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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2014

 

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

 

Commission File Number: 000-29829

 

PACIFIC FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

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

 

1101 S. Boone Street

Aberdeen, Washington 98520-5244

(Address of principal executive offices) (Zip Code)

 

(360) 533-8870

(Registrant's telephone number, including area code)

 

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

 

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

Yes  x    No ¨

 

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

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

 

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

 

The number of shares outstanding of Registrant's common stock as of November 7, 2014 was 10,367,460.

 

 
 

 

Form 10-Q

Table of Contents

 

Part I FINANCIAL INFORMATION  
     
Item I. FINANCIAL STATEMENTS (UNAUDITED) 3
     
  CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2014 AND DECEMBER 31, 2013 3
     
  CONDENSED CONSOLIDATED STATEMENTS OF INCOME THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 4
     
  CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 5
     
  CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 6
     
  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 7
     
  NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 8
     
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 41
     
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 64
     
Item 4. CONTROLS AND PROCEDURES 64
     
Part II OTHER INFORMATION  
     
Item 1. LEGAL PROCEEDINGS 64
     
Item 1A. RISK FACTORS 64
     
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 64
     
Item 3. DEFAULTS UPON SENIOR SECURITIES 65
     
Item 4. MINE SAFETY DISCLOSURES 65
     
Item 5. OTHER INFORMATION 65
     
Item 6. EXHIBITS 66
     
SIGNATURES 66

 

2
 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

PACIFIC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, except per share data)

(UNAUDITED)

 

   September 30,   December 31, 
   2014   2013 
         
ASSETS          
Cash and cash equivalents:          
Cash and due from banks  $15,284   $12,214 
Interest-bearing deposits in banks   25,497    23,734 
Total cash and cash equivalents   40,781    35,948 
Interest-bearing certificates of deposit (original maturities greater than 90 days)   2,727    2,727 
Federal Home Loan Bank stock, at cost   2,926    3,013 
Pacific Coast Bankers' Bank stock, at cost   1,000    - 
Investment securities:          
Investment securities available-for-sale, at fair market value   89,328    96,144 
Investment securities held-to-maturity, at amortized cost (fair value of $1,873 and $2,158)   1,857    2,132 
Total investment securities   91,185    98,276 
           
Loans held-for-sale   8,161    7,765 
Loans, net of deferred loan fees   552,140    504,666 
Allowance for loan losses   (8,255)   (8,359)
Loans, net   543,885    496,307 
           
Premises and equipment, net of accumulated depreciation and amortization   16,460    16,790 
Other real estate owned and foreclosed assets   1,210    2,771 
Accrued interest receivable   2,337    2,307 
Cash surrender value of life insurance   18,615    18,237 
Goodwill   12,168    12,168 
Other intangible assets   1,449    1,481 
Other assets   6,143    7,249 
           
TOTAL ASSETS  $749,047   $705,039 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
LIABILITIES          
Deposits:          
Demand  $182,259   $145,028 
Interest-bearing demand and savings   343,524    336,260 
Time deposits   118,221    126,059 
Total deposits   644,004    607,347 
Accrued interest payable   141    167 
Short-term borrowings   -    - 
Long-term borrowings   11,491    10,000 
Junior subordinated debentures   13,403    13,403 
Other liabilities   6,751    6,985 
Total liabilities   675,790    637,902 
COMMITMENTS AND CONTINGENCIES (Note 7)          
SHAREHOLDERS' EQUITY          
           
Preferred Stock, par value none
5,000,000 shares authorized, none outstanding
          
Common Stock, par value $1
25,000,000 shares authorized, 10,367,460 shares issued and outstanding at 09/30/2014 and 10,182,083 at 12/31/2013
   10,367    10,182 
Additional paid-in-capital   42,940    41,817 
Retained earnings   20,312    16,507 
Accumulated other comprehensive income/(loss)   (362)   (1,369)
Total shareholders' equity   73,257    67,137 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  $749,047   $705,039 

 

See accompanying notes.

 

3
 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except per Share Data)

(UNAUDITED)

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2014   2013   2014   2013 
INTEREST AND DIVIDEND INCOME                    
Loans  $6,894   $6,116   $20,132   $18,158 
Deposits in banks and federal funds sold   24    34    62    85 
Investment securities:                    
Taxable   298    220    980    471 
Tax-exempt   183    234    645    761 
FHLB dividends   1    1    2    1 
                     
Total interest and dividend income   7,400    6,605    21,821    19,476 
                     
INTEREST EXPENSE                    
Deposits:                    
Interest-bearing demand and savings   134    167    415    547 
Time   269    307    835    1,026 
Long-term borrowings   54    54    158    168 
Junior subordinated debentures   61    62    181    186 
                     
Total interest expense   518    590    1,589    1,927 
                     
Net interest income   6,882    6,015    20,232    17,549 
                     
LOAN LOSS PROVISION   100    -    200    (450)
                     
Net interest income after loan loss provision   6,782    6,015    20,032    17,999 
                     
NON-INTEREST INCOME                    
Service charges on deposit accounts   450    440    1,359    1,281 
Net gains (loss) on sale of other real estate owned   (85)   18    (179)   43 
Net gains from sales of loans   1,120    1,128    2,717    4,306 
Net gains (loss) on sales of securities available for sale   38    14    88    401 
Net other-than-temporary impairment (net of $0, $7, $15, $2 respectively recognized in other comprehensive income before taxes)   -    (4)   (48)   (38)
Earnings on bank owned life insurance   127    105    378    342 
Other operating income   624    531    1,743    1,698 
                     
Total non-interest income   2,274    2,232    6,058    8,033 
                     
NON-INTEREST EXPENSE                    
Salaries and employee benefits   4,286    4,098    12,624    12,983 
Occupancy   483    473    1,494    1,338 
Equipment   261    233    775    619 
Data processing   492    449    1,387    1,688 
Professional services   220    198    606    696 
Other real estate owned write-downs   1    176    67    636 
Other real estate owned operating costs   100    67    191    276 
State taxes   110    110    314    360 
FDIC and state assessments   119    129    381    395 
Other non-interest expense   1,061    1,156    3,189    3,389 
                     
Total non-interest expense   7,133    7,089    21,028    22,380 
                     
INCOME BEFORE PROVISION FOR INCOME TAXES   1,923    1,158    5,062    3,652 
                     
PROVISION FOR INCOME TAXES   549    249    1,257    710 
                     
NET INCOME APPLICABLE TO COMMON SHAREHOLDERS  $1,374   $909   $3,805    2,942 
                     
EARNINGS PER COMMON SHARE:                    
BASIC  $0.13   $0.09   $0.37    0.29 
DILUTED  $0.13   $0.09   $0.37    0.29 
                     
WEIGHTED AVERAGE SHARES OUTANDING:                    
BASIC   10,281,745    10,121,853    10,218,103    10,121,853 
DILUTED   10,379,166    10,194,826    10,309,436    10,179,928 

 

See accompanying notes.

 

4
 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(UNAUDITED)

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2014   2013   2014   2013 
                 
NET INCOME  $1,374   $909   $3,805   $2,942 
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:                    
Change in fair value of securities available-for-sale   (42)   509    920    (1,494)
Defined benefit plan   29    28    87    84 
Total other comprehensive income (loss), net of tax   (13)   537    1,007    (1,410)
COMPREHENSIVE INCOME  $1,361   $1,446   $4,812   $1,532 

 

See accompanying notes.

 

5
 

 

PACIFIC FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(Dollars in Thousands, Except Share Amounts)

(UNAUDITED)

 

                   Accumulated     
   Common Stock   Additional   Retained   Other
Comprehensive
   Total
Shareholders'
 
   Shares   Amount   Paid-in Capital    Earnings    Income/(Loss)    Equity 
BALANCE - December 31, 2012   10,121,853   $10,122   $41,366   $14,812   $421   $66,721 
Net income   -    -         2,942    -    2,942 
Other comprehensive income, net of tax                              
Unrealized holding loss on securities less reclassification adjustments for net gains included in net income   -    -    -    -    (1,494)   (1,494)
Amortization of unrecognized prior service costs and net gains   -    -    -    -    84    84 
Stock-based compensation expense   -    -    83    -    -    83 
BALANCE - September 30, 2013   10,121,853   $10,122   $41,449   $17,754   $(989)  $68,336 
                               
BALANCE - December 31, 2013   10,182,083   $10,182   $41,817   $16,507   $(1,369)  $67,137 
Net income   -    -         3,805    -    3,805 
Other comprehensive income, net of tax                              
Unrealized holding gain on securities less reclassification adjustments for net gains included in net income   -    -    -    -    920    920 
Amortization of unrecognized prior service costs and net gains   -    -    -    -    87    87 
Stock repurchased (RSU)   -    -    (3)   -    -    (3)
Issuance of common stock   185,377    185    1,020    -    -    1,205 
Stock-based compensation expense   -    -    106    -    -    106 
BALANCE - September 30, 2014   10,367,460   $10,367   $42,940   $20,312   $(362)  $73,257 

 

See accompanying notes.

 

6
 

 

PACIFIC FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(UNAUDITED)

 

   For the Nine Months Ended 
   September 30,   September 30, 
   2014   2013 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net Income  $3,805   $2,942 
Adjustments to reconcile net income to net cash from operating activities          
Provision for credit losses   200    (450)
Depreciation and amortization   1,981    1,710 
Originations of loans held for sale   (112,797)   (201,278)
Proceeds from sales of loans held for sale   115,117    211,204 
Net (gain) on sales of loans   (2,717)   (4,306)
Net gain on sales of securities available for sale   (88)   (401)
Net OTTI recognized in earnings   48    38 
(Gain) loss on sales of other real estate owned   179    (43)
(Gain) loss on sale of premises and equipment   6    18 
Earnings on bank owned life insurance   (378)   (342)
Increase in accrued interest receivable   (30)   (241)
Decrease in accrued interest payable   (26)   (33)
Other real estate owned write-downs   67    636 
(Increase) decrease in prepaid expenses   (39)   2,127 
Other — net   2,524    1,192 
           
Net cash provided by operating activities   7,853    12,773 
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Net increase in interest bearing balances with banks   (1,763)   (11,476)
Purchase of certificates of deposits held for investment, net   -    1,250 
Activity in securities available for sale:          
Sales   17,755    7,237 
Maturities, prepayments and calls   5,552    8,467 
Purchases   (16,779)   (48,892)
Activity in securities held to maturity:          
Maturities, prepayments and calls   275    4,549 
(Increase) decrease in loans made to customers, net of principal collections   (47,925)   (36,395)
Purchases of premises and equipment   (683)   (2,012)
Proceeds from sales of other real estate owned   1,463    1,343 
Proceeds from sales of premises and equipment   8    - 
Cash received in acquisition, net of cash paid   -    31,941 
           
Net cash used in investing activities   (42,097)   (43,988)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Net increase in deposits   36,657    33,041 
Net decrease in short-term borrowings   -    (3,000)
Proceeds from issuance of long-term debt   1,500    2,500 
Repayments of long-term debt   (9)   - 
Warrants exercised   1,205    - 
Repurchase of stock (RSU)   (3)   - 
Cash dividends paid   (2,036)   - 
           
Net cash provided by financing activities   37,314    32,541 
           
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   3,070    1,326 
CASH AND DUE FROM BANKS - BEGINNING OF THE PERIOD   12,214    14,168 
CASH AND DUE FROM BANKS - END OF THE PERIOD  $15,284   $15,494 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION          
Cash paid for interest  $1,615   $1,958 
Cash paid for taxes  $-   $440 
           
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND          
FINANCING ACTIVITIES          
Change in fair value of securities available-for-sale, net of tax  $920   $(1,494)
Transfer of loans held for sale to loans held for investment  $-   $64 
Other real estate owned acquired in settlement of loans  $(842)  $(1,591)
Financed sale of other real estate owned  $694   $- 

 

See accompanying notes.

 

7
 

 

PACIFIC FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

As of and for the nine months ended September 30, 2014

(Unaudited)

(Dollars in thousands, except per share amounts)

 

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

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

 

The Company conducts its banking business through the Bank, which operates 17 branches located in communities in Grays Harbor, Pacific, Whatcom, Clark, Skagit and Wahkiakum counties in the state of Washington and three in Clatsop County, Oregon. In addition, the Bank operates two loan production offices in Burlington and Dupont, Washington and has a residential real estate mortgage department. During second quarter 2013, the Bank completed the acquisition of three branches from Sterling Savings Bank. Total deposits assumed were $37.6 million and loans acquired totaled $4.0 million. Of the three branches purchased, two were consolidated into existing Pacific branches to maximize branch efficiencies resulting in one new branch in Astoria, Oregon. Separately, the Company opened a full-service branch in Warrenton, Oregon in October 2013 that further expands operations on the northern Oregon coast.

 

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with instructions to Form 10-Q. Accordingly, these financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of Management, adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2014, are not necessarily indicative of the results anticipated for the year ending December 31, 2014. Certain information and footnote disclosures included in the Company's consolidated financial statements for the year ended December 31, 2013, have been condensed or omitted from this report. Accordingly, these statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Annual Report”).

 

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

 

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

 

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

 

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

 

In preparing these financial statements, the Company has evaluated events and transactions subsequent to September 30, 2014, for potential recognition or disclosure in the financial statements. In Management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation.

 

8
 

 

NOTE 2 – EARNINGS PER SHARE

 

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

 

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

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
Basic:                    
Net income  $1,374   $909   $3,805   $2,942 
Weighted average shares outstanding   10,281,745    10,121,853    10,218,103    10,121,853 
Basic earnings per share  $0.13   $0.09   $0.37   $0.29 
                     
Diluted:                    
Net income  $1,374   $909   $3,805   $2,942 
Weighted average shares outstanding   10,281,745    10,121,853    10,218,103    10,121,853 
Effect of dilutive stock options   97,421    72,973    91,333    58,075 
Weighted average shares outstanding assuming dilution   10,379,166    10,194,826    10,309,436    10,179,928 
Diluted earnings per share  $0.13   $0.09   $0.37   $0.29 

 

   September 30,
2014
   September 30,
2013
 
Shares subject to outstanding options   367,595    433,995 
Shares subject to outstanding warrants   -    699,642 

 

As of September 30, 2014 and 2013, the shares subject to outstanding options and for September 30, 2013, the shares subject to outstanding warrants, had exercise prices in excess of the current market value. All of these shares are not included in the table above, as exercise of these options and warrants would not be dilutive to shareholders.

 

9
 

 

NOTE 3 – INVESTMENT SECURITIES

 

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

 

   September 30, 2014 
At September 30, 2014  Amortized Cost   Gross unrealized gains   Gross unrealized losses   Fair value 
Available-for-sale:                    
Collateralized mortgage obligations: agency issued  $40,562   $209   $732   $40,039 
Collateralized mortgage obligations: non agency   592    -    13    579 
Mortgage-backed securities: agency issued   12,710    24    235    12,499 
U.S. Government agency securities   8,637    64    46    8,655 
State and municipal securities   26,825    834    103    27,556 
Total available-for-sale  $89,326   $1,131   $1,129   $89,328 
                     
Held-to-maturity:                    
Mortgage-backed securities: agency issued  $131   $13   $-   $144 
State and municipal securities   1,726    4    -    1,730 
Total held-to-maturity  $1,857   $17   $-   $1,874 

 

   December 31, 2013 
At September 30, 2014  Amortized Cost   Gross unrealized gains   Gross unrealized losses   Fair value 
Available-for-sale:                    
Collateralized mortgage obligations: agency issued  $39,791   $246   $1,246   $38,791 
Collateralized mortgage obligations: non agency   2,251    3    243    2,011 
Mortgage-backed securities: agency issued   13,671    21    303    13,389 
U.S. Government agency securities   8,859    34    82    8,811 
State and municipal securities   31,973    774    587    32,160 
Corporate bonds   991    -    9    982 
Total available-for-sale  $97,536   $1,078   $2,470   $96,144 
                     
Held-to-maturity:                    
Mortgage-backed securities: agency issued  $159   $13   $-   $172 
State and municipal securities   1,973    13    -    1,986 
Total held-to-maturity  $2,132   $26   $-   $2,158 

 

10
 

 

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 September 30, 2014, and December 31, 2013, are summarized as follows:

 

(Dollars in Thousands)

 

   Less than 12 months   12 months or more   Total 
       Unrealized       Unrealized       Unrealized 
At September 30, 2014  Fair Value   Losses   Fair Value   Losses   Fair Value   Losses 
Available-for-sale:                              
Collateralized mortgage obligations: agency issued  $10,548   $75   $18,934   $657   $29,482   $732 
Collateralized mortgage obligations: non agency   361    2    217    11    578    13 
Mortgage-backed securities: agency issued   3,442    103    7,576    132    11,018    235 
U.S. Government agency securities   -    -    3,607    46    3,607    46 
State and municipal securities   1,752    16    6,795    87    8,547    103 
Corporate bonds   -    -    -    -    -    - 
Total  $16,103   $196   $37,129   $933   $53,232   $1,129 

 

   Less than 12 months   12 months or more   Total 
       Unrealized       Unrealized       Unrealized 
At December 31, 2013  Fair Value   Losses   Fair Value   Losses   Fair Value   Losses 
Available-for-sale:                              
Collateralized mortgage obligations: agency issued  $21,043   $778   $6,265   $468   $27,308   $1,246 
Collateralized mortgage obligations: non agency   389    27    1,619    216    2,008    243 
Mortgage-backed securities: agency issued   7,752    218    2,643    85    10,395    303 
U.S. Government agency securities   5,550    82    -    -    5,550    82 
State and municipal securities   11,551    485    1,821    102    13,372    587 
Corporate bonds   982    9    -    -    982    9 
Total  $47,267   $1,599   $12,348   $871   $59,615   $2,470 

 

At September 30, 2014, there were 66 investment securities in an unrealized loss position, of which 46 were in a continuous loss position for 12 months or more. The unrealized losses on these securities were caused by changes in interest rates, widening pricing spreads and market illiquidity, leading to a decline in the fair value subsequent to their purchase. The Company has evaluated the securities shown above and anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market environment. Based on management’s evaluation, and because the Company does not have the intent to sell these securities and it is not more likely than not that it will have to sell the securities before recovery of cost basis, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2014.

 

11
 

 

For non-agency mortgage-backed securities (MBS) the Company estimates expected future cash flows of the underlying collateral, together with any credit enhancements. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which considers current delinquencies, future expected default rates and collateral value by vintage) and prepayments. The expected cash flows of the security are then discounted to arrive at a present value amount. For the nine months ended September 30, 2014, no non-agency MBS was determined to be other-than-temporarily-impaired. For the nine months ended September 30, 2013, one non-agency MBS was determined to be other-than-temporarily-impaired. This security was sold in second quarter 2014, incurring a loss of $69,000. The Company recorded $48,000 and $38,000 in impairments related to credit losses through earnings for the nine months ended September 30, 2014 and 2013, respectively.

 

The following table presents the cash proceeds from the sales of securities and their associated gross realized gains and gross realized losses that are included in earnings for the nine months ended September 30, 2014 and 2013:

 

Investment securities gross gains and losses

 

(Dollars in Thousands)

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,
2014
   September 30,
2013
   September 30,
2014
   September 30,
2013
 
Gross realized gain on sale of securities  $94   $57   $315   $444 
Gross realized loss on sale of securities   (56)   (43)   (227)   (43)
Net realized gain on sale of securities  $38   $14   $88   $401 
                     
Proceeds from sale of securities  $3,928   $308   $17,755   $7,237 

 

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

 

The amortized cost and estimated fair value of investment securities at September 30, 2014, by maturity are shown below.  The amortized cost and fair value of collateralized mortgage obligations and mortgage-backed securities are presented by expected average life, rather than contractual maturity.  Expected maturities may differ from contractual maturities because borrowers may have the right to prepay underlying loans without prepayment penalties.

 

(Dollars in Thousands)

 

   Held-to-maturity   Available-for-sale 
   Amortized       Amortized     
   Cost   Fair Value   Cost   Fair Value 
                 
Due in one year or less  $-   $-   $1,079   $1,080 
Due after one year through five years   -    -    7,120    7,108 
Due after five years through ten years   1,124    1,127    14,334    14,594 
Due after ten years   602    603    12,928    13,429 
Mortgage-backed securities   131    144    53,865    53,117 
                     
Total investment securities  $1,857   $1,874   $89,326   $89,328 

 

At September 30, 2014, investment securities with an estimated fair value of $49.2 million were pledged to secure public deposits, certain nonpublic deposits and borrowings.

 

12
 

 

As required of all members of the Federal Home Loan Bank (“FHLB”) system, the Company maintains an investment in the capital stock of the FHLB in an amount equal to the greater of $500,000 or 0.5% of home mortgage loans and pass-through securities plus 5.0% of the outstanding balance of mortgage home loans sold to FHLB under the Mortgage Purchase Program. The FHLB system, the largest government sponsored entity in the United States, is made up of 12 regional banks, including the FHLB of Seattle. Participating banks record the value of FHLB stock equal to its par value at $100 per share. At September 30, 2014, the Company held approximately $2.9 million in FHLB stock.

 

The Company is required to hold FHLB’s stock in order to receive advances and views this investment as long-term. Thus, when evaluating it for impairment, the value is determined based on the recovery of the par value through redemption by the FHLB or from the sale to another member, rather than by recognizing temporary declines in value. The FHLB of Seattle disclosed that it reported net income for the three and nine month periods ended September 30, 2014, at which time it declared a cash dividend. On November 22, 2013, the FHLB of Seattle entered into an amended Stipulation and Consent to the Issuance of a Consent Order with the Federal Housing Finance Agency (“Finance Agency”), modifying the previous order issued on October 25, 2010. The Finance Agency now deems the FHLB of Seattle to be “adequately capitalized” under the Finance Agency’s Prompt Corrective Action rule. The Company has concluded that its investment in FHLB is not impaired as of September 30, 2014, and believes that it will ultimately recover the par value of its investment in this stock.

 

The Company owns $1.0 million in common stock in Pacific Coast Bankers’ Bancshares (PCBB), from which the Company receives a variety of corresponding banking services through its banking subsidiary Pacific Coast Bankers Bank. An investment by the Company in such an entity is permissible under 12 CFR 362.3(a)(2)(iv). When evaluating this investment for impairment, the value is determined based on the recovery of the par value through any redemption by PCBB or from the sale to another eligible purchaser, rather than by recognizing temporary declines in value. PCBB disclosed that it reported net income for the three and nine month periods ended September 30, 2014 and maintains capital ratios that exceed “well capitalized” standards for regulatory purposes.

 

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

 

Loans

 

Loans held in the portfolio at September 30, 2014 and December 31, 2013, are as follows:

 

(Dollars in Thousands)  September 30,
2014
   December 31,
2013
 
         
Commercial and agricultural  $112,873   $104,111 
Real estate:          
Construction and development   25,419    29,096 
Residential 1-4 family   94,101    87,762 
Multi-family   20,554    17,520 
Commercial real estate — owner occupied   122,090    105,594 
Commercial real estate — non owner occupied   120,569    117,294 
Farmland   22,926    23,698 
Consumer/Finance   34,787    20,728 
Gross loans   553,319    505,803 
Less:  deferred fees   (1,179)   (1,137)
           
Portfolio Loans  $552,140   $504,666 

 

13
 

 

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 the economic trends and conditions, industry conditions, levels and trends in delinquencies and impaired loans, levels and trends in charge-offs and recoveries, among others. The loss factors are applied to loan category pools segregated by risk classification to estimate the loss inherent in the Company’s loan portfolio pursuant to ASC 450 “Accounting for Contingencies.”

 

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

  

·In the event that a current appraisal to support the fair value of the real estate collateral underlying an impaired loan has not yet been received, 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 credit losses for the three and nine months ended September 30, 2014 and 2013 were as follows:

 

Allowance for Credit Losses

 

Dollars in Thousands      Commercial Real   Residential             
   Commercial   Estate ("CRE")   Real Estate   Consumer   Unallocated   Total 
For the three months ended September 30, 2014                        
                         
Beginning balance  $904   $3,807   $702   $882   $2,020   $8,315 
Charge-offs and concessions   -    (127)   (61)   (12)   -    (200)
Recoveries   7    29    4    -    -    40 
Provision / (recapture)   78    (96)   102    41    (25)   100 
                               
Ending balance  $989   $3,613   $747   $911   $1,995   $8,255 
                               
For the nine months ended September 30, 2014                              
                               
Beginning balance  $775   $3,506   $675   $744   $2,659   $8,359 
Charge-offs and concessions   (26)   (523)   (105)   (59)   -    (713)
Recoveries   9    381    17    2    -    409 
Provision / (recapture)   231    249    160    224    (664)   200 
                               
Ending balance  $989   $3,613   $747   $911   $1,995   $8,255 

 

14
 

 

Allowance for Credit Losses

 

Dollars in Thousands      Commercial Real   Residential             
   Commercial   Estate ("CRE")   Real Estate   Consumer   Unallocated   Total 
                         
For the three months ended September 30, 2013                              
                               
Beginning balance  $809   $3,414   $813   $638   $3,288   $8,962 
Charge-offs and concessions   (40)   (37)   (29)   (79)   -    (185)
Recoveries   20    5    3    1    -    29 
Provision / (recapture)   45    164    (16)   149    (342)   - 
                               
Ending balance  $834   $3,546   $771   $709   $2,946   $8,806 
                               
For the nine months ended September 30, 2013                              
                               
Beginning balance  $923   $4,098   $829   $531   $2,977   $9,358 
Charge-offs and concessions   (40)   (83)   (95)   (145)   -    (363)
Recoveries   35    220    4    2    -    261 
Provision / (recapture)   (84)   (689)   33    321    (31)   (450)
                               
Ending balance  $834   $3,546   $771   $709   $2,946   $8,806 

 

Recorded investment in loans as of September 30, 2014 and 2013 are as follows:

 

Recorded Investment in Financing Receivables

 

Dollars in Thousands      Commercial Real   Residential             
   Commercial   Estate ("CRE")   Real Estate   Consumer   Unallocated   Total 
As of September 30, 2014                              
                               
Allowance for Credit Losses:                              
Ending balance: individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
                               
Ending balance: collectively evaluated for impairment  $989   $3,613   $747   $911   $1,995   $8,255 
                               
Loans:                              
Ending balance  $112,873   $291,004   $114,655   $34,787   $-   $553,319 
Ending balance: individually evaluated for impairment  $402   $5,938   $1,089   $-   $-   $7,429 
Ending balance: collectively evaluated for impairment  $112,471   $285,066   $113,566   $34,787   $-   $545,890 
                               
Less deferred fees                           $(1,179)
                               
Ending balance total loans                           $552,140 

 

15
 

 

Recorded Investment in Financing Receivables

 

Dollars in Thousands      Commercial Real   Residential             
   Commercial   Estate ("CRE")   Real Estate   Consumer   Unallocated   Total 
As of December 31, 2013                              
                               
Allowance for Credit Losses:                              
Ending balance: individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
                               
Ending balance: collectively evaluated for impairment  $775   $3,506   $675   $744   $2,659   $8,359 
                               
Loans:                              
Ending balance  $104,111   $275,682   $105,282   $20,728   $-   $505,803 
Ending balance: individually evaluated for impairment  $587   $8,656   $626   $53   $-   $9,922 
Ending balance: collectively evaluated for impairment  $103,524   $267,026   $104,656   $20,675   $-   $495,881 
                               
Less deferred fees                           $(1,137)
                               
Ending balance total loans                           $504,666 

 

Credit Quality Indicators

 

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

 

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

 

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

 

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

 

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

 

16
 

 

Credit quality indicators as of September 30, 2014 and December 31, 2013 were as follows:

(Dollars in Thousands)

 

September 30, 2014      Other Loans             
       Especially             
   Pass   Mentioned   Substandard   Doubtful   Total 
                     
Commercial and agricultural  $104,073   $6,648   $2,152   $-   $112,873 
Real estate:                         
Construction and development   24,288    50    1,081    -    25,419 
Residential 1-4 family   90,387    448    3,266    -    94,101 
Multi-family   20,285    269    -    -    20,554 
Commercial real estate — owner occupied   114,120    1,675    6,295    -    122,090 
Commercial real estate — non owner occupied   97,102    17,880    5,587    -    120,569 
Farmland   21,001    1,878    47    -    22,926 
Total real estate   367,183    22,200    16,276    -    405,659 
                          
Consumer/Finance   34,692    74    21    -    34,787 
                          
Less deferred fees   -    -    -    -    (1,179)
                          
Total loans  $505,948   $28,922   $18,449   $-   $552,140 

 

December 31, 2013      Other Loans             
       Especially             
   Pass   Mentioned   Substandard   Doubtful   Total 
                     
Commercial and agricultural  $100,262   $2,858   $991   $-   $104,111 
Real estate:                         
Construction and development   26,587    1,101    1,408    -    29,096 
Residential 1-4 family   84,407    554    2,801    -    87,762 
Multi-family   17,520    0    0    -    17,520 
Commercial real estate — owner occupied   100,612    1,019    3,963    -    105,594 
Commercial real estate — non owner occupied   98,044    16,752    2,498    -    117,294 
Farmland   20,228    2,464    1,006    -    23,698 
Total real estate   347,398    21,890    11,676    -    380,964 
                          
Consumer/Finance   20,570    62    96    -    20,728 
                          
Less deferred fees   -    -    -    -    (1,137)
                          
Total loans  $468,230   $24,810   $12,763   $-   $504,666 

 

17
 

 

Impaired Loans

 

Impaired loans by type as of September 30, 2014, and interest income recognized for the three and nine months ended September 30, 2014, were as follows:

 

(Dollars in Thousands)              3 Month   9 Month   3 Month   9 Month 
   Unpaid           Average   Average   Interest   Interest 
   Principal   Recorded   Related   Recorded   Recorded   Income   Income 
   Balance   Investment   Allowance   Investment   Investment   Recognized   Recognized 
September 30, 2014                                   
                                    
With no Related Allowance:                                   
Commercial  $440   $402   $-   $407   $455   $4   $15 
Consumer             -    26    53    -    - 
Residential real estate   1,425    1,089    -    932    815    18    43 
Commercial real estate:                                   
CRE — owner occupied   1,640    1,640    -    1,650    1,732    -    - 
CRE — non owner occupied   3,589    3,217    -    3,557    4,064    17    28 
Farmland             -    478    716    -    225 
Construction and development   3,139    1,081    -    1,177    1,260    15    48 
Total  $10,233   $7,429   $-   $8,227   $9,095   $54   $359 
                                    
With a Related Allowance:                                   
Consumer/Finance  $-   $-   $-   $-   $-   $-   $- 
Residential real estate   -    -    -    -    -    -    - 
Total  $-   $-   $-   $-   $-   $-   $- 
                                    
Total Impaired Loans:                                   
Commercial  $440   $402   $-   $407   $455   $4   $15 
Consumer             -    26    53    -    - 
Residential real estate   1,425    1,089    -    932    815    18    43 
Commercial real estate:                                   
CRE — owner occupied   1,640    1,640    -    1,650    1,732    -    - 
CRE — non owner occupied   3,589    3,217    -    3,557    4,064    17    28 
Farmland             -    478    716    -    225 
Construction and development   3,139    1,081    -    1,177    1,260    15    48 
Total Impaired Loans  $10,233   $7,429   $-   $8,227   $9,095   $54   $359 

 

18
 

 

Impaired loans by type as of September 30, 2013, and interest income recognized for the three and nine months ended September 30, 2013, were as follows:

 

(Dollars in Thousands)              3 Month   9 Month   3 Month   9 Month 
   Unpaid           Average   Average   Interest   Interest 
   Principal   Recorded   Related   Recorded   Recorded   Income   Income 
   Balance   Investment   Allowance   Investment   Investment   Recognized   Recognized 
September 30, 2013                                   
                                    
With no Related Allowance:                                   
Commercial  $766   $766   $-   $984   $1,440   $1   $6 
Consumer   -    -    -    -    -    -    - 
Residential real estate   1,102    871    -    1,233    1,150    9    19 
Commercial real estate:                                   
CRE — owner occupied   1,787    1,787    -    2,327    2,674    -    24 
CRE — non owner occupied   6,791    4,591    -    4,584    5,349    9    32 
Farmland   955    955    -    955    960    20    60 
Construction and development   3,685    1,413    -    1,435    1,626    -    - 
Total  $15,086   $10,383   $-   $11,518   $13,199   $39   $141 
                                    
With a Related Allowance:                                   
Consumer  $-   $-   $-   $5   $2   $-   $- 
Residential real estate   -    -    -    100    50    -    1 
Total  $    $    $    $105   $52   $    $1 
                                    
Total Impaired Loans:                                   
Commercial  $766   $766   $-   $984   $1,440   $1   $6 
Consumer                  5    2    -    - 
Residential real estate   1,102    871         1,333    1,200    9    20 
Commercial real estate:                                   
CRE — owner occupied   1,787    1,787    -    2,327    2,674         24 
CRE — non owner occupied   6,791    4,591    -    4,584    5,349    9    32 
Farmland   955    955    -    955    960    20    60 
Construction and development   3,685    1,413    -    1,435    1,626    -    - 
Total Impaired Loans  $15,086   $10,383   $-   $11,623   $13,251   $39   $142 

 

19
 

 

Aging Analysis

 

The following tables summarize the Company’s loans past due, both accruing and nonaccruing, by type as of September 30, 2014 and December 31, 2013:

 

(Dollars in Thousands)                            
           Greater                 
   30-59 Days   60-89 Days   Than   Total Past   Non-accrual       Total 
   Past Due   Past Due   90 Days   Due   Loans   Current   Loans 
September 30, 2014:                                   
                                    
Commercial and agricultural  $7   $-   $-   $7   $113   $112,753   $112,873 
Real estate:                                   
Construction and development   -    -    -    -    1,081    24,338    25,419 
Residential 1-4 family   251    -    -    251    714    93,136    94,101 
Multi-family   -    -    -         -    20,554    20,554 
Commercial real estate — owner occupied   -    -    409    409    1,586    120,095    122,090 
Commercial real estate — non owner occupied   2,612    -    -    2,612    1,163    116,794    120,569 
Farmland   -    -    -    -    -    22,926    22,926 
Total real estate   2,863         409    3,272    4,544    397,843    405,659 
                                    
Consumer/Finance   2    -    -    2    154    34, 631    34,787 
                                    
Less deferred fees   -    -    -    -    -    (1,179)   (1,179)
                                    
Total  $2,872        $ $409  $3,281   $4,811   $544,048   $552,140 
                                    
December 31, 2013:                                   
                                    
Commercial and agricultural  $14   $-   $-   $14   $286   $103,811   $104,111 
Real estate:                                   
Construction and development   -    -    -    -    1,408    27,688    29,096 
Residential 1-4 family   333    -    -    333    400    87,029    87,762 
Multi-family   -    -    -    -    -    17,520    17,520 
Commercial real estate — owner occupied   -    -    -    -    1,659    103,935    105,594 
Commercial real estate — non owner occupied   -    -    -    -    2,482    114,812    117,294 
Farmland   875    -    -    875    955    21,868    23,698 
Total real estate   1,208    -    -    1,208    6,904    372,852    380,964 
                                    
Consumer/Finance   165    3    -    168    53    20,507    20,728 
                                    
Less deferred fees   -    -    -    -    -    (1,137)   (1,137)
                                    
Total  $1,387   $3   $-   $1,390   $7,243   $496,033   $504,666 

 

Modifications

 

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

 

Loans modified in a TDR are considered impaired loans and typically already on non-accrual status. Partial charge-offs have in some cases already been taken against the outstanding loan balance.  Loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan.  An allowance for impaired loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent.  The Company’s practice is to re-appraise collateral dependent loans every six to nine months. During the nine months ended September 30, 2014, there was no impact on the allowance from TDRs during the period, as the loans classified as TDRs during the period did not have a specific reserve and were already considered impaired loans at the time of modification and no further impairment was required upon modification. The Company had no commitments to lend additional funds for loans classified as TDRs at September 30, 2014.

 

20
 

 

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 for the nine months ended September 30, 2014 and 2013, all of which were modified due to financial stress of the borrower.

 

Restructured loans by type current and subsequently defaulted

(Dollars in Thousands)

 

   September 30, 2014 
   Current Restructured Loans   Subsequently Defaulted Restructured Loans 
   Number of Loans   Pre-TDR
Outstanding
Recorded
Investment
   Post-TDR
Outstanding
Recorded
Investment
   Number of Loans   Pre-TDR
Outstanding
Recorded
Investment
   Post-TDR
Outstanding
Recorded
Investment
 
Commercial and agriculture   1   $335   $288    -   $-   $- 
Construction and development   2    2,764    1,081    -    -    - 
Residential real estate   2    272    221    -    -    - 
CRE — owner occupied   1    59    54    -    -    - 
CRE — non owner occupied   1    2,180    2,054    -    -    - 
Total restructured loans (1)   7   $5,610   $3,698    -   $-   $- 

 

   September 30, 2013 
   Current Restructured Loans   Subsequently Defaulted Restructured Loans 
   Number of Loans   Pre-TDR
Outstanding
Recorded
Investment
   Post-TDR
Outstanding
Recorded
Investment
   Number of Loans   Pre-TDR
Outstanding
Recorded
Investment
   Post-TDR
Outstanding
Recorded
Investment
 
Commercial and agriculture   1   $335   $306    -   $-   $- 
Construction and development   3    2,972    1,413    -    -    - 
Residential real estate   2    272    227    -    -    - 
CRE — owner occupied   1    59    56    -    -    - 
CRE — non owner occupied   1    2,180    2,110    -    -    - 
Total restructured loans (1)   8   $5,818   $4,112    -   $-   $- 

 

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

 

The following table summarizes the Company’s troubled debt restructured loans by type and geographic region as of September 30, 2014:

 

Restructured loans by type and geographic region

(Dollars in Thousands)

 

   September 30, 2014 
   Restructured Loans 
   Central Western
Washington
   Southwestern
Washington
   Northern
Washington
   Oregon   Totals   Number of
Loans
 
Commercial and agriculture  $-   $-   $288   $-   $288    1 
Construction and development             841    240    1,081    2 
Residential real estate   -    -    -    221    221    2 
CRE — owner occupied   54    -    -    -    54    1 
CRE — non owner occupied   -    -    2,054    -    2,054    1 
Total restructured loans  $54   $-   $3,183   $461   $3,698    7 

 

21
 

 

The following table presents troubled debt restructurings by accrual or nonaccrual status as of September 30, 2014 and 2013:

 

Restructured loans by accrual or nonaccrual status

(Dollars in Thousands)

 

   September 30, 2014 
   Restructured loans 
   Accrual Status   Non-accrual
Status
   Total
Modifications
 
Commercial and agriculture  $288   $-   $288 
Construction and development   -    1,081    1,081 
Residential real estate   221    -    221 
CRE — owner occupied   54    -    54 
CRE — non owner occupied   2,054    -    2,054 
Total restructured loans  $2,617   $1,081   $3,698 

 

   September 30, 2013 
   Restructured loans 
   Accrual Status   Non-accrual
Status
   Total
Modifications
 
Commercial and agriculture  $306   $-   $306 
Construction and development   -    1,413    1,413 
Residential real estate   227    -    227 
CRE — owner occupied   56    -    56 
CRE — non owner occupied   2,110    -    2,110 
Total restructured loans  $2,699   $1,413   $4,112 

 

22
 

 

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 nine months ended September 30, 2014 and 2013:

 

(Dollars in Thousands)  Net Unrealized         
   Gains and Losses         
   On Investment   Defined Benefit     
   Securities   Plans   Total 
             
Balance, January 1, 2014  $(919)  $(450)  $(1,369)
                
Other comprehensive gain before reclassifications   946    87    1,033 
Amounts reclassified from AOCI   (26)   -    (26)
Net Current period other comprehensive income (loss)   920    87    1,007 
                
Balance, September 30, 2014  $1   $(363)  $(362)

 

   Net Unrealized         
   Gains and Losses         
   On Investment   Defined Benefit     
   Securities   Plans   Total 
Balance, January 1, 2013  $956   $(535)  $421 
                
Other comprehensive gain before reclassifications   (1,254)   84    (1,170)
Amounts reclassified from AOCI   (240)   -    (240)
Net Current period other comprehensive income (loss)   (1,494)   84    (1,410)
                
Balance, September 30, 2013  $(538)  $(451)  $(989)

 

23
 

 

The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (“AOCI”) for the three and nine months ended September 30, 2014 and 2013:

 

(Dollars in Thousands)       
        
Details about Accumulated Other
Comprehensive Income Components
  Amounts Reclassified from AOCI   Affected Line Item in the Statement Where Net
Income is Presented
   Three Months   Nine Months    
   Ended September   Ended September    
   30, 2014   30, 2014    
              
Net Unrealized Gains and Losses  $(38)  $(88)  (Gain)/loss on sales of investments available for sale
on Investment Securities   -    48   Net OTTI losses
    13    14   Income tax expense
   $(25)  $(26)  Unrealized gain on investment securities net of tax

 

(Dollars in Thousands)           
            
Details about Accumulated Other
Comprehensive Income Components
  Amounts Reclassified from AOCI   Affected Line Item in the Statement Where Net
Income is Presented
            
   Three Months   Nine Months    
   Ended September   Ended September    
   30, 2013   30, 2013    
              
Net Unrealized Gains and Losses  $(14)  $(401)  (Gain) on sales of investments available for sale
on Investment Securities   4    38   Net OTTI losses
    3    123   Income tax expense
   $(7)  $(240)  Unrealized gain on investment securities net of tax

 

24
 

 

The following table presents the components of other comprehensive income (loss) for the three and nine months ended September 30, 2014 and 2013:

 

(Dollars in Thousands)            
             
   Before Tax   Tax Effect   Net of Tax 
                
Three months ended September 30, 2014               
                
Net unrealized losses on investment securities:               
Net unrealized gains arising during the period  $(26)  $(9)  $(17)
Less: reclassification adjustments for net gains realized in net income   (38)  $(13)   (25)
Net unrealized losses on investment securities  $(64)  $(22)  $(42)
                
Net unrealized losses on investment securities:               
Amortization of unrecognized prior service costs and net  actuarial gains/losses  $44   $15   $29 
                
Other Comprehensive Income (Loss)  $(20)  $(7)  $(13)
                
Nine months ended September 30, 2014               
                
Net unrealized losses on investment securities:               
Net unrealized gains arising during the period  $1,433   $487   $946 
Less: reclassification adjustments for net gains realized in net income   (40)  $(14)   (26)
Net unrealized losses on investment securities  $1,393   $473   $920 
                
Net unrealized losses on investment securities:               
Amortization of unrecognized prior service costs and net actuarial gains/losses  $132   $45   $87 
                
Other Comprehensive Income (Loss)  $1,525   $518   $1,007 

 

25
 

 

(Dollars in Thousands)            
             
   Before Tax   Tax Effect   Net of Tax 
                
Three months ended September 30, 2013               
                
Net unrealized losses on investment securities:               
Net unrealized losses arising during the period  $781   $265   $516 
Less: reclassification adjustments for net gains realized in net income   (10)  $(3)   (7)
Net unrealized losses on investment securities  $771   $262   $509 
                
Net unrealized losses on investment securities:               
Amortization of unrecognized prior service costs and net  actuarial gains/losses  $43   $15   $28 
                
Other Comprehensive Income (Loss)  $814   $277   $537 
                
Nine months ended September 30, 2013               
                
Net unrealized losses on investment securities:               
Net unrealized losses arising during the period  $(1,901)  $(647)  $(1,254)
Less: reclassification adjustments for net gains realized in net income   (363)   (123)   (240)
Net unrealized losses on investment securities  $(2,264)  $(770)  $(1,494)
                
Net unrealized losses on investment securities:               
Amortization of unrecognized prior service costs and net actuarial gains/losses  $128   $44   $84 
                
Other Comprehensive Income (Loss)  $(2,136)  $(726)  $(1,410)

 

NOTE 6 – STOCK BASED COMPENSATION

 

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

 

Stock Options

 

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

 

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

 

Grant period ended  Expected
Life
  Risk Free
Interest Rate
   Expected
Volatility
   Dividend
Yield
   Average
Fair Value
 
                    
September 30, 2014  6.5 years   2.11%   23.24%   3.27%  $1.02 
September 30, 2013  6.5 years   1.35%   23.04%   4.14%  $0.57 

 

26
 

 

A summary of stock option activity as of September 30, 2014 and 2013, and changes during the nine months then ended are presented below:

 

   Shares   Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
(Years)
   Aggregate
Intrinsic
Value
 
September 30, 2014                    
                     
Outstanding beginning of period   625,495   $9.53           
                     
Granted   22,500    6.13           
Exercised   -    -           
Forfeited   -    -           
Expired   (70,400)   15.17           
                     
Outstanding end of period   577,595   $8.71    5.2   $227,900 
                     
Exercisable end of period   295,495   $11.43    3.3   $42,875 

 

   Shares   Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
(Years)
   Aggregate
Intrinsic
Value
 
September 30, 2013                    
                     
Outstanding beginning of period   537,107   $11.28           
                     
Granted   183,500    5.03           
Exercised   -    -           
Forfeited   (33,275)   9.25           
Expired   (64,337)   11.36           
                     
Outstanding end of period   622,995   $9.54    5.4   $114,450 
                     
Exercisable end of period   313,245   $13.25    2.7   $4,443 

 

A summary of the status of the Company’s non-vested options as of September 30, 2014 and 2013 and changes during the nine months then ended, are presented below:

 

   September 30, 2014   September 30, 2013 
   Shares   Weighted
Average
Fair Value
   Shares   Weighted
Average
Fair Value
 
                 
Non-vested beginning of period   296,650   $0.47    147,280   $0.31 
                     
Granted   22,500    1.02    183,500    0.57 
Vested   (37,050)   0.59    (2,275)   0.65 
Forfeited   -    -    (18,755)   0.40 
                     
Non-vested end of period   282,100   $0.50    309,750   $0.45 

 

27
 

  

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

 

Stock-based compensation expense            
(Unaudited)            
(Dollars in Thousands)            
             
Nine months ended September 30, 2014  Before Tax   Tax Effect   Net of Tax 
                
Recognized compensation expense  $32   $11   $21 

 

Nine months ended September 30, 2013  Before Tax   Tax Effect   Net of Tax 
                
Recognized compensation expense  $38   $13   $25 

 

   September
30, 2014
   September
30, 2013
 
         
Future compensation expense  (1)  $70   $90 
           
Weighted Average Remaining Contractual Term (Years)   1.7    1.8 

 

(1) related to non-vested stock options

 

28
 

  

Restricted Stock Units

 

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

 

The following table summarizes RSU activity during the nine months ended September 30, 2014 and 2013:

 

   September 30, 2014 
   Shares   Weighted
Average
Grant Price
   Weighted
Average
Remaining
Contractual
terms (in years)
 
             
Outstanding, January 1, 2014   50,024         
                
Granted   11,673   $6.45      
Exercised   (476)   -      
Forfeited   (944)  $5.27      
                
Non-vested end of period   60,277         1.7 

 

   September 30, 2013 
   Shares   Weighted
Average
Grant
Price
   Weighted
Average
Remaining
Contractual
terms (in years)
 
             
Outstanding, January 1, 2013   16,059         
                
Granted   35,476   $4.93      
Exercised   -           
Forfeited   (1,511)  $-      
                
Non-vested end of period   50,024         2.2 

 

29
 

  

The following table summarizes RSU compensation expense during the nine months ended September 30, 2014 and 2013:

 

RSU compensation expense            
(Unaudited)            
(Dollars in Thousands)            
             
Nine months ended September 30, 2014  Before Tax   Tax Effect   Net of Tax 
                
RSU recognized compensation expense  $74   $25   $49 

 

Nine months ended September 30, 2013  Before Tax   Tax Effect   Net of Tax 
                
RSU recognized compensation expense  $46   $16   $30 

 

   September
30, 2014
   September
30, 2013
 
           
Future compensation expense  (1)  $174   $193 

 

(1) related to non-vested RSU's

 

NOTE 7 – 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 September 30, 2014 and December 31, 2013 is as follows:

 

(Dollars in Thousands)        
   September 30,
2014
   December 31,
2013
 
         
Commitments to extend credit  $96,817   $106,017 
Standby letters of credit  $1,351   $1,733 

 

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

 

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

 

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

 

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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 8 – FAIR VALUE MEASUREMENTS

 

Fair Value Hierarchy

 

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

 

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

 

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

 

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

 

Investment Securities Available-for-Sale

 

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

 

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

 

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

 

On a quarterly basis, management reviews the pricing information received from the third party-pricing service through a combination of procedures that include an evaluation of methodologies used by the pricing service, analytical reviews and performance analyses of the prices against statistics and trends and maintenance of an investment watch list. Based on this review, management determines whether the current placement of the security in the fair value hierarchy is appropriate or whether transfers may be warranted. As necessary, the Company compares prices received from the pricing service to discounted cash flow models or through performing independent valuations of inputs and assumptions similar to those used by the pricing service in order to ensure prices represent a reasonable estimate of fair value. Although the Company does identify differences from time to time as a result of these validation procedures, the Company did not make any significant adjustments as of September 30, 2014 or December 31, 2013.

 

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The following table presents the balances of assets measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013.

 

(Dollars in Thousands)  Fair Value Measurements 
   At September 30, 2014 
Description  Fair Value
09/30/2014
   Quoted Prices in Active
Markets for Identical
Assets (Level 1)
   Other Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)
 
Available-for-sale securities:                    
Collateralized mortgage obligations: agency issued  $40,039   $-   $40,039   $- 
Collateralized mortgage obligations: non agency   579    -    579    - 
Mortgage-backed securities: agency issued   12,499    -    12,499    - 
U.S. Government agency securities   8,655    -    8,655    - 
State and municipal securities   27,556    -    26,198    1,358 
Total assets measured at fair value  $89,328   $   $87,970   $1,358 

 

   Fair Value Measurements 
   At December 31, 2013 
Description  Fair Value
12/31/2013
   Quoted Prices in Active
Markets for Identical
Assets (Level 1)
   Other Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)
 
Available-for-sale securities:                    
Collateralized mortgage obligations: agency issued  $38,791   $-   $38,791   $- 
Collateralized mortgage obligations: non agency   2,011    -    2,011    - 
Mortgage-backed securities: agency issued   13,389    -    13,389    - 
U.S. Government agency securities   8,811    -    8,811    - 
State and municipal securities   32,160    -    30,741    1,419 
Corporate bonds   982    -    982    - 
Total assets measured at fair value  $96,144   $   $94,725   $1,419 

 

As of September 30, 2014 and December 31, 2013, the Company had three investments classified as Level 3 investments which consist of local non-rated municipal bonds for which the Company is the sole owner of the entire bond issue. The valuation of these securities is supported by analysis prepared by an independent third party. Their approach to determining fair value involves using recently executed transactions and market quotations for similar securities. As these securities are not rated by the rating agencies and there is no trading volume, management determined that these securities should be classified as Level 3 within the fair value hierarchy. Additionally, these securities are considered sensitive to changes in credit given the unobserved assumed credit ratings.

 

The following table presents a reconciliation of assets that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and nine months ended September 30, 2014 and 2013, respectively. There were no transfers of assets into or out of Level 1, 2 or 3 for the three and nine months ended September 30, 2014.

 

(Dollars in Thousands)  Three months ended September 30,   Nine months ended September 30, 
   2014   2013   2014   2013 
                 
Balance beginning of period  $1,394   $1,491    1,419   $1,614 
Principal paydowns   (61)   (61)   (92)   (90)
Change in FV (included in other comprehensive income)   25    (3)   31    (97)
                     
Balance end of period  $1,358   $1,427    1,358   $1,427 

 

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Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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The following table presents the Company’s assets that were held at the end of each period that were measured at fair value on a nonrecurring basis during the nine months ended September 30, 2014 and year ended December 31, 2013:

 

(Dollars in Thousands)  Fair Value Measurements 
   As of September 30, 2014 
Description  Fair Value
09/30/2014
   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Other Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
 
Other real estate owned and foreclosed assets  $291   $   $   $291 
Loans measured for impairment, net of specific reserves   441              441 
Total impaired assets measured at fair value  $732   $   $   $732 

 

   Fair Value Measurements 
   As of December 31, 2013 
Description  Fair Value
12/31/2013
   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Other Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
 
Other real estate owned and foreclosed assets  $1,960   $   $   $1,960 
Loans measured for impairment, net of specific reserves   162              162 
Total impaired assets measured at fair value  $2,122   $   $   $2,122 

 

Other real estate owned with a pre-foreclosure loan balance of $652,000 was acquired during the nine months ended September 30, 2014. Upon foreclosure, write downs totaling $127,000 were applied to the allowance for credit losses during the period related to these assets.

 

The following table presents quantitative information about Level 3 inputs for financial instruments measured at fair value on a nonrecurring basis at September 30, 2014:

 

(Dollars in Thousands)              
               
Description  Fair Value
09/30/2014
   Valuation
Technique
  Significant
Unobservable
Inputs
  Range
(Weighted
Average)
 
Other real estate owned and foreclosed assets  $291    Appraised value  Adjustment for   0-10% (1.6%) 
           market conditions     
                 
Loans measured for impairment, net of specific reserves  $441    Appraised value  Adjustment for  market conditions   0-20% (2.8%) 

 

Fair Value of Financial Instruments

 

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

 

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

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

 

Investment securities available-for-sale and held-to-maturity

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

 

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Federal Home Loan Bank Stock

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

 

Pacific Coast Bankers’ Bancshares Stock

PCBB stock is carried at cost which approximates fair value and equals its par value based on the price per share paid at the capital offering concluded during the current quarter.

 

Loans, net and loans held for sale

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

 

Deposits

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

 

Borrowings

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

 

Junior subordinated debentures

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

 

Off-Balance-Sheet Instruments

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

 

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The estimated fair value of the Company’s financial instruments at September 30, 2014 and December 31, 2013 is as follows:

 

(Dollars in Thousands)    
   As of September 30, 2014 
   Carrying Value   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
   Total Fair
Value
 
                     
Financial assets:                         
Cash and cash equivalents  $40,781   $40,781   $-   $-   $40,781 
Interest-bearing certificates of deposit (original maturities greater than 90 days)   2,727    2,727    -    -    2,727 
Investment securities available-for-sale   89,328    -    87,970    1,358    89,328 
Investment securities held-to-maturity   1,857    -    1,874    -    1,874 
Federal Home Loan Bank stock   2,926    -    2,926    -    2,926 
Loans held-for-sale   8,161    -    8,161    -    8,161 
Loans   543,885    -    -    517,498    517,498 
                          
Financial liabilities:                         
Deposits  $644,004   $   $644,518   $-   $644,518 
Short-term borrowings   -    -    -    -    - 
Long-term borrowings   11,491    -    10,145    -    10,145 
Junior subordinated debentures   13,403    -    -    7,541    7,541 

 

   As of December 31, 2013 
   Carrying Value   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
   Total Fair
Value
 
                     
Financial assets:                         
Cash and cash equivalents  $35,948   $35,948   $-   $-   $35,948 
Interest-bearing certificates of deposit (original maturities greater than 90 days)   2,727    2,727    -    -    2,727 
Investment securities available-for-sale   96,144    -    94,725    1,419    96,144 
Investment securities held-to-maturity   2,132    -    2,158    -    2,158 
Federal Home Loan Bank stock   3,013    -    3,013    -    3,013 
Loans held-for-sale   7,765    -    7,765    -    7,765 
Loans   496,307    -    -    473,224    473,224 
                          
Financial liabilities:                         
Deposits  $607,347   $   $606,654   $-   $606,654 
Short-term borrowings   -    -    -    -    - 
Long-term borrowings   10,000    -    10,195    -    10,195 
Junior subordinated debentures   13,403    -    -    7,646    7,646 

 

NOTE 9 – JUNIOR SUBORDINATED DEBENTURES

 

At September 30, 2014, two wholly-owned subsidiary grantor trusts established by the Company had outstanding $13.0 million of Trust Preferred Securities (“trust preferred securities”). Trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in the indentures. The trusts used the net proceeds from the offering of trust preferred securities to purchase a like amount of Junior Subordinated Debentures (the “Debentures”) of the Company. The Debentures are the sole assets of the trusts. The Company’s obligations under the Debentures and the related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole or in part, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date.

 

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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 September 30, 2014 for the common capital securities issued by the issuer trusts.

 

As of September 30, 2014, regular accrued interest on junior subordinated debentures totaled $40,000 and is included in accrued interest payable on the balance sheet. Following are the terms of the junior subordinated debentures as of September 30, 2014.

  

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

 

(1)Pacific Financial Corporation Statutory Trust I securities incurred interest at the fixed rate of 6.39% until mid March 2011, at which the rate changed to a variable rate of 3-month LIBOR (0.234% at September 11, 2014) plus 1.45% or 1.68%, adjusted quarterly, through the final maturity date in March 2036.
(2)Pacific Financial Corporation Statutory Trust II securities incur interest at a variable rate of 3-month LIBOR (0.234% at July 11, 2014) plus 1.60% or 1.83%, adjusted quarterly, through the final maturity date in July 2036.

 

NOTE 10 – RECENTLY ISSUED ACCOUNTING STANDARDS

 

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

 

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

 

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

 

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In July 2013, FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." The provisions of ASU No. 2013-11 require an entity to present an unrecognized tax benefit, or portion thereof, in the statement of financial position as a reduction to a deferred tax asset for a net operating loss carryforward or a tax credit carryforward, with certain exceptions related to availability. ASU No. 2013-11 is effective for interim and annual reporting periods beginning after December 15, 2013. The adoption of ASU No. 2013-11 has not had a material impact on the Company's Consolidated Financial Statements.

 

NOTE 11 – BUSINESS COMBINATION

 

On January 28, 2013, the Bank and Sterling Savings Bank, a Washington state-chartered bank (“Sterling”), entered into a Purchase and Assumption Agreement (the “Agreement”) pursuant to which the Bank agreed to purchase from Sterling three branches located in Aberdeen, Washington; Astoria, Oregon; and Seaside, Oregon; including certain deposit liabilities, loans and other assets and liabilities associated with such branch locations.  The actual amount of loans and deposits, the value of other assets and liabilities transferred to the Bank and the actual price paid were determined at the time of the closing of the transaction on September 1, 2013, in accordance with the terms of the Agreement.  The purchase price was $976,000 and exceeded the estimated fair value of tangible net assets acquired by approximately $1.1 million, which was recorded as goodwill and intangible assets.

 

Cash flow information relative to the agreement is as follows (in thousands):

 

Fair value of tangible net assets acquired  $37,533 
Cash paid for deposit premium   (976)
Liabilities assumed   (37,684)
      
Goodwill and intangible assets recorded  $1,127 

 

The primary purposes of the acquisition are to expand the Company’s market share in the northern Oregon coast, to provide existing customers with added convenience and service, and to provide our new customers with the opportunity to enjoy the outstanding personalized service and commitment of our community-based bank.

 

Fair value adjustments and related goodwill were recorded in the statement of financial condition of the Company.  The following is a condensed balance sheet disclosing the estimated fair value amounts of the acquired branches of Sterling assigned to the major consolidated asset and liability captions at the acquisition date (in thousands):

 

Cash and cash equivalents  $31,941 
Loans receivable   3,989 
Premises and equipment   604 
Goodwill and intangible assets   1,127 
Other assets   23 
      
Total assets  $37,684 
      
Deposits and accrued interest payable  $37,636 
Deferred tax liability   47 
Other liabilities   1 
      
Total liabilities and shareholders’ equity  $37,684 

 

The core deposit intangible asset that was recognized as part of the business combination was $242,000 and will be amortized over its estimated useful life of approximately ten years utilizing an accelerated method. The goodwill of $885,000 will not be amortized for financial statement purposes; instead, it will be reviewed annually for impairment.

 

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The fair value of savings and transaction deposit accounts acquired from Sterling was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand.  Certificates of deposit were valued by comparing the contractual cost of the portfolio to an identical portfolio bearing current market rates.  The projected cash flows from maturing certificates were calculated based on contractual rates.  The fair value of certificates of deposit was calculated by discounting their contractual cash flows at a market rate for a certificate of deposit with a corresponding maturity.

 

Direct costs related to the Sterling acquisition were expensed as incurred in the year ended December 31, 2013.  These acquisition and integration expenses included salaries and benefits, technology and communications, occupancy and equipment, professional services and other noninterest expenses.  For the year ended December 31, 2013, the Company incurred $615,000 of expenses related to acquisition costs.

 

NOTE 12 – GOODWILL

 

The majority of goodwill and intangibles generally arise from business combinations accounted for under the purchase method.  Goodwill and other intangibles deemed to have indefinite lives generated from purchase business combinations are not subject to amortization and are instead tested for impairment no less than annually.

 

During the second quarter of 2014, the Company initiated its annual goodwill impairment test to determine whether an impairment of its goodwill asset exists. The test was completed during the current quarter. The goodwill impairment test involves a two-step process.  The first step is a comparison of the reporting unit’s fair value to its carrying value. If the reporting unit’s fair value is less than its carrying value, the Company is required to progress to the second step. In the second step the Company calculates the implied fair value of its reporting unit and, in accordance with applicable GAAP standards, compares the implied fair value of goodwill to the carrying amount of goodwill on the Company’s balance sheet.  If the carrying amount of the goodwill is greater than the implied fair value of that goodwill, an impairment loss must be recognized in an amount equal to that excess.  The implied fair value of goodwill is determined in the same manner as goodwill recognized in a business combination.  The estimated fair value of the Company is allocated to all of the Company’s individual assets and liabilities, including any unrecognized identifiable intangible assets, as if the Company had been acquired in a business combination and the estimated fair value of the Company is the price paid to acquire it. The allocation process is performed only for purposes of determining whether a goodwill impairment exists and the amount of any such impairment. No assets or liabilities are written up or down, nor are any additional unrecognized identifiable intangible assets recorded as a part of this process.

 

The Company estimates fair value using the best information available, including market information and a discounted cash flow analysis, which is also referred to as the income approach. The income approach uses a reporting unit’s projection of estimated operating results and cash flows that is discounted using a rate that reflects current market conditions. The projection uses management’s best estimates of economic and market conditions over the projected period including growth rates in loans and deposits, estimates of future expected changes in net interest margins and cash expenditures. The market approach estimates fair value by applying cash flow multiples to the reporting unit’s operating performance. The multiples are derived from comparable publicly traded companies with similar operating and investment characteristics of the reporting unit. We validate our estimated fair value by comparing the fair value estimates using the income approach to the fair value estimates using the market approach.

 

As part of our process for performing the step one impairment test of goodwill, the Company estimated the fair value of the reporting unit utilizing the income approach and the market approach in order to derive an enterprise value of the Company. In determining the discount rate for the discounted cash flow model, the Company used a modified capital asset pricing model that develops a rate of return utilizing a risk-free rate and equity risk premium resulting in a discount rate of 12.0%. This approach also includes adjustments for the industry the Company operates in and size of the Company. In addition, assumptions used by the Company in its discounted cash flow model (income approach) included an average annual revenue growth rate that approximated 23%; an asset growth of 4.4% in years one through five; net interest margin ranging from 4.02% in the base year to 4.24% in year five; and a return on assets that ranged from 0.62% to 1.24%.

 

In applying the market approach method, the Company considered all banks that announced a sale between January 1, 2013 and September 30, 2014, with total assets under $5 billion and a return on assets greater than zero. This resulted in selecting 24 institutions which fit these criteria.  After selecting these institutions, the Company derived the fair value of the reporting unit by completing a comparative analysis of the relationship between their financial metrics listed above and their market values utilizing various market multiples.  Focus was placed on the price to tangible book value of equity multiple as this multiple generally reflects returns on the capital employed within the industry and is generally correlated with the profitability of each individual company.

 

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The Company concluded its reporting unit had a fair value of $8.50 per share, or $86.6 million, after giving similar consideration to the values derived from 1) the market approach of $8.20 per share weighted at 80%, and 2) the income approach of $9.67 per share million weighted at 20%. This estimate compares to a carrying value of its reporting unit of $70.9 million. Accordingly, following step one of the Company’s goodwill impairment test, the Company concluded that its reporting unit’s fair value exceeded its carrying value and no goodwill impairment existed.

 

Even though the Company determined that there was no goodwill impairment, a future impairment charge may be necessary if our stock price declines, market values of others in the financial industry decrease, the Bank’s revenue falls, or there are significant adverse changes in the operating environment for the financial industry. It is also possible that changes in circumstances existing now or in the future, or in the numerous estimates, judgments, and assumptions made by management in assessing the fair value of our goodwill, could result in a future goodwill impairment. If the Company records an impairment charge, its financial position and results of operations would be adversely affected; however, such an impairment charge would have no impact on liquidity, day-to-day operations or regulatory capital.

 

NOTE 13 – INCOME TAXES

 

The Company recorded an income tax provision for the three months ended September 30, 2014, June 31, 2014 and September 30, 2013. 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 September 30, 2014, the Company maintained a deferred tax asset balance of $4.1 million. The Company believes it will be fully utilized in the normal course of business, thus no valuation allowance is maintained against this asset.

 

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

 

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

 

The Company applies the provisions of FASB ASC 740, Income Taxes, relating to the accounting for uncertainty in income taxes. The Company periodically reviews its income tax positions based on tax laws and regulations, and financial reporting considerations, and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations of the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment. The Company’s uncertain tax positions were nominal in amount as of September 30, 2014.

 

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

 

The following discussion should be read in conjunction with the audited consolidated financial statements and related notes to those statements of Pacific Financial Corporation (“Company”) that appear under the heading “Financial Statements and Supplementary Data” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 10-K”), as well as the unaudited consolidated financial statements for the current quarter found under Item 1 above.

 

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

 

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

 

Any forward-looking statements in this document are subject to the risks of our business, including risk factors described in our 2013 10-K, as well as risks relating to, among other things, the following:

 

·changing laws, regulations, standards, and government programs that may limit our revenue sources, significantly increase our costs, including compliance and insurance costs, limit our opportunities to generate noninterest income, and place additional burdens on our limited management resources;

 

·economic or business conditions, nationally and in the regions in which we do business that may result in, among other things, reduced demand for credit and other banking services, lower credit quality and additional workout and other real estate owned (“OREO”) expenses;

 

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

 

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

 

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

 

·integration of three bank branches and related assets acquired from Sterling that may cost more or be less beneficial to us than expected.

 

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

 

Third Quarter 2014 Highlights (as of, or for the period ended September 30, 2014, except as noted):

 

Earnings per share (“EPS”) declined by 7% to $0.13, compared to $0.14 in second quarter 2014, primarily due more shares outstanding reflecting the exercise of warrants during the quarter. EPS grew 44% from $0.09 in third quarter 2013. Year-to-date, EPS increased 28% to $0.37, from $0.29 for the same period in 2013.

 

Net interest income increased $86,000, or 1%, to $6.9 million, compared to $6.8 million in second quarter 2014, and grew $867,000, or 14%, from $6.0 million in third quarter 2013. For the first nine months of 2014, net interest income increased $2.7 million, or 15%, to $20.2 million, from $17.5 million for the like period in 2013.

   

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Net interest margin (NIM) was 4.13%, compared to 4.28% for the preceding quarter, and 3.88% for third quarter 2013. Year-to-date, net interest margin expanded 23 basis points to 4.22%, compared to 3.99% for the first nine months of 2013.

 

Gross loans grew to $552.1 million, an increase of $4.8 million, or 1% from $547.3 million at June 30, 2014, and up 13% from $486.7 million at September 30, 2013.

 

Nonperforming assets declined to $6.4 million, or 0.86% of total assets, down from $7.4 million, or 1.03% of total assets, at June 30, 2014 and $12.4 million, or 1.73% of total assets at September 30, 2013.

 

Classified loans increased to $18.4 million, or 3.33% of gross loans, up from $16.0 million, or 2.91% of gross loans, at June 30, 2014, and $13.7 million, or 2.82% of gross loans at September 30, 2013.

 

Net charge-offs totaled $160,000, compared to $73,000 in second quarter 2014 and $156,000 for third quarter 2013. Year-to-date, net charge-offs were $304,000, compared to $102,000 for the first nine months of 2013.