders' equity
TO TAL LIABILITIES AND SHAREHO LDERS' EQ UITY $
2,287
42
15,732
76,285
92,017
$
2,585
84,864
655
88,104
13,403
2,178
40
15,621
72,483
88,104
38
Pacific Financial Corporation – Parent Company Only
Consolidated Statements of Income
(in thousands)
Twelve Months Ended
December 31,
2015
2014
INCO ME
Dividend income from the bank
$
2,786 $
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 INCO ME O F THE BANK
NET INCO ME
$
7
2,793
834
1,959
162
2,121
3,455
5,576 $
1,678
7
1,685
902
783
215
998
3,929
4,927
Pacific Financial Corporation – Parent Company Only
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
NET INCO ME
Change in fair value of securities available for sale
Defined benefit plan
Other comprehensive income, net of tax
CO MPREHENSIVE INCO ME
Twelve Months Ended
December 31,
2015
2014
5,576 $
4
231
235
5,811 $
4,927
1,269
(35)
1,234
6,161
$
$
39
Pacific Financial Corporation – Parent Company Only
Consolidated Statements of Cash Flows
(Dollars in thousands)
Cash flows from operating 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
Stock compensation expense
Net cash provided by operating activities
Cash flows from financing activities
Common stock issued
Warrants exercised
Repurchase of restricted stock units
Cash dividends paid
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
$
Twelve Months Ended
December 31,
2015
2014
$
5,576
$
4,927
(3,455)
(162)
2
213
2,174
21
-
-
(2,178)
(2,157)
17
2,585
2,602
$
(3,929)
(362)
-
139
775
1,224
142
(3)
(2,036)
(673)
102
2,483
2,585
NOTE 20 – SELECTED DATA
Results of operations on a quarterly basis were as follows (unaudited):
Year Ended December 31, 2015
First
Q uarter
Second
Q uarter
Third
Q uarter
Fourth
Q uarter
(dollars in thousands, except per share amounts)
Interest and dividend income
$
7,432 $
7,817 $
7,946 $
Interest expense
Net interest income
Loan loss provision
Noninterest income
Noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
Earnings per common share
Basic
Diluted
509
6,923
30
1,973
7,484
1,382
528
7,289
187
2,823
7,732
2,193
561
7,385
165
2,686
7,709
2,197
286
1,096 $
611
1,582 $
596
1,601 $
0.11 $
0.10 $
0.15 $
0.15 $
0.15 $
0.15 $
$
$
$
8,145
603
7,542
200
2,317
7,934
1,725
428
1,297
0.12
0.12
40
Year Ended December 31, 2014
First
Q uarter
Second
Q uarter
Third
Q uarter
Fourth
Q uarter
(dollars in thousands, except per share amounts)
Interest and dividend income
$
7,085 $
7,337 $
7,400 $
Interest expense
Net interest income
Loan loss provision
Noninterest income
Noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
Earnings per common share
Basic
Diluted
530
6,555
-
1,608
6,830
1,333
541
6,796
100
2,176
7,066
1,806
518
6,882
100
2,274
7,133
1,923
305
1,028 $
403
1,403 $
549
1,374 $
0.10 $
0.10 $
0.14 $
0.14 $
0.13 $
0.13 $
$
$
$
7,336
536
6,800
100
2,021
7,127
1,594
473
1,121
0.11
0.11
41
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 U.S: 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 27, 2016 at 4 p.m. at 1101 S. Boone Street, Aberdeen, WA 98520.
Annual Report
This annual report, including accompanying financial statements and schedules, is available without charge to shareholders or
beneficial owners of our common stock upon written request to Sandra Clark, Corporate Secretary, Pacific Financial
Corporation, P.O. Box 1826, Aberdeen, Washington 98520. It is also 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.
42
BOARD OF DIRECTORS
Gary C. Forcum, Chairman
Private Investor
Douglas M. Schermer
Owner and President
Schermer Construction Inc.
& Wishkah Rock Products
Denise Portmann
President & CEO
Pacific Financial Corporation and
Bank of the Pacific
Randy W. Rognlin, Vice Chairman
Co-Owner
Rognlins, Inc.
Randy J. Rust
Private Investor
Susan C. Freese
Pharmacist
Dwayne M. Carter
President & General Manager
Brooks Manufacturing Co.
Edwin W. Ketel
Owner
Oceanside Animal Clinic
Kristi Gundersen
Partner & Chief Financial Officer
Knutzen Farms, LP
John Van Dijk
Retired President & COO
Bank of the Pacific
Dan J. Tupper
Vice President & General Manager
Crown Distributing Co. of Aberdeen, Inc.
OFFICERS
SUBSIDIARIES
Bank of the Pacific
300 E. Market Street
Aberdeen, WA 98520
360-533-8870
www.bankofthepacific.com
Denise J. Portmann
President & CEO
Pacific Financial Corporation and Bank of the Pacific
Bruce MacNaughton
Vice President
Executive Vice President & CCO, Bank of the Pacific
Douglas N. Biddle
Treasurer
Executive Vice President & CFO, Bank of the Pacific
Sandra P. Clark
Corporate Secretary
43