Pacific Financial Corporation
Annual Report 2022

Plain-text annual report

Dear Fellow Shareholders: We began 2022 in a historically low interest rate environment. As inflation continued to heat up, the Federal Reserve begin increasing interest rates in March 2022 and then in an effort to restore price stability, continued to raise rates at the fastest pace in over 40 years. With these increases in the federal funds rate, the Company’s net interest income improved substantially in the second half of the year, benefiting from an asset-sensitive balance sheet, an exceptional core deposit franchise and a strong liquidity position. Net income for 2022 was $10.9 million, or $1.04 per diluted share, resulting in a return on average assets (ROAA) of 0.82% and return on average equity (ROAE) of 10.24%. Commercial loan production in the third and fourth quarter ramped up with total originations of over $150 million in new loan commitments, the highest since 2016 and loan payoffs slowed to a more normalized pace, both contributing to a strong finish for the year. As a result of the increase in loan production and an improved net interest margin, the Company recognized record quarterly profits in the fourth quarter with net income of $4.7 million, ROAA of 1.41%, ROAE of 18.70%, and an Efficiency Ratio of 59.67%, all of which exceeded our strategic goals. This strong performance allowed us to return $5.4 million in capital to our shareholders in 2022 through a quarterly cash dividend. This represented a dividend yield of 4.34% for our shareholders. During 2022, we also celebrated 50 years of serving our customers and shareholders. Thank you to our customers for continuing to do business with us and valuing our relationship. Thank you to our prospects for meeting with us and considering our solutions. Thank you to our shareholders for your support and loyalty. Thank you to our Board of Directors for your direction and oversight, Ed Ketel in particular as he retires after 20 years of service. And thank you to our dedicated and amazing employees for living out our mission and holding steadfast to our values, enabling us to grow our Company and reinvest in our local communities. Looking ahead, we are well positioned for the current rate environment and expect to continue the momentum of strong financial performance into 2023. Although we do anticipate some headwinds as deposit costs increase, mortgage banking activity slows, and inflation pressures persist, we have prudently managed our balance sheet, asset quality, and capital levels to help withstand these challenges. We are proud of our proven track record and, as a vibrant Pacific Northwest Bank, we plan to continue to build an outstanding franchise. Please join us for our annual Shareholders’ meeting on Wednesday, April 26, 2023, at 4:00 pm. You may access the meeting virtually via the internet at www.virtualshareholdermeeting.com/PFLC2023. As a shareholder, you will be required to enter your control number found on your proxy card. The Board and management team are excited about the opportunities we see in our markets and aim to generate fiscally responsible growth capable of delivering long-term value for our shareholders. Sincerely, Denise Portmann President and Chief Executive Officer Pacific Financial Corporation $ $ $ $ $ $ $ $ $ Operations Data Interest and dividend income Interest expense Net interest income Provision (benefit) for loan losses Noninterest income Noninterest expense Income before income taxes Income tax expense Net income Net income per share: Basic Diluted Dividends declared per share(1) Dividends declared Dividend payout ratio Performance Ratios Return on average equity Return on average assets Net interest margin Efficiency ratio Balance Sheet Data Total assets Loans, net Total deposits Total borrowings Shareholders' equity Equity to assets ratio Book value per share Tangible book value per share Asset Quality Ratios Allowance for loan losses to total loans Allowance for loan losses to nonperforming loans Nonperforming loans to total loans Nonperforming assets to total assets $ $ $ $ $ $ 2022 42,152 1,206 40,946 - 7,227 34,974 13,199 2,311 10,888 1.05 1.04 0.52 5,407 50% 10.24% 0.82% 3.29% 72.60% $ $ 2019 For the Year Ended December 31, 2021 2020 (dollars in thousands, except per share data) (unaudited) 39,574 2,380 37,194 3,500 20,146 39,594 14,246 2,862 11,384 37,159 1,254 35,905 (3,650) 16,729 40,702 15,582 2,885 12,697 41,570 2,928 38,642 - 13,895 35,556 16,981 3,223 13,758 $ $ $ $ $ $ 1.22 1.22 0.52 5,418 43% $ $ $ $ 1.08 1.07 0.38 4,023 35% 10.85% 1.00% 3.00% 77.33% 10.33% 1.07% 3.73% 69.05% 1.30 1.29 0.31 3,288 24% 13.70% 1.50% 4.58% 67.68% $ $ $ $ $ $ 2018 40,060 2,590 37,470 - 10,031 33,793 13,708 2,378 11,330 1.07 1.06 0.30 3,170 28% 12.63% 1.26% 4.52% 71.14% $ 1,306,203 631,722 1,180,362 13,403 103,162 $ $ 1,319,966 620,036 1,178,940 13,806 117,642 1,167,293 717,330 1,028,424 13,956 114,186 $ 929,415 675,445 798,638 16,606 105,293 907,929 694,054 783,549 21,756 92,483 7.90% 9.91 8.62 $ $ 8.91% 11.32 10.03 $ $ 9.78% 10.94 9.65 $ $ 11.33% 9.90 8.64 $ $ 10.19% 8.75 7.47 1.29% 1.32% 1.65% 1.31% 1.29% 947.76% 0.14% 0.07% 679.52% 0.19% 0.11% 504.52% 0.33% 0.20% 873.96% 0.15% 0.11% 838.65% 0.15% 0.12% (1) In 2019, the Company transitioned to a quarterly cash dividend. The fourth quarter dividend of $0.11 per common share paid on February 26, 2020. This fourth quarter dividend is not included in the 2019 dividend declared number, as it was not declared until January 2020. CliftonLarsonAllen LLP CLAconnect.com INDEPENDENT AUDITORS' REPORT Board of Directors Pacific Financial Corporation Aberdeen, Washington Report on the Audit of the Consolidated Financial Statements Opinion We have audited the accompanying consolidated financial statements of Pacific Financial Corporation and its subsidiary, Bank of the Pacific, (the Company), which comprise the consolidated statements of financial condition as of December 31, 2022 and 2021, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for the years then ended, and the related notes to the consolidated financial statements. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pacific Financial Corporation and its subsidiary as of December 31, 2022 and 2021, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. We have also audited in accordance with auditing standards generally accepted in the United States of America, Pacific Financial Corporation and its subsidiary’s internal control over financial reporting, including controls over the preparation of regulatory financial statements in accordance with the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income (call report instructions), as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2023, expressed an unqualified opinion. Basis for Opinion We conducted our audits in accordance with auditing standards generally accepted in the United States of America (GAAS). Our responsibilities under those standards are further described in the Auditors’ Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are required to be independent of Pacific Financial Corporation and its subsidiary and to meet our other ethical responsibilities in accordance with the relevant ethical requirements relating to our audits. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Responsibilities of Management for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and for 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. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Board of Directors Pacific Financial Corporation and its ubsidiary Page 2 In preparing the consolidated financial statements, management is required to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about Pacific Financial Corporation and its subsidiary's ability to continue as a going concern for one year after the date the consolidated financial statements are available to be issued. Auditors’ Responsibilities for the Audit of the Consolidated Financial Statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors’ report that includes our opinion. Reasonable assurance is a high level of assurance but is not absolute assurance and therefore is not a guarantee that an audit conducted in accordance with GAAS will always detect a material misstatement when it exists. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Misstatements are considered material if there is a substantial likelihood that, individually or in the aggregate, they would influence the judgment made by a reasonable user based on the consolidated financial statements. In performing an audit in accordance with GAAS, we:  Exercise professional judgment and maintain professional skepticism throughout the audit.  Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, and design and perform audit procedures responsive to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements.  Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances.  Evaluate the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluate the overall presentation of the consolidated financial statements.  Conclude whether, in our judgment, there are conditions or events, considered in the aggregate, that raise substantial doubt about Pacific Financial Corporation and its subsidiary’s ability to continue as a going concern for a reasonable period of time. We are required to communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit, significant audit findings, and certain internal control related matters that we identified during the audit. Other Information Included in the Annual Report Management is responsible for the other information included in the annual report. The other information comprises the letter to the shareholders, financial information, and nonfinancial information but does not include the consolidated financial statements and our auditors’ report thereon. Our opinion on the consolidated financial statements does not cover the other information, and we do not express an opinion or any form of assurance thereon. Board of Directors Pacific Financial Corporation and its ubsidiary Page 3 In connection with our audit of the consolidated financial statements, our responsibility is to read the other information and consider whether a material inconsistency exists between the other information and the consolidated financial statements, or the other information otherwise appears to be materially misstated. If, based on the work performed, we conclude that an uncorrected material misstatement of the other information exists, we are required to describe it in our report. CliftonLarsonAllen LLP Bellevue, Washington March 16, 2023 Pacific Financial Corporation Consolidated Statements of Financial Condition (Dollars in thousands, except per share data) ASSETS Ca sh on ha nd a nd i n ba nks Interest bea ri ng depos i ts Federa l Funds Sol d Ca s h and ca sh equi va l ents Other i nteres t ea rni ng depos i ts Inves tment securi ti es a va i l a bl e for sa l e, a t fai r va l ue Inves tment securi ti es hel d to maturi ty (fa i r val ue of $56,513 a nd $788, respecti vel y) Loans hel d for sa l e Loans , net of deferred fees Al lowa nce for l oa n l oss es Total l oa ns , net Nonmarketa bl e equi ty securi ti es Premi s es a nd equi pment, net Opera ti ng l eas e ri ght-of-use a s s ets Ca sh s urrender va l ue of l i fe i ns ura nce Goodwi l l Other i nta ngi bl e a ss ets , net Accrued i nteres t recei va bl e Prepai d expens es and other a s sets Total a s s ets LIABILITIES AND SHAREHOLDERS' EQUITY Depos i ts Federa l Home Loan Ba nk a dva nces Juni or subordi na ted debentures Opera ti ng l eas e l i a bi l i ti es Accrued expens es and other l i a bi l i ti es Total l i a bi l i ti es Shareholders' Equity: Preferred Stock, no pa r va l ue; 5,000,000 s ha res a uthori zed; no s ha res i s s ued or outs tandi ng a t December 31, 2022 a nd December 31, 2021 Common Stock, $1 pa r va l ue; 25,000,000 s ha res a uthori zed, 10,414,276 a nd 10,388,267 s ha res i s sued a nd outs ta ndi ng a t December 31, 2022 a nd 2021, res pecti vel y Addi ti ona l pa i d-i n-capi ta l Reta i ned ea rni ngs Accumul ated other comprehensi ve i ncome (l os s), net Tota l sha rehol ders ' equi ty Tota l l i a bi l i ti es a nd s ha rehol ders' equi ty $ $ $ December 31, 2022 December 31, 2021 $ 18,673 $ 295,563 - 314,236 4,250 226,784 59,513 - 639,958 (8,236) 631,722 2,583 12,871 1,077 26,776 12,168 1,268 4,044 8,911 1,306,203 $ 1,180,362 $ - 13,403 1,149 8,127 1,203,041 15,859 319,626 50,881 386,366 3,250 232,947 788 6,104 628,333 (8,297) 620,036 2,416 13,004 1,462 26,072 12,168 1,276 3,357 10,720 1,319,966 1,178,940 403 13,403 1,482 8,096 1,202,324 - - 10,414 42,065 69,844 (19,161) 103,162 1,306,203 $ 10,388 41,884 64,363 1,007 117,642 1,319,966 See accompanying Notes to Consolidated Financial Statements. 1 Pacific Financial Corporation Consolidated Statements of Income (Dollars in thousands, except per share data) INTEREST AND DIVIDEND INCOME Interes t and fees on l oa ns Ta xa bl e i nterest on i nves tment s ecuri ti es Nonta xa bl e i nteres t on i nves tment s ecuri ti es Interes t and di vi dends on other i nteres t ea rni ng a s sets Tota l i nteres t a nd di vi dend i ncome INTEREST EXPENSE Deposi ts Juni or s ubordi na ted debentures Federa l Home Loa n Ba nk a dvances Tota l i nteres t expens e Net i nterest i ncome Benefi t for l oa n l os ses Net i nterest i ncome a fter l oan l os s benefi t NONINTEREST INCOME Servi ce cha rges on depos i ts Ga i n on sa l e of l oa ns , net Ea rni ngs on ba nk owned l i fe i nsura nce Other i ncome Tota l noni nteres t i ncome NONINTEREST EXPENSE Compens a ti on and empl oyee benefi ts Occupa ncy Equi pment Da ta process i ng Profes si onal s ervi ces Ma rketi ng Sta te a nd l oca l ta xes Federa l depos i t i ns ura nce premi um Other expense Tota l noni nteres t expens e Income before i ncome ta xes Income ta x expense Net i ncome Bas i c ea rni ngs per common sha re Di l uted ea rni ngs per common sha re Twelve Months Ended December 31, 2022 2021 $ $ $ $ 30,079 $ 4,418 1,048 6,607 42,152 742 460 4 1,206 40,946 - 40,946 1,621 1,406 682 3,518 7,227 22,401 2,023 1,184 3,506 709 400 693 357 3,701 34,974 13,199 2,311 10,888 $ 1.05 1.04 $ $ 33,563 2,061 1,002 533 37,159 1,011 232 11 1,254 35,905 (3,650) 39,555 1,446 9,448 1,384 4,451 16,729 27,114 1,978 1,244 3,288 943 300 858 422 4,555 40,702 15,582 2,885 12,697 1.22 1.22 See accompanying Notes to Consolidated Financial Statements. 2 Pacific Financial Corporation Consolidated Statements of Comprehensive Income (Dollars in thousands) Twelve Months Ended December 31, 2022 2021 $ 10,888 $ 12,697 (20,707) 539 (20,168) (3,430) 195 (3,235) 9,462 Net Income Other comprehensi ve i ncome (l oss ), net of ta x: Securi ti es a va i l a bl e for s a l e, net of tax Defi ned benefi t pl a ns, net of ta x Tota l other comprehens i ve i ncome (l os s), net of ta x Comprehens i ve i ncome (l os s ) $ (9,280) $ See accompanying Notes to Consolidated Financial Statements. 3 Pacific Financial Corporation Consolidated Statements of Shareholders’ Equity (Dollars in thousands, except share amounts) Balance at December 31, 2020 Net i ncome Other compre hens i ve l os s, ne t of ta x Stock option exerci s es /s tock uni t ves ted Stock ba se d compens a ti on expense Stock repurcha s e a nd ca ncel a ti on of s ha res Ca s h divi dends decl a red ($0.52 per s ha re ) Balance at December 31, 2021 Net i ncome Other compre hens i ve l os s, ne t of ta x Stock option exerci s es /s tock uni t ves ted Stock ba se d compens a ti on expense Ca s h divi dends decl a red ($0.52 per s ha re ) Balance at December 31, 2022 Number of Common Shares 10,434,533 $ - - 11,326 - (57,592) - 10,388,267 $ - - 26,009 - - 10,414,276 $ Common Stock Additional Paid-in Capital Retained Earnings 10,435 $ 42,425 $ - - 11 - (58) - - - (8) 126 (659) - 10,388 $ 41,884 $ - - 26 - - - - 31 150 - 10,414 $ 42,065 $ 57,084 $ 12,697 - - - - (5,418) 64,363 $ 10,888 - - - (5,407) 69,844 $ Accumulated Other Comprehensive Income (Loss) , net Total Shareholders' Equity 4,242 $ - (3,235) - - - - 1,007 $ - (20,168) - - - (19,161) $ 114,186 12,697 (3,235) 3 126 (717) (5,418) 117,642 10,888 (20,168) 57 150 (5,407) 103,162 See accompanying Notes to Consolidated Financial Statements. 4 Pacific Financial Corporation Consolidated Statements of Cash Flows (Dollars in thousands) Cash flows from operating activities: Net Income Adjus tments to reconci l e ne t i ncome to net ca s h on ha nd a nd i n ba nks from opera ti ng a cti vi ti e s Benefi t for l oa n l os s e s Depreci a ti on a nd a morti za ti on Deferred i ncome ta xes Ori gi na ti ons of l oa ns he l d for s a l e Proceeds from s a l e s of l oa ns Ga i n on s a l e of l oa ns , net (Ga i n) l os s on s a l e of premi s es a nd e qui pment Ea rni ngs on ba nk owned l i fe i ns ura nce Net cha nge i n a ccrue d i nte re s t re ce i va bl e Net cha nge i n a ccrue d i nte re s t pa ya bl e Net cha nge i n prepa i d e xpens e s Other ope ra ti ng a cti vi ti e s Net ca s h provi ded by ope ra ti ng a cti vi ti e s Cash flows from investing activities: Net cha nge i n l oa ns Ma turi ti es of i nves tme nt s e curi ti es he l d to ma turi ty Ma turi ti es a nd pa ydowns of i nve s tment s e curi ti es a va i l a bl e for s a l e Purcha s e of i nve s tme nt s ecuri ti es a va i l a bl e for s a l e Purcha s e of i nve s tme nt s ecuri ti es hel d to ma turi ty Purcha s es of nonma rke ta bl e equi ty s e curi ti es Increa s e i n othe r i nteres t ea rni ng depos i ts Purcha s e of ba nk owne d l i fe i ns ura nce Purcha s es of pre mi s es a nd equi pment Proce eds from s a l es of nonma rketa bl e e qui ty s e curi ti es Proce eds from ba nk owne d l i fe i ns ura nce dea th be nefi t Proce eds from s a l es of premi s e s a nd equi pme nt Net ca s h us ed i n i nves ti ng a cti vi ti e s Cash flows from financing activities: Net i ncrea s e i n depos i ts Re pa yments of FHLB Adva nce s Net ca s h from s tock opti on exe rci s e s Re purcha s e of common s tock Ta xe s re l a te d to net s ha re s e ttl eme nt for equi ty a wa rds Ca s h di vi dends pa i d Net ca s h provi ded by (us ed i n) fi na nci ng a cti vi ti es Net i ncrea s e (de cre a s e ) i n ca s h a nd ca s h equi va l e nts Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosures of cash flow information: Ca s h pa i d for i nteres t Ca s h pa i d for ta xe s Supplemental non-cash disclosures of cash flow information: Tra ns fe r of l oa ns he l d for s a l e to l oa ns he l d for i nve s tment Twelve Months Ended December 31, 2022 2021 $ 10,888 $ 12,697 - 3,357 59 (65,030) 71,690 (1,406) 13 (682) (687) 73 (184) 7,283 25,374 (10,150) 3,470 18,047 (40,309) (61,839) (184) (1,000) (36) (1,174) 17 14 - (93,144) 1,422 (403) 52 - (24) (5,407) (4,360) (72,130) 386,366 314,236 1,133 115 $ $ $ (3,650) 3,055 1,443 (425,575) 470,461 (9,448) (12) (1,384) 1,324 (30) (332) (9,897) 38,652 96,451 135 19,000 (133,538) - (286) - (6,036) (597) 7 2,689 24 (22,151) 150,516 (150) 64 (717) (53) (5,418) 144,242 160,743 225,623 386,366 1,284 2,275 850 $ 6,636 $ $ $ $ See accompanying Notes to Consolidated Financial Statements. 5 Pacific Financial Corporation and Subsidiary Notes to Consolidated Financial Statements For the Years Ended December 31, 2022 and December 31, 2021 NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization – Pacific Financial Corporation (the “Company”) 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 fourteen branches located in communities in Grays Harbor, Pacific, Whatcom, Clark, Skagit and Wahkiakum counties in the state of Washington and two branches in Clatsop County, Oregon. In addition, the Bank operates two loan production offices in Burlington, Washington; and Salem, Oregon; and a residential real estate mortgage department. Basis of presentation – The consolidated financial statements include the accounts of Pacific Financial Corporation and its wholly- owned subsidiaries. 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 2022 presentation. These reclassifications did not change previously reported net income or shareholders’ equity. 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, the identification of impaired loans, the fair value of available for sale investment securities and the identification of deferred tax 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 15, 2023, the date these financial statements were available to be issued. 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.” 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. For callable securities amortization of premiums are recognized over the period to first call date. 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. 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. For callable securities amortization of premiums are recognized over the period to first call date. 6 Other than temporary impairment (OTTI) – 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 fair value of the debt security is below the carrying value primarily due to changes in interest rates, there has not been significant deterioration in the financial condition of the issuer, and it is not more likely than not that the Company will be required to, nor does it have the intent to sell the security before the anticipated recovery of its remaining carrying value. Credit component losses are reported in noninterest income. Nonmarketable equity securities – The Company’s investment in Federal Home Loan Bank (“FHLB”) stock is carried at cost and cash and stock dividends are recorded as income. The Company’s investment in Pacific Coast Bankers Bank ("PCBB”) stock is carried at cost, less impairment and plus or minus observable prices, if any, and cash and stock dividends are recorded as income. Nonmarketable equity securities are periodically evaluated for impairment based on ultimate recovery of par value. 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. At December 31, 2022 and 2021 the stock was that of FHLB of Des Moines. 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. The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) – In response to the Coronavirus Disease 2019 (“COVID-19”) pandemic, the CARES Act was signed into law on March 27, 2020 to provide national emergency economic relief measures. Many of the CARES Act’s programs are dependent upon the direct involvement of U.S. financial institutions and have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the Federal Reserve and other federal banking agencies, including those with direct supervisory jurisdiction over the Company and the Bank. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) – The CARES Act amended the SBA’s loan program, in which the Bank participated, to create a guaranteed, unsecured loan program, the PPP, to fund operational costs of eligible businesses, organizations and self-employed persons during COVID-19. The Consolidated Appropriations Act of 2021 (“CA Act”) was signed into law on December 27, 2020 and provided COVID-19 emergency response and relief, including renewing and extending the SBA PPP. During 2021, the Company participated in the CARES Act by offering PPP loans to clients affected by the COVID-19 pandemic. Troubled Debt Restructuring (“TDR”) and Loan Modifications for Affected Borrowers – The CARES Act permits banks to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs and suspend any determination related thereto if loans met certain criteria and was not more than 30 days past due at December 31, 2019. The CA Act also extended relief offered under the CARES Act related to TDRs as a result of COVID-19 through January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier. The Company modified loans due to the effects of the COVID-19 pandemic that were not classified as TDRs in 2021. 7 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 Impairment delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. 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. 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. Right of Use Lease Asset & Lease Liability –The Company leases retail space, office space and equipment under operating leases. For operating leases greater than 12 months, an operating right of use (ROU) asset and an operating lease liability (lease liability) is recorded on the consolidated financial statements. The Company elected not to include short-term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the consolidated financial statements. The calculated amount of the ROU assets and lease liabilities are impacted by the length of the lease term and the discount rates used to calculate the present value the minimum lease payments. For the discount rate the Company utilizes its incremental borrowing rate at lease inception over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used. Other real estate owned – Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are initially recorded Any write-down to fair value at the time of transfer to other real at the fair value of the properties less estimated costs of disposal. 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. Bank-owned life insurance – Bank owned life insurance is carried at the amount due upon surrender of the policy, which is also the estimated fair value. This amount was provided by the insurance companies based on the terms of the underlying insurance contract. 8 Off-balance-sheet credit related financial instruments – In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded. The Company maintains a separate allowance for off-balance- sheet commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance-sheet commitments is included in accrued expenses and other liabilities. Goodwill and other intangible assets – At December 31, 2022 the Company had $13.4 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 reviewed for potential impairment 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. An assessment of qualitative factors is completed to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative analysis concludes that further analysis is required, then a quantitative impairment test would be completed. The quantitative goodwill impairment test is used to identify the existence of impairment and the amount of impairment loss and compares the reporting unit’s estimated fair value, including goodwill, to its carrying amount. If the fair value exceeds the carrying amount then goodwill is not considered impaired. If the carrying amount exceeds its fair value, an impairment loss would be recognized equal to the amount of excess, limited to the amount of total goodwill allocated to that reporting unit. The impairment loss would be recognized as a charge to earnings. For the years ended December 31, 2022 and 2021, the Company’s goodwill impairment evaluation, based on its qualitative assessment, indicated there was no impairment. 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 was $0 and $8,000 at December 31, 2022 and 2021, respectively. Amortization expense related to core deposit intangible totaled $8,000 and $11,000 during the years ended December 31, 2022 and 2021, 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 The premium, and the resultant right to Authority to the Bank authorizing it to conduct a banking business in the State of Oregon. 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. Advertising – Advertising costs are expensed as incurred. 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, 2022, 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. The amount of interest and penalties accrued as of December 31, 2022 and December 31, 2021 and recognized during the years ended December 31, 2022, and 2021 were 9 immaterial. The tax years that remain subject to examination by federal and state taxing authorities are the years ended December 31, 2021, 2020 and 2019. Stock-based compensation – Accounting guidance requires measurement of compensation cost for all stock based awards based on the grant date fair value and recognition of compensation cost over the service period of stock based awards. The fair value of stock options is determined using the Black-Scholes valuation model. The Company’s stock compensation plans are described more fully in Note 16. Cash equivalents and cash flows – The Company considers all amounts included in the balance sheet caption “Cash and due from banks” to be cash equivalents. Cash and cash equivalents have a maturity of 90 days or less at the time of purchase. Cash flows from loans, interest bearing deposits in banks, federal funds sold, short-term borrowings, secured borrowings and deposits are reported net. The Company maintains balances in depository institution accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. Certificates of deposit held for investment – Certificates of deposit held for investments include amounts invested with financial institutions for a stated interest rate and maturity date and are included in the balance sheet caption “Other interest earning deposits”. 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 exercised or issued under the Company’s stock compensation plans. Stock options and restricted stock units excluded from the calculation of diluted earnings per share because they are antidilutive, were 122,000 and 121,000 in 2022 and 2021, respectively. Comprehensive income – Recognized revenue, expenses, gains and losses are included in net income. Certain changes in assets and liabilities, such as prior service costs and amortization of prior service costs related to defined benefit plans and unrealized gains and losses on securities available for sale, are reported within equity in other accumulated comprehensive loss in the consolidated balance sheet. Such items, along with net income, are components of comprehensive loss. 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, 2022 and 2021. Revenue Recognition – The Company recognizes revenue as it is earned based on contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured. The principal source of revenue is interest income from loans and investments, which is out of scope of ASC 606 Revenue Recognition. The Company also earns non-interest income from various banking services offered to its customers. Gain on sales of loans, investment securities, earnings on bank-owned life insurance, and other income are not within the scope of ASC 606. The Company’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income. Certain specific policies related to those in scope with revenue streams income include the following: Service Charges on Deposit Accounts – The Company earns fees from its deposit customers by providing contractual transaction- based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed at the point in time the Company fulfills the customer’s request for product or service. Fees, which relate primarily to deposit account maintenance, are earned over the course of a month, representing the period over which the Company satisfies its performance obligation. Fees for performing that service are then assessed at the close of the statement period. Overdraft fees are recognized at the point in time that the overdraft is created by the payment of a check against a deposit account in which there are not sufficient funds to pay that item. Service charges on deposits are collected directly from the customer’s account balance per the terms of the contract with the depositor. Interchange and Other Fees – The Company earns interchange fees from debit or credit cardholder transactions, from cards issued by the Company to its customers or processed for non-customers, conducted through various card payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Other service charges include revenue from processing wire 10 transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for interchange and other service charges are largely satisfied, and related revenue recognized, when completion of the services are rendered at a point in time. The following table presents the Company’s noninterest income by revenue stream and reportable segment for the years ended December 31, 2022 and 2021. Items outside the scope of ASC 606 are noted as such. Servi ce charges on deposi ts Gai n on sa l e of l oans , net (1) Ea rni ngs on ba nk owned l i fe ins ura nce (1) Intercha nge a nd other fees Other (1) Tota l noni nterest i ncome $ (1) Not wi thi n the s cope of ASC 606 Recent accounting pronouncements – not yet effective Twelve Months Ended December 31, 2022 2021 (i n thousa nds ) 1,621 $ 1,446 $ 1,406 682 3,519 (1) 7,227 $ 9,448 1,384 4,383 68 16,729 FASB ASU 2016-13, Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued in June 2016. Commonly referred to as the current expected credit loss model ("CECL"), this Update requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The amendment affects loans, debt securities, trade receivables, net investments in leases, off balance-sheet credit exposures, reinsurance receivables, and any other financial asset not excluded from the scope that have the contractual right to receive cash. The Update replaces the incurred loss impairment methodology, which generally only considered past events and current conditions, with a methodology that reflects the expected credit losses and required consideration of a broader range of reasonable and supportable information to estimate all expected credit losses. In October 2019, the FASB voted to approve amendments to the effective date of ASU No. 2016-13 for smaller reporting companies, as defined by the SEC, and other non-SEC reporting entities. The amendment delays the effective date for the Company until interim and annual periods beginning after December 15, 2022. An entity will apply the amendments through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. A prospective transition approach is required for debt securities. The Company is finalizing the allowance for credit losses under CECL and related methodology, and is not expecting the adoption of ASU 2016-13 to have a material impact on the Consolidated Financial Statements. FASB ASU 2020-04, Reference Rate Reform (Topic 848), as amended by ASU 2021-01, was issued in March 2020 and provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or remeasurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts. ASU 2020-04 also provides numerous optional expedients for derivative accounting and is effective March 12, 2020 through December 31, 2022. In December 2022, the FASB issued ASU 2022-06 Reference Rate Reform (Topic 848) Deferral of the Sunset Date of Topic 848. This amendment provides an update to defer the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which all entities will no longer be permitted to apply the relief in Topic 848. The Company’s LIBOR exposure is with trust preferred securities, LIBOR indexed CMO’s, and LIBOR indexed loans. The Company is finalizing the modifications for the transfer away from LIBOR and not expecting the adoption of this ASU to have a material impact on the Company's business operations and the Consolidated Financial Statements. 11 NOTE 2 – RESTRICTED ASSETS The Federal Reserve has the authority to establish reserve requirements on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or deposits with the Federal Reserve Bank. Effective on March 26, 2020, the Federal Reserve reduced requirements to zero percent. The Federal Reserve may adjust reserve requirement ratios in the future at its discretion. NOTE 3 – INVESTMENT SECURITIES AND NONMARKETABLE INVESTMENT SECURITIES Investment securities Investment securities consist principally of short and intermediate term debt instruments issued by the U.S. Treasury, other U.S. Investment government agencies, state and local governments, other corporations, and mortgaged backed securities (“MBS”). securities have been classified according to management’s intent. The amortized cost of securities and their approximate fair value were as follows: Available for Sale Col l a tera l i zed mortga ge obl i ga ti ons Mortga ge ba cked s ecuri ti es Muni ci pal securi ti es Corpora te debt s ecuri ti es U.S. government a nd agency obl i ga ti ons Tota l avai l a bl e for s a l e Held to maturity Col l a tera l i zed mortga ge obl i ga ti ons Mortga ge ba cked s ecuri ti es Muni ci pal securi ti es U.S. government Tota l hel d to ma turi ty Available for Sale Col l a tera l i zed mortga ge obl i ga ti ons Mortga ge ba cked s ecuri ti es Muni ci pal securi ti es Corpora te debt s ecuri ti es U.S. government a nd agency obl i ga ti ons Tota l avai l a bl e for s a l e Held to maturity Mortga ge ba cked s ecuri ti es Muni ci pal securi ti es Tota l hel d to ma turi ty $ $ $ $ $ $ $ $ Fair Value 101,958 13,110 61,771 1,999 47,946 226,784 16,853 9,299 2,500 27,861 56,513 Fair Value 92,050 17,435 71,549 2,010 49,903 232,947 2 786 788 Amortized Cost December 31, 2022 Gross Unrealized Gains Gross Unrealized Losses (i n thous a nds) 110,573 $ 14,023 69,707 2,000 55,407 251,710 $ 18,072 $ 9,857 2,506 29,078 59,513 $ 8 $ 9 84 - - 101 $ - $ - 32 - 32 $ 8,623 $ 922 8,020 1 7,461 25,027 $ 1,219 $ 558 38 1,217 3,032 $ Amortized Cost December 31, 2021 Gross Unrealized Gains Gross Unrealized Losses (i n thous a nds) 712 $ 270 3,099 9 12 4,102 $ - $ - - $ 982 $ 180 546 - 738 2,446 $ - $ - - $ 92,320 $ 17,345 68,996 2,001 50,629 231,291 $ 2 $ 786 788 $ 12 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, 2022 and 2021 were as follows: Available for sale (i n thousa nds) Less Than 12 Months December 31, 2022 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses Col l atera l i zed mortga ge obl i ga ti ons Mortga ge ba cked s ecuri ti es Muni ci pa l securi ti es Corpora te debt s ecuri ti es U.S. government a nd a gency obl i ga ti ons Tota l Held to maturity Col l atera l i zed mortga ge obl i ga ti ons Mortga ge ba cked s ecuri ti es Muni ci pa l securi ti es U.S. government a nd a gency obl i ga ti ons Tota l $ $ $ $ 44,373 $ 7,239 33,564 1,999 - 87,175 $ 1,557 $ 370 1,884 1 - 3,812 $ 56,895 $ 5,545 20,497 - 47,946 130,883 $ 7,066 $ 552 6,136 - 7,461 21,215 $ 101,268 $ 12,784 54,061 1,999 47,946 218,058 $ 8,623 922 8,020 1 7,461 25,027 Less Than 12 Months December 31, 2022 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (i n thousa nds) 16,853 $ 9,299 1,340 27,862 55,354 $ 1,219 $ 558 38 1,217 3,032 $ - $ - - - - $ - $ - - - - $ 16,853 $ 9,299 1,340 27,862 55,354 $ 1,219 558 38 1,217 3,032 Less Than 12 Months December 31, 2021 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses Available for sale (i n thousa nds) Col l atera l i zed mortga ge obl i ga ti ons Mortga ge ba cked s ecuri ti es Muni ci pa l securi ti es U.S. government a nd a gency obl i ga ti ons $ 57,016 $ 9,269 17,897 48,002 702 $ 154 441 738 Tota l $ 132,184 $ 2,035 $ 5,299 $ 1,634 2,256 - 9,189 $ 280 $ 26 105 - 62,315 $ 10,903 20,153 48,002 982 180 546 738 411 $ 141,373 $ 2,446 At December 31, 2022, there were 241 available for sale and held to maturity 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, 2022. For collateralized mortgage obligations (“CMOs”) 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 The expected cash flows of the security are then discounted to arrive default rates and collateral value by vintage) and prepayments. at a present value amount. For the years ended December 31, 2022 and 2021, no CMO was determined to be other-than-temporarily- impaired. The Company has not recorded impairments related to credit losses through earnings for the years ended December 31, 2022 and 2021. There were no sales of securities for the years ended December 31, 2022 and 2021. 13 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. The amortized cost and estimated fair value of investment securities at December 31, 2022 by maturity is presented in the following table. The amortized cost and estimated fair value of CMOs and MBS are presented by the contractual maturity date. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay underlying loans without prepayment penalties. December 31, 2022 Held to Maturity Available for Sale Amortized Cost Fair Value Amortized Cost Fair Value - $ 30,793 5,255 23,465 59,513 $ (i n thous a nds) - $ 29,548 5,003 21,962 56,513 $ 43 $ 26,735 91,312 133,620 251,710 $ 42 24,943 81,529 120,270 226,784 Due i n one yea r or l ess Due a fter one year through fi ve years Due a fter fi ve yea rs through ten yea rs Due a fter ten yea rs Tota l i nves tment s ecuri ti es $ $ At December 31, 2022 and 2021, investment securities with an estimated fair value of $135.3 million and $126.3 million were pledged to secure public deposits, certain nonpublic deposits and borrowings, respectively. Nonmarketable investment securities As required of all members of the 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 record the value of FHLB stock equal to its par value at $100 per share. At December 31, 2022 and 2021 the Company held $1.6 million and $1.4 million in FHLB stock, respectively. The Company owns $1.0 million in common stock in PCBB, from which the Company receives a variety of corresponding banking services through its banking subsidiary Pacific Coast Bankers Bank. 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, 2022 and maintains capital ratios that exceed “well capitalized” standards for regulatory purposes. 14 NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY Loans held in the portfolio at December 31, 2022 and 2021 were as follows: Commerci a l a nd a gri cul tura l PPP Rea l esta te: Constructi on a nd devel opment Res i denti a l 1-4 fa mi l y Mul ti -fa mi l y Commerci a l rea l esta te -- owner occupi ed Commerci a l rea l esta te -- non owner occupi ed Fa rml and Tota l rea l es ta te Consumer Gros s l oa ns Deferred fees, net Loans , net of deferred fees $ December 31, 2022 2021 (i n thousa nds) 75,705 $ 515 85,309 25,081 $ 37,287 82,653 41,122 154,380 153,707 26,935 496,084 68,412 640,716 (758) 639,958 $ 28,318 67,393 39,854 154,901 148,730 23,905 463,101 56,269 629,760 (1,427) 628,333 Commercial and Agricultural. The Company's commercial and agricultural loans consist primarily of secured revolving operating lines of credit, equipment financing, accounts receivable and inventory financing and business term loans, some of which may be partially guaranteed by the Small Business Administration or the U.S. Department of Agriculture. The Company’s credit policies determine advance rates against the different forms of collateral that can be pledged against commercial loans. Typically, the majority of loans will be limited to a percentage of the underlying collateral values such as equipment, eligible accounts receivable and finished inventory. Individual advance rates may be higher or lower depending upon the financial strength of the borrower, quality of the collateral and/or term of the loan. Paycheck Protection Program (“PPP”). This program was established by the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), enacted on March 27, 2020, in response to the Coronavirus Disease 2019 (“COVID-19”) pandemic. The PPP was administered by the Small Business Administration (SBA). PPP loans may be forgiven by the SBA and are 100 percent guaranteed by the SBA. These loans have either a two-year or five-year maturity date and earn interest at 1%. The Bank also earns a fee based on the size of the loan, which is recognized over the life of the loan. The balance of unamortized net deferred fees on SBA PPP loans was $17,000 and $944,000 at December 31, 2022 and 2021, respectively. Real Estate. The Company originates owner occupied and non-owner occupied commercial real estate and multifamily loans within its primary market areas. Commercial real estate and multifamily loans typically involve a greater degree of risk than single-family residential mortgage loans. Payments on loans secured by multifamily and commercial real estate properties are dependent on successful operation and management of the properties and repayment of these loans is affected by adverse conditions in the real The Company seeks to minimize these risks by scrutinizing the financial condition of the borrower, the estate market or the economy. quality and value of the collateral, and the management of the property securing the loan. In addition, commercial real estate loan portfolios are reviewed annually to evaluate the performance of individual loans that are $1 million and larger for potential changes in interest rates, occupancy, and collateral values. Non-owner occupied commercial real estate loans are loans in which less than 50% of the property is occupied by the owner and include loans such as apartment complexes, hotels and motels, retail centers and mini-storage facilities. Repayment of non-owner occupied commercial real estate loans is dependent upon the lease or resale of the subject property. Loan amortizations range from 10 to 30 years, although terms typically do not exceed 10 years. Interest rates can be either floating or fixed. Floating rates are typically indexed to the prime rate, SOFR, or Federal Home Loan Bank advance rates plus a defined margin. Fixed rates are generally set for periods of three to ten years with either a rate reset provision or a payment due at maturity. Prepayment penalties are often sought on term commercial real estate loans. 15 The Company originates single-family residential construction loans for custom homes where the home buyer is the borrower. It has also provided financing to builders for the construction of pre-sold homes and to builders for the construction of speculative residential property. The Company endeavors to limit construction lending risks through adherence to specific underwriting guidelines and Repayment of construction loans is dependent upon the sale of individual homes to consumers or in some cases to other procedures. developers. Construction loans are generally short-term in nature and most loans mature in one to two years. Interest rates are usually floating and fully indexed to a short-term rate index. The Company's credit policies address maximum loan to value, cash equity requirements, inspection requirements, and overall credit strength. The majority of one-to-four family residential loans are secured by single-family residences located in the Company’s primary market areas. Single-family portfolio loans are generally owner-occupied with terms typically range from 15 to 30 years. Repayment of these loans comes from the borrower’s personal cash flows and liquidity, and collateral values are a function of residential real estate values These loans include primary residences, second homes, rental homes and home equity loans and home in the markets we serve. equity lines of credit. Consumer. The Company originates consumer loans and lines of credit that are both secured and unsecured. Underwriting standards ensures a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans are significantly influenced by statutory requirements. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. The majority of consumer loans are disbursed among many individual borrowers which reduces the credit risk for this type of loan. The Company also purchases indirect consumer loans for classic and exotic cars. Deposit account overdrafts reported as consumer loans totaled $108,000 and $110,000 at December 31, 2022 and 2021, respectively. At December 31, 2022 and 2021, $289.1 million and $262.5 million, respectively, of loans were pledged as collateral on FHLB advances. The Company has also pledged $80.8 million and $81.2 million of loans to the FRB for additional borrowing capacity at December 31, 2022 and 2021, respectively. 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:  The Company classifies loans into relatively homogeneous pools by loan type in accordance with regulatory guidelines for regulatory reporting purposes. The Company regularly reviews all loans within each loan category to establish risk ratings for them that include Pass, Watch, Special Mention, Substandard, Doubtful and Loss. Pursuant to ASC 310 “Accounting by Creditors for Impairment of a Loan”, the impaired portion of collateral dependent loans is charged-off. Other risk-related loans not considered impaired have loss factors applied to the various loan pool balances to establish loss potential for provisioning purposes.  Analyses are performed to establish the loss factors based on historical experience, as well as expected losses based on qualitative evaluations of such factors, as such economic trends and conditions, industry conditions, levels and trends in delinquencies and impaired loans, levels and trends in charge-offs and recoveries, among others. The loss factors are applied to loan category pools segregated by risk classification to estimate the loss inherent in the Company’s loan portfolio pursuant to ASC 450 “Accounting for Contingencies.”  Additionally, impaired loans are evaluated for loss potential on an individual basis in accordance with ASC 310 “Accounting by Creditors for Impairment of a Loan” and specific reserves are established based on thorough analysis of collateral values where loss potential exists. When an impaired loan is collateral dependent and a deficiency exists in the fair value of collateral securing the loan in comparison to the associated loan balance, the deficiency is charged-off at that time or a specific reserve is established. Impaired loans are reviewed no less frequently than quarterly. 16  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, 2022 and 2021 were as follows: Commerci a l a nd a gri cul tura l PPP Rea l es ta te: Res i denti a l 1-4, Mul ti fami l y, Cons t & Dev Commerci a l rea l es ta te -- owner occupi ed Commerci a l rea l es ta te -- non owner occupi ed Fa rml a nd Tota l rea l es ta te Consumer Una l l oca ted Tota l Commerci a l a nd a gri cul tura l PPP Rea l es ta te: Res i denti a l 1-4, Mul ti fami l y, Cons t & Dev Commerci a l rea l es ta te -- owner occupi ed Commerci a l rea l es ta te -- non owner occupi ed Fa rml a nd Tota l rea l es ta te Consumer Una l l oca ted Tota l Twelve Months Ended December 31, 2022 Balance at Beginning of Year Charge-offs Recoveries (i n thous a nds ) Provision (benefit) for Loan Losses Balance at End of Year 668 $ - 1,071 1,299 2,479 478 5,327 1,464 838 8,297 $ - $ - - - - - - (90) - (90) $ - $ - - - - - - 29 - 29 $ 336 $ - 132 (252) (673) (69) (862) 471 55 - $ 1,004 - 1,203 1,047 1,806 409 4,465 1,874 893 8,236 Balance at Beginning of Year 1,524 $ - 1,055 2,187 4,037 839 8,118 1,386 1,040 12,068 $ Twelve Months Ended December 31, 2021 Charge-offs Recoveries (i n thous a nds ) Provision (benefit) for Loan Losses Balance at End of Year (34) $ - - - - - - (196) - (230) $ 42 $ - 49 - - - 49 18 - 109 $ (864) $ - (33) (888) (1,558) (361) (2,840) 256 (202) (3,650) $ 668 - 1,071 1,299 2,479 478 5,327 1,464 838 8,297 $ $ $ $ 17 The allowance for loan losses disaggregated on the basis of the Company's impairment method as of December 31, 2022 and 2021 were as follows: Loans Individually Evaluated for Impairment December 31, 2022 Loans Collectively Evaluated for Impairment (i n thous a nds ) 1,004 $ - - $ - - 48 - 1 49 - - 49 $ 1,203 999 1,806 408 4,416 1,874 893 8,187 $ Loans Individually Evaluated for Impairment December 31, 2021 Loans Collectively Evaluated for Impairment (i n thous a nds ) 664 $ - 4 $ - - 86 - 22 108 - - 112 $ 1,071 1,213 2,479 456 5,219 1,464 838 8,185 $ Total Allowance for Loan Losses 1,004 - 1,203 1,047 1,806 409 4,465 1,874 893 8,236 Total Allowance for Loan Losses 668 - 1,071 1,299 2,479 478 5,327 1,464 838 8,297 Commerci a l and a gri cul tura l PPP Rea l esta te: Res i denti a l 1-4, Mul ti fa mi l y, Cons t & Dev Commerci a l rea l esta te -- owner occupi ed Commerci a l rea l esta te -- non owner occupi ed Fa rml and Tota l rea l es ta te Consumer Una l l oca ted Tota l Commerci a l and a gri cul tura l PPP Rea l esta te: Res i denti a l 1-4, Mul ti fa mi l y, Cons t & Dev Commerci a l rea l esta te -- owner occupi ed Commerci a l rea l esta te -- non owner occupi ed Fa rml and Tota l rea l es ta te Consumer Una l l oca ted Tota l $ $ $ $ 18 The recorded investment of loans disaggregated on the basis of the Company’s impairment method as of December 31, 2022 and 2021, were as follows: Loans Individually Evaluated for Impairment December 31, 2022 Loans Collectively Evaluated for Impairment (i n thous a nds ) 75,251 $ 515 454 $ - 313 1,290 - 294 1,897 101 2,452 $ 160,749 153,090 153,707 26,641 494,187 68,311 638,264 $ Loans Individually Evaluated for Impairment December 31, 2021 Loans Collectively Evaluated for Impairment (i n thous a nds ) 84,529 $ 25,081 780 $ - 343 1,321 - 299 1,963 110 2,853 $ 135,222 153,580 148,730 23,606 461,138 56,159 626,907 $ Gross Loans 75,705 515 161,062 154,380 153,707 26,935 496,084 68,412 640,716 Gross Loans 85,309 25,081 135,565 154,901 148,730 23,905 463,101 56,269 629,760 Commerci a l and a gri cul tura l PPP Rea l esta te: Res i denti a l 1-4, Mul ti fa mi l y, Cons t & Dev Commerci a l rea l esta te -- owner occupi ed Commerci a l rea l esta te -- non owner occupi ed Fa rml and Tota l rea l es ta te Consumer Tota l Commerci a l and a gri cul tura l PPP Rea l esta te: Res i denti a l 1-4, Mul ti fa mi l y, Cons t & Dev Commerci a l rea l esta te -- owner occupi ed Commerci a l rea l esta te -- non owner occupi ed Fa rml and Tota l rea l es ta te Consumer Tota l $ $ $ $ Credit Quality Indicators As part of the on-going monitoring of the credit quality of Bank’s loan portfolio, management tracks certain credit quality indicators including trends related to risk rating classifications of loans, the level of classified loans, net charge-offs, past due and non-performing loans, as well as general economic conditions of the United States of America and specifically the states of Washington and Oregon. Numerical risk rating classifications for loans are established at origination. Changes to the risk rating classification are considered as new information about the performance of the loan becomes available, including but not limited to receipt of updated financial information from the borrower, results of annual term loan reviews and scheduled loan reviews. Federal regulations require that the Bank periodically evaluate the risks inherent in its loan portfolios. In addition, the Washington Division of Banks and the Federal Deposit Insurance Corporation (“FDIC”) have authority to identify problem loans and, if appropriate, require them to be reclassified. There are three classifications for problem loans: Substandard, Doubtful, and Loss. These terms are used as follows:  “Substandard” loans have one or more defined weaknesses and are characterized by the distinct possibility some loss will be sustained if the deficiencies are not corrected. 19  “Doubtful” loans have the weaknesses of loans classified as "Substandard," with additional characteristics that suggest the weaknesses make collection or recovery in full after liquidation of collateral questionable on the basis of currently existing facts, conditions, and values. There is a high possibility of loss in loans classified as "Doubtful."  “Loss” loans are considered uncollectible and of such little value that continued classification of the credit as a loan is not warranted. If a loan or a portion thereof is classified as "Loss," it must be charged-off; meaning the amount of the loss is charged against the allowance for 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. Credit quality indicators as of December 31, 2022 and 2021 were as follows: Commerci a l and agri cul tural PPP Rea l esta te: Constructi on and devel opment Res i denti a l 1-4 fa mi l y Mul ti -fa mi l y Commerci a l rea l es ta te -- owner occupi ed Commerci a l rea l es ta te -- non owner occupi ed Fa rml and Tota l rea l es ta te Consumer Gross Loa ns Commerci a l and agri cul tural PPP Rea l esta te: Constructi on and devel opment Res i denti a l 1-4 fa mi l y Mul ti -fa mi l y Commerci a l rea l es ta te -- owner occupi ed Commerci a l rea l es ta te -- non owner occupi ed Fa rml and Tota l rea l es ta te Consumer Gross Loa ns $ $ $ $ Pass 69,072 $ 515 37,287 82,206 41,122 154,160 152,296 25,027 492,098 68,361 630,046 $ December 31, 2022 Other Loans Especially Mentioned Substandard (i n thousa nds ) Doubtful Total 5,453 $ - - 53 - - 1,411 - 1,464 - 6,917 $ 1,180 $ - - 394 - 220 - 1,908 2,522 51 3,753 $ December 31, 2021 - $ - - - - - - - - - - $ 75,705 515 37,287 82,653 41,122 154,380 153,707 26,935 496,084 68,412 640,716 Other Loans Especially Mentioned Pass Substandard (i n thousa nds ) Doubtful Total 82,390 $ 25,081 1,551 $ - 1,368 $ - 334 116 - 2,449 6,764 856 10,519 - 12,070 $ - 1,275 - 495 4,088 2,895 8,753 80 10,201 $ 27,984 66,002 39,854 151,957 137,878 20,154 443,829 56,189 607,489 $ 20 - $ - - - - - - - - - - $ 85,309 25,081 28,318 67,393 39,854 154,901 148,730 23,905 463,101 56,269 629,760 Impaired Loans Impaired loans by type as of December 31, 2022 and 2021, and interest income recognized for the twelve months ended December 31, 2022 and 2021 were as follows: December 31, 2022 Recorded Investment With No Specific Valuation Allowance Recorded Investment With Specific Valuation Allowance Total Recorded Investment Unpaid Contractual Principal Balance (i n thousa nds ) Related Specific Valuation Allowance Average Recorded Investment Interest Income Recognized 454 $ - 313 220 - - 533 101 1,088 $ - $ - - 1,070 - 294 1,364 - 1,364 $ 454 $ - 313 1,290 - 294 1,897 101 2,452 $ 494 $ - 352 1,316 - 295 1,963 127 2,584 $ - $ - - - 48 - 1 49 - 49 $ 506 $ - 357 1,328 - 297 1,982 132 2,620 $ 28 - 20 69 - 15 104 9 141 December 31, 2021 Recorded Investment With No Specific Valuation Allowance Recorded Investment With Specific Valuation Allowance Total Recorded Investment Unpaid Contractual Principal Balance (i n thousa nds ) Related Specific Valuation Allowance Average Recorded Investment Interest Income Recognized 636 $ - 343 241 - - 584 110 1,330 $ 144 $ - - 1,080 - 299 1,379 - 1,523 $ 780 $ - 343 1,321 - 299 1,963 110 2,853 $ 820 $ - 360 1,335 - 299 1,994 136 2,950 $ 4 $ - - - 86 - 22 108 - 112 $ 881 $ - 376 1,339 - 300 2,015 137 3,033 $ 43 - 22 69 - 14 105 10 158 $ $ $ $ Commercia l a nd a gri cul tura l PPP Rea l Estate: Re si denti a l 1-4, Mul ti fa mi l y, Const & Dev Commerci a l real es ta te -- owne r occupi ed Commerci a l real es ta te -- non owner occupi ed Fa rml a nd Total rea l es ta te Cons umer Tota l Commercia l a nd a gri cul tura l PPP Rea l Estate: Re si denti a l 1-4, Mul ti fa mi l y, Const & Dev Commerci a l real es ta te -- owne r occupi ed Commerci a l real es ta te -- non owner occupi ed Fa rml a nd Total rea l es ta te Cons umer Tota l 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 2022 and 2021. Total related party loans outstanding at December 31, 2022 and 2021 to executive officers and directors were $2.6 million and $2.8 million, respectively. During 2022 and 2021, new loans or advances on existing loans of $350,000 and $376,000, respectively, were made, and repayments totaled $490,000 and $310,000, 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, 2022. 21 Aging Analysis The following tables summarize the Company’s loans past due, both accruing and non-accruing, by type as of December 31, 2022 and 2021. The Company did not recognize any interest income on non-accrual loans during the years ended December 31, 2022 and 2021. No allowance was established on non-accrual loans as of December 31, 2022 and 2021. 30-59 Days Past Due 60-89 Days Past Due Greater Than 90 Days Total Past Due Non-accrual Loans Loans Not Past Due Total (i n thousa nds ) 2022 $ $ $ $ 199 $ - - 49 - - - - 49 101 349 $ 191 $ - - - - - - - - 4 195 $ - $ - - - - - - - - - - $ 390 $ - - 49 - - - - 49 105 544 $ 2021 336 $ - - 313 - 220 - - 533 - 869 $ 74,979 $ 515 75,705 515 37,287 82,291 41,122 154,160 153,707 26,935 495,502 68,307 639,303 $ 37,287 82,653 41,122 154,380 153,707 26,935 496,084 68,412 640,716 30-59 Days Past Due 60-89 Days Past Due Greater Than 90 Days Total Past Due Non-accrual Loans Loans Not Past Due Total (i n thousa nds ) - $ - - - - - - - - 55 55 $ - $ - - - - - - - - - - $ - $ - - - - - - - - - - $ - $ - - - - - - - - 55 55 $ 636 $ - 84,673 $ 25,081 85,309 25,081 - 343 - 242 - - 585 - 1,221 $ 28,318 67,050 39,854 154,659 148,730 23,905 462,516 56,214 628,484 $ 28,318 67,393 39,854 154,901 148,730 23,905 463,101 56,269 629,760 Commerci a l a nd a gri cul tura l PPP Rea l esta te: Cons tructi on a nd devel opment Resi de nti a l 1-4 fa mi l y Mul ti -fa mi l y Commerci a l re a l esta te -- owner occupi ed Commerci a l re a l esta te -- non owner occupi ed Fa rml a nd Tota l rea l esta te Cons umer Gros s Loa ns Commerci a l a nd a gri cul tura l PPP Rea l esta te: Cons tructi on a nd devel opment Resi de nti a l 1-4 fa mi l y Mul ti -fa mi l y Commerci a l re a l esta te -- owner occupi ed Commerci a l re a l esta te -- non owner occupi ed Fa rml a nd Tota l rea l esta te Cons umer Gros s Loa ns 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. 22 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, 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 twelve months. During the twelve months ended December 31, 2022, there was $63,000 decrease on the allowance from TDRs during the period. The Company had $87,000 in commitments to lend additional funds for loans classified as TDRs at December 31, 2022. 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 by type as of December 31, 2022 and 2021, all of which were modified due to financial stress of the borrower. There were not any subsequent defaulted TDRs as of December 31, 2022 and 2021: Number of Loans Commerci a l a nd a gri cul ture Commerci a l rea l es tate -- owner occupi ed Fa rml a nd Consumer Tota l TDRs (1) 2 1 1 1 5 Number of Loans Commerci a l a nd a gri cul ture Commerci a l rea l es tate -- owner occupi ed Fa rml a nd Consumer Tota l TDRs (1) 2 1 1 1 5 December 31, 2022 Pre-TDR Outstanding Recorded Investment Post-TDR Outstanding Recorded Investment (dol l a rs i n thous a nds) $ 554 $ 1,080 303 137 2,074 $ $ 340 1,070 295 101 1,806 December 31, 2021 Pre-TDR Outstanding Recorded Investment Post-TDR Outstanding Recorded Investment (dol l a rs i n thous a nds) $ 554 $ 1,080 303 137 $ 2,074 $ 376 1,080 299 110 1,865 (1) The peri od end ba l a nces a re i ncl us i ve of a l l pa rti a l pa y-downs a nd cha rge-offs si nce the modi fi ca ti on date. 23 The following table presents TDRs modified or recorded during the years ended December 31, 2022 and 2021. December 31, 2022 Commerci al a nd a gri cul ture Tota l Commerci al a nd a gri cul ture Fa rml a nd Consumer Tota l Recorded Number of Loans Investment (doll a rs i n thous a nds) 222 222 1 1 $ $ December 31, 2021 Recorded Number of Loans Investment (doll a rs i n thous a nds) 1,080 299 110 1,489 1 1 1 3 $ $ The following tables present troubled debt restructurings by accrual or nonaccrual status as of December 31, 2022 and 2021: Commerci al a nd a gri cul ture Commerci al rea l esta te -- owner occupi ed Fa rml a nd Consumer Tota l TDRs Commerci al a nd a gri cul ture Commerci al rea l esta te -- owner occupi ed Fa rml a nd Consumer Tota l TDRs Accrual Status December 31, 2022 Non-Accrual Status (i n thousa nds ) Total TDRs 118 $ 1,070 295 101 1,584 $ 222 $ - - - 222 $ 340 1,070 295 101 1,806 Accrual Status December 31, 2021 Non-Accrual Status (i n thousa nds ) Total TDRs 144 $ 1,080 299 110 1,633 $ 232 $ - - - 232 $ 376 1,080 299 110 1,865 $ $ $ $ Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” allows financial institutions the option to temporarily suspend certain requirements under U.S. GAAP related to TDRs for a limited period of time during the COVID-19 pandemic. In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the FDIC, (the "agencies") issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. 24 The Company had total outstanding principle balance of $0 and $74,000 of COVID-19 related loan modifications under these provisions as of December 31, 2022 and 2021, respectively. These loans did not have financial difficulty prior to the COVID-19 pandemic and were generally modified for principal and interest payment deferral or interest only payments for up to six months. Modified loans continue to accrue interest and are evaluated for past due status based on the revised payment terms. 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, 2022 and 2021. Investment Securities Defined Benefit Plans (i n thous a nds ) (336) $ - 483 56 539 203 $ 1,343 $ (20,707) - - (20,707) (19,364) $ Investment Securities Defined Benefit Plans (i n thous a nds ) (531) $ - 120 75 195 (336) $ 4,773 $ (3,430) - - (3,430) 1,343 $ Total 1,007 (20,707) 483 56 (20,168) (19,161) Total 4,242 (3,430) 120 75 (3,235) 1,007 Bal a nce, December 31, 2021 Cha nge i n fa i r va l ue of i nvestment s ecuri ti es a va i l a bl e for s al e Unrecogni zed net a ctua ri a l ga i n duri ng the peri od, net of ta x Amorti za ti on of net a ctua ri a l l os s i ncl uded i n i ncome Net current peri od other comprehens i ve i ncome (l oss ) Bal a nce, December 31, 2022 Bal a nce, December 31, 2020 Cha nge i n fa i r va l ue of i nvestment s ecuri ti es a va i l a bl e for s al e Unrecogni zed net a ctua ri a l l oss duri ng the peri od, net of ta x Amorti za ti on of net a ctua ri a l l os s i ncl uded i n i ncome Net current peri od other comprehens i ve i ncome (l oss ) Bal a nce, December 31, 2021 $ $ $ $ 25 The following table presents the components of other comprehensive income for the twelve months ended December 31, 2022 and 2021. Reclassification adjustments related to gains on securities available-for-sale are included in gain on sale of investment securities, net, in the accompanying consolidated statements of income. Reclassification adjustments related to defined benefit plans are included in compensation and employee benefits in the accompanying consolidated statements of income. Net unrea l i zed l os ses on i nves tment s ecuri ti es : Net unrea l i zed l os ses a ri si ng duri ng the peri od Recl a s s i fi ca ti on a djus tments for net ga i ns rea l i zed i n net i ncome Net unrea l i zed l os ses on i nves tment s ecuri ti es Defi ned benefi t pl ans : Net unrecogni zed a ctua ri a l ga i n Recl a s s i fi ca ti on a djus tment of amorti za ti on of net a ctua ri a l l os s Net pens i on pl an l i a bi l i ty a djus tment Other comprehens i ve i ncome (l os s ) Net unrea l i zed ga i ns on i nvestment securi ti es : Net unrea l i zed l os ses a ri si ng duri ng the peri od Recl a s s i fi ca ti on a djus tments for net ga i ns rea l i zed i n net i ncome Net unrea l i zed l os ses on i nves tment s ecuri ti es Defi ned benefi t pl ans : Net unrecogni zed a ctua ri a l ga i n Recl a s s i fi ca ti on a djus tment of amorti za ti on of net a ctua ri a l l os s Net pens i on pl an l i a bi l i ty a djus tment Other comprehens i ve i ncome (l os s ) $ $ $ $ Before Tax Twelve Months Ended December 31, 2022 Net of Tax Tax Effect (i n thousa nds ) (5,888) $ - (5,888) - (26,595) (20,707) - (20,707) (26,595) $ 611 71 682 (25,913) $ 128 15 143 (5,745) $ 483 56 539 (20,168) Before Tax Twelve Months Ended December 31, 2021 Net of Tax Tax Effect (i n thousa nds ) (4,315) $ - (4,315) 152 95 247 (4,068) $ (885) $ - (885) 32 20 52 (833) $ (3,430) - (3,430) 120 75 195 (3,235) NOTE 6 – PREMISES AND EQUIPMENT The components of premises and equipment at December 31, 2022 and 2021 were as follows: La nd a nd premi s es Equi pment, furni ture a nd fi xtures Constructi on i n progress Less a ccumul a ted depreca ti on a nd a morti za ti on Tota l premi s es a nd equi pment December 31, 2022 2021 (i n thous a nds ) 20,535 $ 10,030 78 30,643 (17,772) 12,871 $ 19,786 10,159 177 30,122 (17,118) 13,004 $ $ Depreciation expense was $1.1 million and $1.2 million for years ending December 31, 2022 and 2021, respectively. 26 NOTE 7 – OPERATING LEASE RIGHT-OF-USE ASSET Future minimum payments for operating leases with initial or remaining terms of one year or more as of December 31, 2022 are as follows: 2023 2024 2025 2026 Therea fter $ Tota l future mini mum l ea s e pa yments $ Amounts repres enti ng i nterest Tota l opera ti ng l ea s e l i a bi l i ti es $ December 31, 2022 (i n thous ands) 561 401 191 23 - 1,176 (27) 1,149 At December 31, 2022 the weighted-average remaining lease term was 2.3 years and the weighted-average discount rate was 1.38%. Amortization of ROU assets, short term lease cost, interest on lease liabilities and non-lease component expenses was $647,000 and $654,000 for the years ending December 31, 2022 and 2021, respectively. NOTE 8 – OTHER REAL ESTATE OWNED The Company had no activity related to OREO for the years ended December 31, 2022 and 2021 and had no properties classified as OREO at December 31, 2022 and 2021. NOTE 9 – DEPOSITS Time deposits that meet or exceed the FDIC Insurance limit of $250,000 at December 31, 2022 and 2021 were $9.8 million and $12.8 million, respectively. The composition of deposits at December 31, 2022 and 2021 was as follows: December 31, 2022 2021 (i n thousa nds ) Interest-bea ri ng dema nd ("NOW") $ Money ma rket depos i ts Sa vi ngs depos i ts Ti me deposi ts ("CDs ") Tota l i nterest-beari ng deposi ts Non-i nteres t bea ri ng dema nd Tota l depos i ts $ 253,272 $ 195,814 174,887 48,754 672,727 507,635 1,180,362 $ 242,789 210,344 174,929 58,724 686,786 492,154 1,178,940 27 Scheduled maturities of CDs were as follows for future years ending December 31 (in thousands): 2023 2024 2025 2026 2027 Therea fter Tota l Maturities 32,690 8,494 3,507 1,776 2,129 158 48,754 $ $ NOTE 10 – BORROWINGS Advances from the Federal Home Loan Bank Utilizing a pledge agreement, qualifying loans receivable at December 31, 2022 and 2021, were pledged as security for Federal Home Loan Bank (FHLB) borrowings. At December 31, 2022, the Bank had no outstanding borrowings against its $195.8 million in established borrowing capacity with the FHLB, as compared to $403,000 outstanding against a borrowing capacity of $169.1 million at December 31, 2021. The Bank’s borrowing facility with the FHLB is subject to collateral and stock ownership requirements. A summary of FHLC advances as of December 31, 2022 and 2021 is as follows: Amount outs ta ndi ng a t end of peri od Average ba l a nce duri ng the yea r Average i nterest ra te duri ng the yea r(1) $ $ (1) Fi xed ra te December 31, 2022 2021 (dol l a rs i n thousa nds ) - $ 190 $ 2.23% 403 472 2.23% Federal Reserve Bank of San Francisco and Other Borrowings The Bank may borrow funds on an overnight basis from the Federal Reserve Bank through the Borrower-In-Custody program. Such borrowings are secured by a pledge of eligible loans. At December 31, 2022, the Bank had an available discount window primary credit line with the Federal Reserve Bank of San Francisco of approximately $57.6 million with no balance outstanding. At December 31, 2022, the Bank had unsecured federal funds lines of credit agreements with other financial institutions totaling $60.0 million. No balances were outstanding under these agreements as of December 31, 2022. Availability of lines is subject to continued borrower eligibility. NOTE 11 – JUNIOR SUBORDINATED DEBENTURES At December 31, 2022, two wholly-owned subsidiary grantor trusts established by the Company had outstanding $13.4 million of Trust Preferred Securities. Trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in the indentures. The trusts used the net proceeds from the offering of trust preferred securities to purchase a like amount of Junior Subordinated Debentures (the “Debentures”) of the Company. The Debentures are the sole assets of the trusts. The Company’s obligations under the Debentures and the related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole or in part, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. The Debentures issued by the Company to the grantor trusts totaling $13.0 million are reflected in the consolidated balance sheet in the liabilities section under the caption “junior subordinated debentures.” The Company records interest expense on the corresponding junior subordinated debentures in the consolidated statements of income. The Company recorded $403,000 in the consolidated balance sheet at December 31, 2022 and 2021 for the common capital securities issued by the issuer trusts. As of December 31, 2022 and 2021, regular accrued interest on junior subordinated debentures totaled $126,000 and $38,000, respectively, and is included in accrued expenses and other liabilities on the consolidated balance sheet. 28 The terms of the junior subordinated debentures as of December 31, 2022 and 2021 are: Trust Name Issue Date Issued Amount (dol l a rs i n thousa nds ) Rate Pa ci fi c Fi na nci a l Corpora ti on December Sta tutory Trust I Pa ci fi c Fi na nci a l Corpora ti on Sta tutory Trust II 2005 June 2006 $ 5,000 LIBOR + 1.45% (1) 8,000 13,000 $ LIBOR + 1.60% (2) (1) Va ri a bl e ra te of 3-month l i bor, adjusted qua terl y 3-month LIBOR 4.77% a t December 13, 2022 and 0.20% a t December 13, 2022 (2) Va ri a bl e ra te of 3-month l i bor, adjusted qua terl y 3-month LIBOR 4.08% a t October 13, 2022 a nd 0.12% a t October 13, 2022 Maturity Date Ma rch 2036 Jul y 2036 NOTE 12 – INCOME TAXES The Company recorded an income tax provision for the twelve months ended December 31, 2022 and 2021. 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, 2022, the Company believes that it is more likely than not that it will be able to fully realize its deferred tax asset and therefore has not recorded a valuation allowance. 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, tax-exempt loans 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 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 did not have any uncertain tax positions as of December 31, 2022. Income taxes for the years ended December 31, 2022 and 2021 was as follows: Current Deferred Tota l i ncome ta x expens e December 31, 2022 2021 (i n thous a nds ) 2,252 $ 59 2,311 $ 1,442 1,443 2,885 $ $ 29 The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities and net deferred tax assets (liabilities) are recorded in prepaid expenses and other assets in the consolidated financial statements at December 31, 2022 and 2021 are: Deferred Tax Assets Al l owa nce for l oa n l os ses Deferred compens a ti on Suppl ementa l executi ve reti rement pl a n Compens a ti on expens e Unrea l i zed l oss on s ecuri ti es a vai l a bl e for s a l e Other Tota l deferred ta x a s s ets Deferred Tax Liabilities Depreci a ti on Loan fees /cos ts Unrea l i zed ga i n on s ecuri ti es a vai l a bl e for sa l e Prepa i d expenses Other Tota l deferred ta x l i a bi l i ti es Net deferred tax assets (liabilities) $ $ $ $ December 31, 2022 2021 (i n thous a nds ) 1,868 $ 7 689 64 5,506 335 8,469 $ 1,882 11 878 87 - 242 3,100 189 $ 2,534 - 245 273 3,241 5,228 $ 292 2,606 382 237 258 3,775 (675) The following is a reconciliation between the statutory and effective federal income tax rate for the years ended December 31, 2022 and 2021: December 31, 2022 2021 Amount 2,772 95 (291) (143) (122) 2,311 $ $ Percent of Pre-tax Income Amount (dol l a rs i n thousa nds ) 21.0% $ 3,272 0.7% -2.2% -1.1% -0.9% 17.5% $ 158 (287) (285) 27 2,885 Percent of Pre-tax Income 21.0% 0.9% -1.8% -1.8% 0.2% 18.5% Income tax a t s ta tutory rate Adjustments res ul ti ng from: Sta te i ncome ta xes , net of federa l benefi t Ta x-exempt i ncome Net ea rni ngs on l i fe i ns ura nce pol i ci es Other Tota l i ncome ta x expens e NOTE 13 – 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 $1.0 million and $1.1 million in 2022 and 2021, respectively. 401(k) Plans – The Bank has established a 401(k) plan for those employees who meet the eligibility requirements set forth in the plan. During any calendar year, eligible employees may contribute up to an amount of salary compensation as allowed by applicable IRS code. Matching contributions by the Bank are at the discretion of the Board of Directors. Contributions totaled $743,000 and $806,000 for 2022 and 2021, 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 is currently one participant receiving payments in the director and employee deferred compensation plan. There were no deferrals or ongoing expense to the Company for these plans in 2022 and 2021. 30 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 $3.1 million and $3.0 million at December 31, 2022 and 2021, respectively. In 2022 and 2021, the net benefit recorded from these plans, including the cost of the related life insurance, was $183,000 and $195,000, 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 $34,000 and $48,000 at December 31, 2022 and 2021, respectively. Long-Term Compensation Agreements – The Company has 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. A benefit of $42,000 and a cost of $73,000 was recorded for these agreements for the years ended December 31, 2022 and 2021, 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 key officers. The SERP is unsecured and unfunded and there are no plan assets. The post-retirement benefit provided by the SERP is designed to supplement a participating officer’s retirement benefits from social security, in order to provide the officer with a certain percentage of final average income at retirement age. The benefit is generally based on average earnings, years of service and age at retirement. At the inception of the SERP, the Company recorded a prior service cost to accumulated other comprehensive income of $704,000. The Company has purchased bank owned life insurance covering all participants in the SERP. The cash surrender value of these policies totaled $7.3 million and $7.1 million at December 31, 2022 and 2021, 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, 2022 and 2021: Net peri odi c pens i on cost: Servi ce cost Interest cos t Amorti za ti on of net l os s Net peri odi c pens i on cost Wei ghted avera ge a s s umpti ons : Di scount ra te Sa l a ry sca l e Expected return on pl a n a s s ets December 31, 2022 2021 (dol l a rs i n thous a nds ) 60 59 75 194 58 $ 69 56 183 $ $ $ 2.38% n/a n/a 1.87% n/a n/a The following table sets forth the change in benefit obligation at December 31, 2022 and 2021: Cha nge i n benefi t obl i ga ti on: Benefi t obl i ga ti on a t the beginni ng of yea r $ Servi ce cost Interest cost Benefi ts pa i d Actua ri a l l os s (ga i n) Benefi t obl i ga ti on a t end of year $ December 31, 2022 2021 (i n thous a nds ) 3,018 $ 58 69 (234) (483) 2,428 $ 3,253 60 59 (234) (120) 3,018 31 Amounts recognized in accumulated other comprehensive income at December 31, 2022 and 2021 was as follows: (Gai n) Los s Pri or servi ce cos t Tota l recogni zed i n AOCI December 31, 2022 2021 (i n thous a nds ) (203) $ - (203) $ 336 - 336 $ $ The following table summarizes the projected and accumulated benefit obligations at December 31, 2022 and 2021: Projected benefi t obl i ga ti on Accumul a ted benefi t obl i ga ti on $ $ December 31, 2022 2021 (i n thous a nds ) 2,429 $ 2,429 $ 3,018 3,018 Estimated future benefit payments as of December 31, 2022 were as follows (in thousands): $ 2023 2024 2025 2026 2027 2028-2032 Tota l $ 234 234 234 234 234 1,329 2,499 NOTE 14 – COMMITMENTS AND CONTINGENCIES The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, and involve, to varying degrees, elements of credit risk in excess of the amount recognized on the consolidated balance sheets. 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, 2022 and 2021 is as follows: December 31, 2022 2021 Commi tments to extend credi t $ $ Sta ndby l etters of credi t (i n thous a nds ) $ $ 202,331 4,420 172,216 600 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. 32 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 consolidated financial statements. The Company is currently not party to any material pending litigation. However, because of the nature of its activities, the Company may be subject to or threatened with legal actions in the ordinary course of business. In the opinion of management, liabilities arising from these claims, if any, will not have a material effect on the results of operations or financial condition of the Company. NOTE 15 – 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. Loans to any single borrower or group of borrowers are generally limited by state banking regulations to 20% of the Bank’s capital and Standby letters of credit were granted primarily to commercial surplus, excluding accumulated other comprehensive income (loss). borrowers. The Bank, as a matter of practice, generally does not extend credit to any single borrower or group of borrowers in excess of $13.0 million. NOTE 16 – STOCK BASED COMPENSATION The Company’s 2021 Equity Incentive Plan, (the “2021 Equity Plan”), provides for the issuance of up to 750,000 shares in connection with incentive and nonqualified stock options, restricted stock, restricted stock units and other equity-based awards. Prior to adoption of the 2021 Equity Plan, the Company made equity-based awards under the Company’s 2011 Equity Incentive Plan, which expired April 1, 2021. Stock Options The 2021 Plan authorizes the issuance of incentive and non-qualified stock options, as defined under current tax laws, to key personnel. Options granted under the 2021 Plan either become exercisable ratably over five years or in a single installment five years from the date of grant. The Company uses the Black-Scholes option pricing model to calculate the fair value of stock option awards based on assumptions in the following table. Expected volatility is based on historical volatility of the Company’s common stock. The expected term of stock options granted is based on the simplified method, which is the simple average between contractual term and vesting period. The risk-free rate is based on the expected term of stock options and the applicable U.S. Treasury yield in effect at the time of grant. Grant period ended December 31, 2022 December 31, 2021 Expected Life 6.5 yea rs 7.5 yea rs Risk Free Interest Rate 4.18% 1.51% Expected Stock Price Volatility 27.42% 29.23% Dividend Yield 4.98% 4.48% Weighted Average Fair Value of Options Granted $ 1.93 $ 1.98 33 The following tables summarize the stock option activity for the years ended December 31, 2022 and 2021: Weighted Average Remaining Contractual Term (in Years) Weighted Average Exercise Price Outsta ndi ng a t December 31, 2020 Gra nted Exerci s ed Forfei ted or cancel ed Expi red Outsta ndi ng a t December 31, 2021 Gra nted Exerci s ed Forfei ted or cancel ed Expi red Outsta ndi ng a t December 31, 2022 Shares 210,450 $ 2,500 (9,500) (24,100) (5,200) 174,150 $ 5,000 (25,500) (3,900) (2,400) 147,350 $ 10.46 11.60 6.72 12.36 10.91 10.42 10.45 5.11 12.47 12.69 11.25 Ves ted a nd exerci s a bl e a t December 31, 2022 92,850 $ 11.03 6.36 5.80 The following table summarizes nonvested stock option activity for the years ended December 31, 2022 and 2021: Nonves ted Outsta ndi ng at December 31, 2020 Gra nted Ves ted Forfei ted Nonves ted Outsta ndi ng at December 31, 2021 Gra nted Ves ted Forfei ted Nonves ted Outsta ndi ng at December 31, 2022 Weighted Average Grant Date Fair Value 1.10 1.98 1.00 1.11 1.18 1.93 1.15 1.03 1.28 Shares 127,600 $ 2,500 (27,200) (24,100) 78,800 $ 5,000 (25,400) (3,900) 54,500 $ Information related to the stock option plan during each year follows: Intri ns i c val ue of opti ons exerci s ed Ca sh recei ved from opti on exerci ses $ $ 142 $ 130 $ 48 64 2022 2021 (i n thousa nds ) 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. 34 The following information summarizes information about stock option compensation expense for the years ended December 31, 2022 and 2021: Compens ati on Expens e Ta x Effect Compens ati on Expens e, net Twelve Months Ended December 31, 2022 2021 (i n thous a nds ) $ $ 31 $ 7 24 $ 29 6 23 As of December 31, 2022, there was $63,000 of total unrecognized compensation cost related to stock options. The cost is expected to be recognized over a weighted-average period of 1.84 years. Restricted Stock Units The Company grants restricted stock units (“RSUs”) 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 2021 Plan upon the lapse of applicable restrictions. Outstanding RSUs are subject to forfeiture if the recipient’s employment terminates prior to expiration. The following table summarizes RSU activity during the twelve months ended December 31, 2022 and 2021: Weighted Average Grant Date Fair Value 10.71 11.85 Outsta ndi ng at December 31, 2020 Gra nted Ves ted Forfei ted Outsta ndi ng at December 31, 2021 Gra nted Ves ted Forfei ted Outsta ndi ng at December 31, 2022 Shares 21,850 11,000 $ (7,000) - 25,850 11,000 $ (7,100) - 29,750 The following table summarizes RSU compensation expense during the twelve months ended December 31, 2022 and 2021: Twelve Months Ended 2022 2021 (i n thousa nds ) Compens a ti on Expens e Ta x Effect Compens a ti on Expens e, net $ $ 119 $ 25 94 $ 97 20 77 As of December 31, 2022, there was $142,000 of total unrecognized compensation cost related to nonvested RSUs. The cost is expected to be recognized over a weighted-average period of 1.4 years. NOTE 17 – REGULATORY MATTERS The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the Company’s consolidated financial statements. Under capital adequacy guidelines on the regulatory framework for prompt corrective action, the Bank must meet specific capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under 35 regulatory accounting practices. The Bank’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Effective January 1, 2015 (with some changes transitioned into full effectiveness over two to four years), the Bank became subject to new capital adequacy requirements approved by the Federal Reserve and the FDIC that implement the revised standards of the Basel Committee on Banking Supervision, commonly called Basel III, and address relevant provisions of the Dodd-Frank Act. Pursuant to minimum capital requirements of the FDIC effective on January 1, 2015, all FDIC-insured financial institutions are required to maintain a minimum common equity Tier 1 risk-based capital to risk-weighted assets ratio of 4.5%, a minimum Tier 1 leverage ratio to average assets of 4.0% and minimum risk-based capital ratios of Tier 1 capital to risk-weighted assets and total capital to risk-weighted assets of 6.0% and 8.0%, respectively. The Company is subject to the Basel III regulatory capital framework ("Basel III Capital Rules"), which includes a 2.5% capital conservation buffer. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on the Company's ability to make capital distributions, which includes dividend payments, and stock repurchases and certain discretionary bonus payments based on percentages of eligible retained income that could be utilized for such actions. As of December 31, 2022 and 2021, 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 There are no conditions or events since that notification that management believes have changed the set forth in the table. institution’s category. Actual capital amounts and ratios for December 31, 2022 and 2021 are presented in the table below. Actual Minimum Requirements Well-Capitalized Requirements Amount Ratio Amount Ratio Amount Ratio (dol l ars i n thous a nds ) As of December 31, 2022 Compa ny Common equi ty Ti er 1 ca pi ta l to ri s k-wei ghted a s sets $ Ti er 1 l everage ca pi ta l to avera ge a s s ets Ti er 1 ca pi tal to ri sk-wei ghted a s s ets Tota l ca pi ta l to ri s k-wei ghted a ss ets Ba nk Common equi ty Ti er 1 ca pi ta l to ri s k-wei ghted a s sets Ti er 1 l everage ca pi ta l to avera ge a s s ets Ti er 1 ca pi tal to ri sk-wei ghted a s s ets Tota l ca pi ta l to ri s k-wei ghted a ss ets As of December 31, 2021 Compa ny Common equi ty Ti er 1 ca pi ta l to ri s k-wei ghted a s sets $ Ti er 1 l everage ca pi ta l to avera ge a s s ets Ti er 1 ca pi tal to ri sk-wei ghted a s s ets Tota l ca pi ta l to ri s k-wei ghted a ss ets Ba nk Common equi ty Ti er 1 ca pi ta l to ri s k-wei ghted a s sets Ti er 1 l everage ca pi ta l to avera ge a s s ets Ti er 1 ca pi tal to ri sk-wei ghted a s s ets Tota l ca pi ta l to ri s k-wei ghted a ss ets 108,888 121,888 121,888 130,327 121,112 121,112 121,112 129,551 103,191 116,191 116,191 124,692 115,733 115,733 115,733 124,234 36 14.3% $ 9.4% 16.0% 17.1% 15.9% 9.1% 15.9% 17.0% 14.6% $ 8.8% 16.4% 17.6% 16.4% 8.8% 16.4% 17.6% 34,265 51,867 45,708 60,972 34,277 53,236 45,703 60,965 31,805 52,814 42,509 56,678 31,756 52,606 42,341 56,470 4.5% 4.0% 6.0% 8.0% N/A N/A N/A N/A 4.5% $ 4.0% 6.0% 8.0% 49,511 66,545 60,937 76,206 4.5% 4.0% 6.0% 8.0% N/A N/A N/A N/A 4.5% $ 4.0% 6.0% 8.0% 45,870 65,757 56,455 70,588 N/A N/A N/A N/A 6.5% 5.0% 8.0% 10.0% N/A N/A N/A N/A 6.5% 5.0% 8.0% 10.0% NOTE 18 – FAIR VALUE MEASUREMENTS Fair Value Hierarchy The Company uses an established hierarchy for measuring fair value that is intended to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows: Level 1 – Valuations based on quoted prices in active exchange markets for identical assets or liabilities; also includes certain corporate debt securities actively traded in over-the-counter markets. Level 2 – Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and model–derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services. This category generally includes certain U.S. Government, agency and non- agency securities, state and municipal securities, mortgage backed securities, corporate securities, and residential mortgage loans held for sale. Level 3 – Valuation based on unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, yield curves and similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external data, which may include third-party pricing services. Investment Securities Available for Sale The Company uses an independent pricing service to assist management in determining fair values of investment securities available for sale. This service provides pricing information by utilizing evaluated pricing models supported with market based information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, credit ratings, bids and offers, relative credit information and reference data from market research publications. Investment securities that are deemed to have been trading in illiquid or inactive markets may require the use of significant unobservable inputs. The pricing service provides quoted market prices when available. Quoted prices are not always available due to bond market inactivity. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. Additionally, the pricing service may obtain a broker quote when sufficient Valuations and broker quotes are non-binding and do not represent quotes on information is not available to produce a valuation. 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. 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. 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, 2022 or 2021. 37 The following table presents the balances of assets measured at fair value on a recurring basis at December 31, 2022 and 2021. At December 31, 2022 Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Description Fair Value Avai l a bl e-for-s a l e securi ti es: (i n thous a nds ) Col l a tera l i zed mortga ge obl i ga ti ons $ 101,958 $ - $ 101,958 $ Mortga ge-ba cked s ecuri ti es Muni ci pal s ecuri ti es Corpora te debt s ecuri ti es U.S. government Tota l a s sets mea s ured a t fa i r val ue 13,110 61,771 1,999 - - - 47,946 226,784 $ $ 47,946 47,946 $ 13,110 61,131 1,999 - 178,198 $ - - 640 - - 640 At December 31, 2021 Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Description Fair Value Avai l a bl e-for-s a l e securi ti es: (i n thous a nds ) Col l a tera l i zed mortga ge obl i ga ti ons $ 92,050 $ - $ 92,050 $ Mortga ge-ba cked s ecuri ti es Muni ci pal s ecuri ti es Corpora te debt s ecuri ti es U.S. government 17,435 71,549 2,010 49,903 - - - 49,903 17,435 70,869 2,010 - Tota l a s sets mea s ured a t fa i r val ue $ 232,947 $ 49,903 $ 182,364 $ - - 680 - - 680 As of December 31, 2022, the Company had one available-for-sale security classified as Level 3 investment which consist of a non- rated municipal bond. The valuation of this security 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. The security is not rated by the rating agencies and there is no trading volume, management determined that this security should be classified as Level 3 within the fair value hierarchy. 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 years ended December 31, 2022 and 2021. 38 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, 2022 and 2021, respectively. Twelve Months Ended December 31, 2022 2021 (i n thous a nds) Bal a nce begi nni ng of peri od Tra nsfers i n to l evel 3 Cha nge i n FV (i ncl uded i n other comprehensi ve i ncome) Bal a nce end of peri od $ $ 680 $ - (40) 640 $ 700 - (20) 680 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, loans held for sale and other real estate owned. 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 Impaired be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. loans are classified as Level 3 in the fair value hierarchy. 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. 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. Any write-downs based on the property fair value less estimated costs to sell at the date of acquisition are charged to the allowance for loan losses. Management periodically reviews OREO to ensure the property is carried at the lower of its new basis or fair value, net of estimated costs to sell. Any additional write-downs based on re-evaluation of the property fair value are charged to non-interest expense. Because of the high degree of judgment required in estimating the fair value of OREO and because of the relationship between fair value and general economic conditions, we consider the fair value of OREO to be sensitive to changes in market conditions. 39 The following tables present the Company’s assets that were held at the end of December 31, 2022 and 2021 that were measured at fair value on a nonrecurring basis: Description Fair Value At December 31, 2022 Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (i n thousa nds ) Loa ns mea sured for i mpa i rment, net of speci fi c reserves Tota l as sets mea s ured on a nonrecurri ng ba s i s $ $ 1,316 $ 1,316 $ - $ - $ - $ - $ 1,316 1,316 Description Fair Value Loa ns mea sured for i mpa i rment, net of speci fi c reserves Tota l as sets mea s ured on a nonrecurri ng ba s i s $ $ 1,411 $ 1,411 $ At December 31, 2021 Quoted Prices in Active Markets for Identical Assets (Level 1) Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (i n thousa nds ) - $ - $ - $ - $ 1,411 1,411 The following table presents quantitative information about Level 3 inputs for financial instruments measured at fair value on a nonrecurring basis at December 31, 2022 and 2021 (dollars in thousands): Description Fair Value Valuation Technique Significant Unobservable Inputs Range (Weighted Average) At December 31, 2022 Loans mea sured for i mpa i rme nt, net of s peci fi c res erves $ 1,316 Income a pproa ch Proba bi l ity of defa ul t, di s count rate 3.95%, 5.12% Description Fair Value Valuation Technique Significant Unobservable Inputs Range (Weighted Average) At December 31, 2021 Loans mea sured for i mpa i rme nt, net of s peci fi c res erves $ 1,411 Income a pproa ch Proba bi l ity of defa ul t, di s count rate 7.50%, 5.08% 40 The estimated fair value of the Company’s financial instruments at December 31, 2022 and 2021 was as follows: Fi na nci a l a s sets: As of December 31, 2022 Fair Value Hierarchy Level Carrying Value (i n thous a nds) Estimated Fair Value Cas h a nd cas h equi va l ents Other i nterest ea rni ng depos i ts Investment s ecuri ti es a va i l a bl e-for-s al e Investment s ecuri ti es hel d-to-ma turi ty Investment s ecuri ti es hel d-to-ma turi ty Investment s ecuri ti es hel d-to-ma turi ty Loa ns recei va bl e, net Accrued i nterest recei va bl e Level 1 Level 1 See previ ous ta bl e Level 1 Level 2 Level 3 Level 3 Level 1 $ 314,236 $ 4,250 226,784 24,517 34,345 651 631,722 4,044 314,236 4,250 226,784 23,544 32,318 651 617,533 4,044 Fi na nci a l l i a bi l i ti es: Depos i ts Juni or s ubordi na ted debentures Accrued i nterest pa ya bl e Level 2 Level 3 Level 1 $ 1,180,362 $ 13,403 155 1,178,435 13,785 155 As of December 31, 2021 Fair Value Hierarchy Level Carrying Value (i n thous a nds) Fi na nci a l a s sets: Cas h a nd cas h equi va l ents Other i nterest ea rni ng depos i ts Investment s ecuri ti es a va i l a bl e-for-s al e Investment s ecuri ti es hel d-to-ma turi ty Loa ns hel d-for-sa l e Loa ns recei va bl e, net Accrued i nterest recei va bl e Level 1 Level 1 See previ ous ta bl e Level 3 Level 2 Level 3 Level 1 $ 386,366 $ 3,250 232,947 788 6,104 620,036 3,357 Fi na nci a l l i a bi l i ti es: Depos i ts Long-term borrowi ngs Juni or s ubordi na ted debentures Accrued i nterest pa ya bl e Level 2 Level 2 Level 3 Level 1 $ 1,178,940 $ 403 13,403 82 Estimated Fair Value 386,366 3,250 232,947 788 6,104 619,091 3,357 1,178,962 407 13,775 82 NOTE 19 – SHAREHOLDERS’ EQUITY 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 and restricted stock awards computed under the treasury stock method as if converted to common stock. 41 The following table illustrates the computation of basic and diluted earnings per share: For the Year Ended December 31, 2022 2021 Ba s i c: Net i ncome (numera tor) Wei ghted avera ge sha res outs ta ndi ng (denomi na tor) Ba s i c ea rni ngs per s hare Di l uted: Net i ncome (numera tor) Wei ghted avera ge sha res outs ta ndi ng Effect of di l uti ve stock opti ons Wei ghted avera ge sha res outs ta ndi ng a ss umi ng di l uti on (denomi na tor) Di l uted ea rni ngs per s hare $ $ $ $ Sha res s ubject to outsta ndi ng opti ons (dol l a rs i n thous a nds, except per s ha re a mounts ) 12,697 10,412,845 1.22 10,396,268 1.05 10,888 $ $ 10,888 $ 10,396,268 27,033 10,423,301 1.04 $ 12,697 10,412,845 28,570 10,441,415 1.22 For the Year Ended December 31, 2022 82,600 2021 109,400 Shares subject to outstanding options had exercise prices in excess of the current market value. Those specific shares are not included in the computation of earnings per share above, as exercise of these options would not be dilutive to shareholders. Stock Repurchase Program On February 17, 2021 the Board of Directors for the Company authorized the repurchase of up to $2.61 million, or approximately 2%, of the outstanding common stock of the Company. Stock repurchases may be made from time to time on the open market or through privately negotiated transactions. The timing of purchases and the exact number of shares to be purchased are subject to market conditions and may be suspended as deemed appropriate. The Company repurchased no shares during the year ended December 31, 2022, and repurchased 57,592 shares, at a weighted average share price of $12.44, during the year ended December 31, 2021. 42 NOTE 20 – CONDENSED FINANCIAL INFORMATION – PARENT COMPANY ONLY Pacific Financial Corporation – Parent Company Only Consolidated Statements of Financial Condition (in thousands) ASSETS Ca sh a nd ca sh equi va l ents : Inves tment i n ba nk Other a s s ets Total a s s ets LIABILITIES AND SHAREHOLDERS' EQUITY Juni or s ubordi na ted debentures Other l i a bi l i ti es Total l i a bi l i ti es $ $ $ Tota l s harehol ders ' equi ty Total l i a bi l i ti es a nd s harehol ders' equi ty $ December 31, 2022 December 31, 2021 593 115,386 711 116,690 13,403 125 13,528 103,162 116,690 $ $ $ $ 263 130,185 634 131,082 13,403 37 13,440 117,642 131,082 Pacific Financial Corporation – Parent Company Only Consolidated Statements of Income (in thousands) INTEREST EXPENSE Juni or subordi na ted debentures Total i nteres t expens e NONINTEREST INCOME Di vi dends from s ubs i di a ry ba nk Equi ty i n undi s tri buted i ncome from s ubs i di a ry ba nk Other i ncome Total noni nterest i ncome NONINTEREST EXPENSE Other expens e Total noni nterest i ncome Income before i ncome ta xes Income ta x benefi t Net i ncome Comprehens i ve i ncome (l os s) Twelve Months Ended December 31, 2022 2021 $ $ $ 460 $ 460 6,207 5,370 11 11,588 454 454 10,674 214 10,888 $ (9,280) $ 232 232 6,310 6,915 7 13,232 439 439 12,561 136 12,697 9,462 43 Pacific Financial Corporation – Parent Company Only Consolidated Statements of Cash Flows (Dollars in thousands) Twelve Months Ended December 31, 2022 2021 $ 10,888 $ 12,697 (5,370) (77) 88 149 5,678 83 (24) - - (5,407) (5,348) 330 263 593 $ (6,915) 23 (120) 125 5,810 64 (61) (717) - (5,418) (6,132) (322) 585 263 Cash flows from operating activities: Net Income Adjus tments to reconci l e net i ncome to ca s h a nd ca sh equi val ents from opera ti ng a cti viti es Equi ty i n undi stri buted i ncome of subs i di a ry Net cha nge i n other a s s ets Net cha nge i n other l i a bi l i ti es Stock compensa ti on expense Net ca s h provi ded by opera ti ng a cti vi ti es Cash flows from financing activities: Net cas h from s tock opti on exerci s es Taxes pa i d rel a ted to net s hare settl ement for equi ty awa rds Repurcha se of common stock Stock awa rds i s sued Cas h di vi dends pa i d Net ca s h us ed i n fi na nci ng a ctivi ti es Net i ncrea s e (decrea se) i n cas h a nd ca sh equi va l ents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year $ 44 NOTE 21 – SELECTED DATA Results of operations on a quarterly basis were as follows (unaudited): Year Ended December 31, 2022 First Quarter Second Quarter Third Quarter Fourth Quarter Interest a nd di vi dend i ncome Interest expens e Net interest income Benefi t for l oa n l oss es Noni nteres t i ncome Noni nteres t expense Income before income taxes Income ta x expens e Net income Earnings per common share Bas i c Di l uted Interest a nd di vi dend i ncome Interest expens e Net interest income Benefi t for l oa n l oss es Noni nteres t i ncome Noni nteres t expense Income before income taxes Income ta x expens e Net income Earnings per common share Bas i c Di l uted $ $ $ $ $ $ $ $ (dol l a rs i n thous a nds, except per sha re a mounts ) 8,526 $ 238 8,288 - 2,112 8,576 1,824 167 1,657 11,177 $ 298 10,879 - 1,692 8,950 3,621 705 2,916 9,097 $ 253 8,844 - 1,864 8,800 1,908 310 1,598 $ 13,352 417 12,935 - 1,559 8,648 5,846 1,129 4,717 $ $ 0.17 $ 0.16 $ 0.15 $ 0.15 $ 0.28 $ 0.28 $ 0.45 0.45 Year Ended December 31, 2021 First Quarter Third Quarter Second Quarter Fourth Quarter (dol l a rs i n thous a nds, except per sha re a mounts ) 9,612 $ 387 9,225 (1,400) 5,164 10,504 5,285 1,057 4,228 $ 9,188 $ 284 8,904 (500) 3,951 10,375 2,980 368 2,612 $ 9,318 $ 324 8,994 (1,600) 4,616 10,497 4,713 977 3,736 $ 9,040 259 8,781 (150) 2,998 9,325 2,604 483 2,121 0.41 0.41 $ $ 0.36 0.36 $ $ 0.25 0.25 $ $ 0.20 0.20 45 GENERAL CORPORATE AND SHAREHOLDER INFORMATION (unaudited) Administrative Headquarters 1216 Skyview Drive Aberdeen, WA 98520 (360) 533-8870 Independent Auditors CliftonLarsonAllen LLP Transfer Agent and Registrar Broadridge Financial Solutions, Inc. 51 Mercedes Way Edgewood, NY 11717 www.broadridge.com/ Shareholder Services Broadridge, 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 Consolidation of accounts Duplicate mailings Lost stock certificates Transfer of stock to another person 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 Client Support at www.broadridge.com/. Annual Meeting The annual meeting of shareholders will be held via webcast on April 26th, 2023, at 4:00 p.m., local time. 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 Lisa Dutton, Corporate Secretary, Pacific Financial Corporation, 1216 Skyview Drive, Aberdeen, Washington 98520. It is also furnished upon request to customers of Bank of the Pacific pursuant to the requirements of the FDIC to provide an annual disclosure statement. This statement has not been reviewed or confirmed for accuracy or relevance by the FDIC. Subsidiaries Bank of the Pacific 1216 Skyview Drive Aberdeen, WA 98520 (360) 533-8870 www.bankofthepacific.com Officers Denise J. Portmann President and Chief Executive Officer of the Company and the Bank Carla Tucker Executive Vice President and Chief Financial Officer of the Company and the Bank Daniel E. Kuenzi Vice President of the Company and Executive Vice President and Chief Credit Officer of the Bank Thomas Baker Vice President of the Company and Executive Vice President and Chief Operating Officer of the Bank Walker Evans Vice President of the Company and Executive Vice President and Chief Lending Officer of the Bank Lisa Dutton Corporate Secretary 46 Board of Directors Randy W. Rognlin, Chairman Co-Owner Rognlins, Inc Susan C. Freese Pharmacist Douglas M. Schermer, Vice Chairman Owner and President Schermer Construction Inc. & Wishkah Rock Products Doug Biddle Retired CFO Pacific Financial Corporation and Bank of the Pacific Denise Portmann President & CEO Pacific Financial Corporation and Bank of the Pacific Dwayne Carter Retired President & General Manager Brooks Manufacturing Co. Randy J. Rust Private Investor Daniel Tupper Vice President & General Manager Crown Distributing Co. of Aberdeen, Inc. Kristi Gundersen Partner & Chief Financial Officer Knutzen Farms, LP 47 

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