Table of Contents

 

 

UNITED STATES

SECURITIES & EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark one)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31, 2015.

OR

 

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from                      to                     .

COMMISSION FILE NUMBER: 0-30106

 

 

PACIFIC CONTINENTAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

OREGON		93-1269184
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No)

 

111 West 7th Avenue
Eugene, Oregon		97401
(Address of principal executive offices)		(Zip Code)

(541) 686-8685

(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 website, 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 the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Act. (Check one)

 

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

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 of common stock outstanding as of April 30, 2015 was 19,512,320

 

 

 

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PACIFIC CONTINENTAL CORPORATION

FORM 10-Q

QUARTERLY REPORT

TABLE OF CONTENTS

 

 

PART I		FINANCIAL INFORMATION			3
ITEM 1		Financial Statements			3
		Consolidated Balance Sheets			3
		Consolidated Statements of Income			4
		Consolidated Statements of Comprehensive Income			5
		Consolidated Statements of Changes in Shareholders’ Equity			6
		Consolidated Statements of Cash Flows			7
		Notes to Consolidated Financial Statements			8
ITEM 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations			46
ITEM 3		Quantitative and Qualitative Disclosures about Market Risk			64
ITEM 4		Controls and Procedures			64
PART II		OTHER INFORMATION			65
ITEM 1		Legal Proceedings			65
ITEM 1A		Risk Factors			65
ITEM 2		Unregistered Sales of Equity Securities and Use of Proceeds			68
ITEM 3		Defaults upon Senior Securities			68
ITEM 4		Mine Safety Disclosures			68
ITEM 5		Other Information			68
ITEM 6		Exhibits			69

 

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PART I FINANCIAL INFORMATION

ITEM 1 Financial Statements

Pacific Continental Corporation and Subsidiary

Consolidated Balance Sheets

(In thousands, except share amounts)

(Unaudited)

 

		March 31, 2015				December 31, 2014				March 31, 2014
ASSETS
Cash and due from banks		$	25,718			$	20,929			$	24,455
Interest-bearing deposits with banks			12,491				4,858				3,129
Total cash and cash equivalents			38,209				25,787				27,584
Securities available-for-sale			379,497				351,946				341,992
Loans, less allowance for loan losses and net deferred fees			1,238,982				1,029,384				1,004,751
Interest receivable			5,387				4,773				4,693
Federal Home Loan Bank stock			10,531				10,019				10,327
Property and equipment, net of accumulated depreciation			17,932				17,820				18,621
Goodwill and intangible assets			43,306				23,495				23,585
Deferred tax asset			4,887				4,464				8,572
Other real estate owned			14,167				13,374				11,531
Bank-owned life insurance			22,401				16,609				16,253
Other assets			5,550				6,654				3,682
Total assets		$	1,780,849			$	1,504,325			$	1,471,591
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing demand		$	503,735			$	407,311			$	340,464
Savings and interest-bearing checking			833,325				646,101				588,822
Core time deposits			80,337				57,449				61,647
Total core deposits			1,417,397				1,110,861				990,933
Other deposits			79,350				98,232				106,422
Total deposits			1,496,747				1,209,093				1,097,355
Federal funds and overnight funds purchased			—				—				5,620
Federal Home Loan Bank borrowings			61,000				96,000				175,000
Junior subordinated debentures			8,248				8,248				8,248
Accrued interest and other payables			4,203				6,823				3,970
Total liabilities			1,570,198				1,320,164				1,290,193
Shareholders’ equity
Common stock, shares authorized: 50,000,000; shares issued and outstanding: 19,496,920 at March 31, 2015, 17,717,676 at December 31, 2014, and 17,909,906 at March 31, 2014			155,298				131,375				134,293
Retained earnings			50,014				48,984				45,503
Accumulated other comprehensive income			5,339				3,802				1,602
			210,651				184,161				181,398
Total liabilities and shareholders’ equity		$	1,780,849			$	1,504,325			$	1,471,591

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Income

(In thousands, except share and per share amounts)

(Unaudited)

 

		Three months ended
		March 31,
		2015				2014
Interest and dividend income
Loans		$	14,185			$	13,174
Taxable securities			1,375				1,532
Tax-exempt securities			503				483
Federal funds sold & interest-bearing deposits with banks			5				2
			16,068				15,191
Interest expense
Deposits			810				806
Federal Home Loan Bank & Federal Reserve borrowings			228				280
Junior subordinated debentures			56				56
Federal funds purchased			2				5
			1,096				1,147
Net interest income			14,972				14,044
Provision for loan losses			—				—
Net interest income after provision for loan losses			14,972				14,044
Noninterest income
Service charges on deposit accounts			575				518
Other fee income, principally bankcard			197				217
Bank-owned life insurance income			109				117
Net gain on sale of investment securities			53				63
Other noninterest income			342				408
			1,276				1,323
Noninterest expense
Salaries and employee benefits			6,409				5,819
Property and equipment			980				943
Data processing			684				670
Legal and professional services			400				487
Business development			353				375
FDIC insurance assessment			212				220
Other real estate expense			241				223
Merger related expense			1,836				—
Other noninterest expense			857				774
			11,972				9,511
Income before provision for income taxes			4,276				5,856
Provision for income taxes			1,474				2,024
Net income		$	2,802			$	3,832
Earnings per share
Basic		$	0.15			$	0.21
Diluted		$	0.15			$	0.21
Weighted average shares outstanding
Basic			18,232,076				17,897,593
Common stock equivalents attributable to stock-based awards			212,895				228,595
Diluted			18,444,971				18,126,188

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(Unaudited)

 

		Three months ended
		March 31,
		2015				2014
Net income		$	2,802			$	3,832
Other comprehensive income:
Available-for-sale securities:
Unrealized gain arising during the period			2,696				2,607
Reclassification adjustment for gains realized in net income			(53	)			(63	)
Income tax effects			(1,031	)			(992	)
Derivative agreements—cash flow hedge
Unrealized loss arising during the period			(123	)			(80	)
Income tax effects			48				31
Total other comprehensive income, net of tax			1,537				1,503
Total comprehensive income		$	4,339			$	5,335

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

(In thousands, except share amounts)

(Unaudited)

 

		Number of Shares				Common Stock				Retained Earnings				Accumulated Other Comprehensive Income				Total
Balance, December 31, 2013			17,891,687			$	133,835			$	45,250			$	99			$	179,184
Net income											16,042								16,042
Other comprehensive income, net of tax															3,703				3,703
Stock issuance and related tax benefit			93,069				203												203
Stock repurchase			(267,080	)			(3,600	)											(3,600	)
Share-based compensation expense							1,454												1,454
Vested employee RSUs and SARs surrendered to cover tax consequences							(517	)											(517	)
Cash dividends											(12,308	)							(12,308	)
Balance, December 31, 2014			17,717,676			$	131,375			$	48,984			$	3,802			$	184,161
Net income											2,802								2,802
Other comprehensive income, net of tax															1,537				1,537
Stock option exercise			1,102				13												13
Stock issuance and related tax benefit			1,778,142				23,578												23,578
Share-based compensation expense							332												332
Cash dividends											(1,772	)							(1,772	)
Balance, March 31, 2015			19,496,920			$	155,298			$	50,014			$	5,339			$	210,651

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

		Three months ended
		March 31,
		2015				2014
Cash flows from operating activities:
Net income		$	2,802			$	3,832
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net of accretion			1,836				1,816
Deferred income taxes			—				65
BOLI income			(109	)			(117	)
Share-based compensation			332				324
Gain on sale of investment securities			(53	)			(63	)
Valuation adjustment on foreclosed assets			52				—
Gain on sale from foreclosed assets			—				(7	)
Excess tax benefit of stock options exercised			—				14
Change in:
Interest receivable			(67	)			10
Deferred loan fees			181				46
Accrued interest payable and other liabilities			(3,964	)			(2,235	)
Income taxes receivable			—				80
Other assets			1,838				(208	)
Net cash provided by operating activities			2,848				3,557
Cash flows from investing activities:
Proceeds from maturities and sales of available-for-sale investment securities			18,024				38,652
Purchase of available-for-sale investment securities			(18,277	)			(32,062	)
Net loan principal originations			(6,373	)			(26,868	)
Net purchase of property and equipment			(250	)			(159	)
Proceeds on sale of foreclosed assets			—				4,831
Redemption of Federal Home Loan Bank stock			115				98
Cash consideration paid, net of cash acquired in merger			(3,249	)			—
Net cash used by investing activities			(10,010	)			(15,508	)
Cash flows from financing activities:
Change in deposits			59,687				6,375
Change in federal funds purchased and Federal Home Loan Bank short-term borrowings			(35,000	)			15,470
Proceeds from stock options exercised			13				189
Excess tax benefit from stock options exercised			—				(14	)
Redemption of Capital Pacific Bell State Bank Debt			(3,344	)			—
Dividends paid			(1,772	)			(3,579	)
Vested SARs and RSUs surrendered by employee to cover tax consequence			—				(14	)
Net cash provided by financing activities			19,584				18,427
Net change in cash and cash equivalents			12,422				6,476
Cash and cash equivalents, beginning of period			25,787				21,108
Cash and cash equivalents, end of period		$	38,209			$	27,584
Supplemental information:
Noncash investing and financing activities:
Change in fair value of securities, net of deferred income taxes		$	2,696			$	1,552
Acquisitions:
Assets acquired		$	259,482			$	—
Liabilties assumed		$	235,904			$	—
Cash paid during the period for:
Income taxes		$	98			$	2,145
Interest		$	1,017			$	1,081

See accompanying notes.

 

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Pacific Continental Corporation and Subsidiary

Notes to Consolidated Financial Statements

(Unaudited)

A complete set of Notes to Consolidated Financial Statements is a part of the Company’s 2014 Form 10-K filed March 13, 2015. The notes below are included due to material changes in the consolidated financial statements or to provide the reader with additional information not otherwise available. In preparing these consolidated financial statements, the Company has evaluated subsequent events and transactions for potential recognition or disclosure in the consolidated financial statements. All dollar amounts in the following notes are expressed in thousands, except share and per share amounts or where otherwise indicated.

Certain amounts contained in the prior period consolidated financial statements have been reclassified where appropriate to conform to the financial statement presentation used in the current period. These reclassifications had no effect on previously reported net income, earnings per share or retained earnings.

NOTE 1 - BASIS OF PRESENTATION

The accompanying interim consolidated financial statements include the accounts of Pacific Continental Corporation (the “Company”), a bank holding company, and its wholly owned subsidiary, Pacific Continental Bank (the “Bank”), and the Bank’s wholly owned subsidiaries, PCB Services Corporation and PCB Loan Services Corporation (both of which are presently inactive). All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared by the Company without audit and in conformity with generally accepted accounting principles in the United States of America for interim financial information. The consolidated financial statements include all adjustments and normal accruals, which the Company considers necessary for a fair presentation of the results of operations for such interim periods. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, as of the date of the balance sheets and income and expenses for the periods. Actual results could differ from those estimates.

The balance sheet data as of December 31, 2014, was derived from audited consolidated financial statements, but does not include all disclosures contained in the Company’s 2014 Form 10-K. The interim consolidated financial statements should be read in conjunction with the December 31, 2014, consolidated financial statements, including the notes thereto, included in the Company’s 2014 Form 10-K.

 

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NOTE 2 – BUSINESS COMBINATIONS

On March 6, 2015, the Company completed its acquisition of Capital Pacific Bancorp and its wholly-owned subsidiary, Capital Pacific Bank, of Portland, Oregon. The acquisition of Capital Pacific Bank reflects the Company’s overall banking expansion strategy, and expanded the combined Bank’s presence in the Portland market.

The transaction has been accounted for under the acquisition method of accounting. The assets and liabilities were recorded at their estimated fair values as of the acquisition dates. The application of the acquisition method resulted in the recognition of preliminary goodwill of $16,151. None of the goodwill is deductible for income tax purposes as the Merger is accounted for as a tax-free exchange.

The operations of Capital Pacific Bank are included in the operating results beginning March 6, 2015. Capital Pacific Bank’s results of operations prior to the acquisition are not included in the operating results. Merger-related expense of $1,836 for the quarter ended March 31, 2015, have been incurred in connection with the acquisition of Capital Pacific Bank and recognized within the merger-related expense line item on the Consolidated Statements of Income. Accrued restructuring charges relating to the Capital Pacific Bank acquisition are recorded in other liabilities and were $483 at March 31, 2015.

Included in Capital Pacific Bancorp’s outstanding liabilities at March 6, 2015, was a note payable to Bell State Bank, in the amount of $3,344, including accrued interest. This figure represents debt Capital Pacific Bancorp incurred in connection with the payoff of their TARP funds. This debt was satisfied at merger closing by Pacific Continental Bank.

A summary of the net assets acquired and the estimated fair value adjustments of Capital Pacific Bancorp are presented below:

 

		March 6, 2015
Cost basis net assets		$	26,890
Less:
Cash payment to shareholders			(16,413	)
Cash payment to employees and directors			(1,609	)
Stock issued			(23,578	)
Fair value adjustments:
Loans and leases, net			(5,376	)
Core deposit intangible			3,721
Other			214
Goodwill		$	(16,151	)

 

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The statement of assets acquired and liabilities assumed at their fair values are presented below as of the transaction closing date:

CAPITAL PACIFIC BANCORP

Opening balance sheet

(in thousands)

unaudited

 

		March 6, 2015
ASSETS
Securities available-for-sale		$	26,010
Gross loans			208,782
Fair value adjustments
Credit quality-related			(3,316	)
Interest rate-related			(2,060	)
Net Loans			203,406
Interest receivable			547
Federal Home Loan Bank stock			627
Property and equipment			229
Goodwill			16,151
Core deposit intangible			3,721
Deferred tax asset			1,406
Taxes receivable			656
Other real estate owned			845
Bank-owned life insurance			5,683
Other asset			201
Total Assets		$	259,482
LIABILITIES AND SHAREHOLDERS EQUITY
Cash and due from banks, net of consideration paid		$	3,249
Deposits			227,967
Other liabilities			4,688
Total liabilities			235,904
Common Stock			23,578
Total liabilities and shareholders’ equity		$	259,482

Acquired loans at the acquisition date and as of March 31, 2015, are presented below:

 

		March 6, 2015				March 31, 2015
Contractually required principal payments		$	208,782			$	204,987
Purchase adjustment for credit and interest rate			(5,376	)			(5,127	)
Balance of acquired loans		$	203,406			$	199,860

The acquisition of Capital Pacific Bank is not considered significant to the Company’s consolidated financial statements and therefore pro forma financial information is not presented.

 

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NOTE 3 – SECURITIES AVAILABLE-FOR-SALE

The amortized cost and estimated fair values of securities available-for-sale at March 31, 2015, were as follows:

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Unrealized Loss Positions
Obligations of U.S. government agencies		$	1,500			$	—			$	(7	)		$	1,493
Obligations of states and political subdivisions			9,105				—				(142	)			8,963
Private-label mortgage-backed securities			819				—				(56	)			763
Mortgage-backed securities			24,477				—				(116	)			24,361
SBA variable rate pools			12,919				—				(44	)			12,875
		$	48,820			$	—			$	(365	)		$	48,455
Unrealized Gain Positions
Obligations of U.S. government agencies		$	44,141			$	1,258			$	—			$	45,399
Obligations of states and political subdivisions			73,500				3,767				—				77,267
Private-label mortgage-backed securities			2,707				130				—				2,837
Mortgage-backed securities			179,851				3,805				—				183,656
SBA variable rate pools			20,880				104				—				20,984
Corporate bonds			898				1				—				899
		$	321,977			$	9,065			$	—			$	331,042
		$	370,797			$	9,065			$	(365	)		$	379,497

At March 31, 2015, of the 444 investment securities held, there were 48 in unrealized loss positions. Unrealized losses existed on certain securities classified as obligations of U.S. government agencies, obligations of state and political subdivisions, private-label mortgage-backed securities, mortgage-backed securities and SBA variable rate pools. The unrealized losses on mortgage-backed securities, securities that are obligations of U.S. government agencies, obligations of state and political subdivisions, and SBA variable rate pools were deemed to be temporary, as these securities retain strong credit ratings, continue to perform adequately, and are backed by various government-sponsored enterprises. These decreases in fair value are associated with the changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and are not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal is expected.

 

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The following table presents a summary of securities in a continuous unrealized loss position at March 31, 2015:

 

		Securities in Continuous Unrealized Loss Position for Less Than 12 Months				Gross Unrealized Loss on Securities in Loss Position for Less Than 12 Months				Securities in Continuous Unrealized Loss Position for 12 Months or Longer				Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
Obligations of U.S. government agencies		$	—			$	—			$	1,493			$	7
Obligations of states and political subdivisions			5,570				65				3,393				77
Private-label mortgage-backed securities			293				15				470				41
Mortgage-backed securities			18,942				32				5,419				84
SBA variable rate pools			10,846				42				2,029				2
		$	35,651			$	154			$	12,804			$	211

During the first quarter 2015, management reviewed all private label mortgage backed securities for the presence of other-than-temporary impairment (“OTTI”) and determined no additional OTTI was required. Management’s OTTI evaluation included the use of independently generated third-party credit surveillance reports that analyze the loans underlying each security. These reports include estimates of default rates and severities, life collateral loss rates, and static voluntary prepayment assumptions to generate estimated cash flows at the individual security level. Additionally, management considered factors such as downgraded credit ratings, severity and duration of the impairments, the stability of the issuers, and any discounts paid when the securities were purchased. Management has considered all available information related to the collectability of the impaired investment securities and believes that the estimated credit loss is appropriate.

Following is a tabular roll-forward of the amount of credit-related OTTI recognized in earnings during the three months ended March 31, 2015, and 2014:

 

		Three months ended
		March 31,
		2015				2014
Balance, beginning of period:		$	227			$	227
Additions:
Initial OTTI credit loss			—				—
Balance, end of period:		$	227			$	227

At March 31, 2015, six of the Company’s private-label mortgage-backed securities with an amortized cost of $1,811 were classified as substandard as their underlying credit was considered impaired. Securities with an amortized cost of $1,879 and $2,515 were classified as substandard at December 31, 2014, and March 31, 2014, respectively.

At March 31, 2015, the projected average life of the securities portfolio was 3.79 years.

 

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The amortized cost and estimated fair values of securities available-for-sale at December 31, 2014, were as follows:

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Unrealized Loss Positions
Obligations of U.S. government agencies		$	7,573			$	—			$	(72	)		$	7,501
Obligations of states and political subdivisions			11,755				—				(253	)			11,502
Private-label mortgage-backed securities			847				—				(64	)			783
Mortgage-backed securities			64,644				—				(544	)			64,100
SBA variable rate pools			13,059				—				(56	)			13,003
		$	97,878			$	—			$	(989	)		$	96,889
Unrealized Gain Positions
Obligations of U.S. government agencies		$	31,068			$	616			$	—			$	31,684
Obligations of states and political subdivisions			69,172				3,307				—				72,479
Private-label mortgage-backed securities			2,924				109				—				3,033
Mortgage-backed securities			138,306				2,984				—				141,290
SBA variable rate pools			6,541				30				—				6,571
		$	248,011			$	7,046			$	—			$	255,057
		$	345,889			$	7,046			$	(989	)		$	351,946

At December 31, 2014, of the 409 investment securities held, there were 71 in unrealized loss positions. The following table presents a summary of securities in a continuous unrealized loss position at December 31, 2014:

 

		Securities in Continuous Unrealized Loss Position for Less Than 12 Months				Gross Unrealized Loss on Securities in Loss Position for Less Than 12 Months				Securities in Continuous Unrealized Loss Position for 12 Months or Longer				Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
Obligations of U.S. government agencies		$	4,564			$	10			$	2,936			$	62
Obligations of states and political subdivisions			2,620				39				8,883				214
Private-label mortgage-backed securities			303				12				480				52
Mortgage-backed securities			40,269				177				23,831				366
SBA variable rate pools			11,833				49				1,169				8
		$	59,589			$	287			$	37,299			$	702

 

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The amortized cost and estimated fair values of securities available-for-sale at March 31, 2014, were as follows:

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Unrealized Loss Positions
Obligations of U.S. government agencies		$	26,622			$	—			$	(267	)		$	26,355
Obligations of states and political subdivisions			30,436				—				(1,118	)			29,318
Private-label mortgage-backed securities			2,187				—				(133	)			2,054
Mortgage-backed securities			72,462				—				(1,126	)			71,336
SBA variable rate pool			5,425				—				(52	)			5,373
		$	137,132			$	—			$	(2,696	)		$	134,436
Unrealized Gain Positions
Obligations of U.S. government agencies		$	10,023			$	92			$	—			$	10,115
Obligations of states and political subdivisions			46,912				1,991				—				48,903
Private-label mortgage-backed securities			2,911				96				—				3,007
Mortgage-backed securities			139,104				2,798				—				141,902
SBA variable rate pool			3,608				21				—				3,629
		$	202,558			$	4,998			$	—			$	207,556
		$	339,690			$	4,998			$	(2,696	)		$	341,992

 

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At March 31, 2014, of the 445 investments held, there were 187 investment securities in unrealized loss positions. The following table presents a summary of securities in a continuous unrealized loss position at March 31, 2014:

 

		Securities in Continuous Unrealized Loss Position for Less Than 12 Months				Gross Unrealized Loss on Securities in Loss Position for Less Than 12 Months				Securities in Continuous Unrealized Loss Position for 12 Months or Longer				Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
Obligations of U.S. government agencies		$	26,355			$	267			$	—			$	—
Obligations of states and political subdivisions			20,676				532				8,642				586
Private-label mortgage-backed securities			841				6				1,213				127
Mortgage-backed securities			47,988				584				23,348				542
SBA variable rate pools			5,373				52				—				—
		$	101,233			$	1,441			$	33,203			$	1,255

The amortized cost and estimated fair value of securities at March 31, 2015, December 31, 2014, and March 31, 2014, by maturity are shown below. Obligations of U.S. government agencies and states and political subdivisions are shown by contractual maturity. Mortgage-backed securities and SBA variable pools are shown by projected average life.

 

		March 31, 2015								December 31, 2014								March 31, 2014
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
Due in one year or less		$	20,822			$	21,057			$	17,072			$	17,273			$	11,746			$	11,934
Due after one year through 5 years			231,789				235,865				220,908				223,540				212,733				214,846
Due after 5 years through 10 years			84,847				88,066				69,523				71,584				76,269				76,537
Due after 10 years			33,339				34,509				38,386				39,549				38,942				38,675
		$	370,797			$	379,497			$	345,889			$	351,946			$	339,690			$	341,992

Nine securities were sold during the first quarter 2015 for a total book value of $6,573 and a gain of $53. The sold securities included four mortgage-backed securities and five obligations of states and political subdivisions securities. During first quarter 2014, the Company sold 71 securities with a book value of $25,276 for a gain of $63.

At March 31, 2015, securities with an aggregate amortized cost of $33,249 (estimated aggregate market value of $34,478) were pledged to secure certain public deposits as required by law. At March 31, 2015, securities with an aggregate amortized cost of $3,977 (estimated aggregate market value of $4,125) were pledged for repurchase accounts. At March 31, 2015, there was a balance of $53 for repurchase agreements.

 

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

Loans are stated at the amount of unpaid principal net of loan premiums or discounts for purchased loans, net deferred loan origination fees, discounts associated with retained portions of loans sold, and an allowance for loan losses. Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding. Loan origination fees, net of origination costs and discounts, are amortized over the lives of the loans as adjustments to yield.

Major classifications of period-end loans are as follows:

 

		March 31,				% of Gross				December 31,				% of Gross				March 31,				% of Gross
		2015				Loans				2014				Loans				2014				Loans
Real estate loans
Multi-family residential		$	69,968				5.57	%		$	51,586				4.93	%		$	51,182				5.01	%
Residential 1-4 family			55,702				4.44	%			47,222				4.51	%			46,557				4.56	%
Owner-occupied commercial			337,058				26.84	%			259,805				24.84	%			250,211				24.50	%
Nonowner-occupied commercial			256,119				20.39	%			201,558				19.27	%			168,888				16.54	%
Total permanent real estate loans			718,847				57.24	%			560,171				53.55	%			516,838				50.61	%
Construction loans
Multi-family residential			7,318				0.58	%			8,472				0.81	%			22,717				2.22	%
Residential 1-4 family			28,913				2.30	%			28,109				2.69	%			25,859				2.53	%
Commercial real estate			25,477				2.03	%			18,595				1.78	%			34,936				3.42	%
Commercial bare land and acquisition & development			11,987				0.95	%			12,159				1.16	%			11,456				1.12	%
Residential bare land and acquisition & development			6,272				0.50	%			6,632				0.63	%			7,011				0.71	%
Total construction real estate loans			79,967				6.36	%			73,967				7.07	%			101,979				10.00	%
Total real estate loans			798,814				63.60	%			634,138				60.62	%			618,817				60.61	%
Commercial loans			449,793				35.82	%			406,568				38.87	%			397,738				38.95	%
Consumer loans			3,528				0.28	%			3,862				0.37	%			3,518				0.34	%
Other loans			3,742				0.30	%			1,443				0.14	%			1,042				0.10	%
Gross loans			1,255,877				100.00	%			1,046,011				100.00	%			1,021,115				100.00	%
Deferred loan origination fees			(1,171	)							(990	)							(970	)
			1,254,706								1,045,021								1,020,145
Allowance for loan losses			(15,724	)							(15,637	)							(15,394	)
Total loans, net of allowance for loan losses and net deferred fees		$	1,238,982							$	1,029,384							$	1,004,751

At March 31, 2015, outstanding loans to dental professionals totaled $311,006 and represented 24.76% of total outstanding loans, compared to dental professional loans of $306,391 or 29.29% of total outstanding loans at December 31, 2014, and $305,755 or 29.94% of total outstanding loans at March 31, 2014. See Note 5 for additional information on the dental loan portfolio. There are no other industry concentrations in excess of 10% of the total loan portfolio. However, as of March 31, 2015, 63.60% of the Company’s loan portfolio was collateralized by real estate and is, therefore, susceptible to changes in real estate market conditions.

 

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Allowance for Loan Losses

A summary of activity in the allowance for loan losses for the three months ended March 31, 2015, and 2014 is as follows:

 

		Three months ended
		March 31,
		2015				2014
Balance, beginning of period		$	15,637			$	15,917
Provision charged to income			—				—
Loans charged against allowance			(73	)			(601	)
Recoveries credited to allowance			160				78
Balance, end of period		$	15,724			$	15,394

The allowance for loan losses is established as an amount that management considers adequate to absorb possible losses on existing loans within the portfolio. The allowance consists of general, specific, and unallocated components. The general component is based upon all loans collectively evaluated for impairment. The specific component is based upon all loans individually evaluated for impairment. The unallocated component represents credit losses inherent in the loan portfolio that may not have been contemplated in the general risk factors or the specific allowance analysis. Loans are charged against the allowance when management believes the collection of principal or interest is unlikely.

The Company performs regular credit reviews of the loan portfolio to determine the credit quality and adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process and on an ongoing basis by management. The Company’s internal risk rating methodology assigns risk ratings ranging from one to ten, where a higher rating represents higher risk. The ten-point risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan losses.

Estimated credit losses reflect consideration of all significant factors that affect the collectability of the loan portfolio. The historical loss rate for each group of loans with similar risk characteristics is determined based on the Company’s own loss experience in that group. Historical loss experience and recent trends in losses provide a reasonable starting point for analysis, however they do not by themselves form a sufficient basis to determine the appropriate level for the allowance for loan losses. Qualitative or environmental factors that are likely to cause estimated credit losses to differ from historical losses are also considered, including but not limited to:

 

•

Changes in international, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments,

 

•

Changes in the nature and volume of the portfolio and in the terms of loans,

 

•

Changes in the experience, ability, and depth of lending management and other relevant staff,

 

•

Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans,

 

•

Changes in the quality of the institution’s loan review system,

 

•

Changes in the value of underlying collateral for collateral-dependent loans,

 

•

The existence and effect of any concentrations of credit, and changes in the level of such concentrations,

 

•

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio,

 

•

Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses, and

 

•

Changes in the current and future US political environment, including debt ceiling negotiations, government shutdown and healthcare reform, that may affect national, regional and local economic conditions, taxation, or disruption of national or global financial markets.

 

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The adequacy of the allowance for loan losses and the reserve for unfunded commitments is determined using a systematic methodology and is monitored regularly based on management’s evaluation of numerous factors. For each portfolio segment, these factors include:

 

•

The quality of the current loan portfolio,

 

•

The trend in the migration of the loan portfolio’s risk ratings,

 

•

The velocity of migration of losses and potential losses,

 

•

Current economic conditions,

 

•

Loan concentrations,

 

•

Loan growth rates,

 

•

Past-due and nonperforming trends,

 

•

Evaluation of specific loss estimates for all significant problem loans,

 

•

Recovery experience, and

 

•

Peer comparison loss rates.

A summary of the activity in the allowance for loan losses by major loan classification follows:

 

						For the three months ended March 31, 2015
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Beginning balance		$	5,733			$	7,494			$	1,077			$	54			$	1,279			$	15,637
Charge-offs			(32	)			(41	)			—				—				—				(73	)
Recoveries			104				45				5				6				—				160
Provision (reclassification)			(255	)			39				(20	)			(8	)			244				—
Ending balance		$	5,550			$	7,537			$	1,062			$	52			$	1,523			$	15,724

 

		For the three months ended March 31, 2014
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Beginning balance		$	5,113			$	7,668			$	1,493			$	68			$	1,575			$	15,917
Charge-offs			(417	)			(24	)			(155	)			(5	)			—				(601	)
Recoveries			72				1				3				2				—				78
Provision (reclassification)			635				(416	)			242				(2	)			(459	)			—
Ending balance		$	5,403			$	7,229			$	1,583			$	63			$	1,116			$	15,394

At March 31, 2015, the allowance for loan losses on dental loans was $3,912 compared to $4,187 at December 31, 2014 and $3,901 at March 31, 2014. See Note 5 for additional information on the dental loan portfolio.

 

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		Balances as of March 31, 2015
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Ending allowance: collectively evaluated for impairment		$	5,492			$	7,482			$	949			$	52			$	1,523			$	15,498
Ending allowance: individually evaluated for impairment			58				55				113				—				—				226
Total ending allowance		$	5,550			$	7,537			$	1,062			$	52			$	1,523			$	15,724
Ending loan balance: collectively evaluated for impairment		$	451,040			$	712,869			$	79,449			$	3,528			$	—			$	1,246,886
Ending loan balance: individually evaluated for impairment			2,495				5,978				518				—				—				8,991
Total ending loan balance		$	453,535			$	718,847			$	79,967			$	3,528			$	—			$	1,255,877
		Balances as of December 31, 2014
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Ending allowance: collectively evaluated for impairment		$	5,662			$	7,438			$	959			$	54			$	1,279			$	15,392
Ending allowance: individually evaluated for impairment			71				56				118				—				—				245
Total ending allowance		$	5,733			$	7,494			$	1,077			$	54			$	1,279			$	15,637
Ending loan balance: collectively evaluated for impairment		$	405,414			$	555,146			$	73,610			$	3,862			$	—			$	1,038,032
Ending loan balance: individually evaluated for impairment			2,597				5,025				357				—				—				7,979
Total ending loan balance		$	408,011			$	560,171			$	73,967			$	3,862			$	—			$	1,046,011
		Balances as of March 31, 2014
		Commercial and Other				Real Estate				Construction				Consumer				Unallocated				Total
Ending allowance: collectively evaluated for impairment		$	5,286			$	7,229			$	1,457			$	63			$	1,116			$	15,151
Ending allowance: individually evaluated for impairment			117				—				126				—				—				243
Total ending allowance		$	5,403			$	7,229			$	1,583			$	63			$	1,116			$	15,394
Ending loan balance: collectively evaluated for impairment		$	392,976			$	511,951			$	101,609			$	3,518			$	—			$	1,010,054
Ending loan balance: individually evaluated for impairment			5,804				4,887				370				—				—				11,061
Total ending loan balance		$	398,780			$	516,838			$	101,979			$	3,518			$	—			$	1,021,115

Management believes that the allowance for loan losses was adequate as of March 31, 2015. However, future loan losses may exceed the levels provided for in the allowance for loan losses and could possibly result in additional charges to the provision for loan losses.

 

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Credit Quality Indicators

The Company uses the following loan grades, which are also often used by regulators when assessing the credit quality of a loan portfolio.

Pass – Credit exposure in this category ranges between the highest credit quality to average credit quality. Primary repayment sources generate satisfactory debt service coverage under normal conditions. Cash flow from recurring sources is expected to continue to produce adequate debt service capacity. There are many levels of credit quality contained in the Pass definition, but none of the loans contained in this category rise to the level of Special Mention. This category includes loans with an internal risk rating of 1-6.

Special Mention – A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. The Bank strictly and carefully employs the FDIC definition in assessing assets that may apply to this category. It is apparent that in many cases asset weaknesses relevant to this definition either (1) better fit a definition of a “well-defined weakness,” or (2) in management’s experience ultimately migrate to worse risk grade categories, such as Substandard and Doubtful. Consequently, management elects to downgrade most potential Special Mention credits to Substandard or Doubtful, and therefore adopts a conservative risk grade process in the use of the Special Mention risk grade. This category includes loans with an internal risk rating of 7.

Substandard – A Substandard asset is inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans in this category are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified Substandard. This category includes loans with an internal risk rating of 8.

Doubtful – An asset classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values, highly questionable and improbable. This category includes loans with an internal risk rating of 9.

Management strives to consistently apply these definitions when allocating its loans by loan grade. The loan portfolio is continuously monitored for changes in credit quality and management takes appropriate action to update the loan risk ratings accordingly. Management has not changed the Company’s policy towards its use of credit quality indicators during the periods reported.

 

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The following tables present the Company’s loan portfolio information by loan type and credit grade at March 31, 2015, December 31, 2014, and March 31, 2014:

Credit Quality Indicators

As of March 31, 2015

 

		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Real estate loans
Multi-family residential		$	68,464			$	—			$	1,504			$	—			$	69,968
Residential 1-4 family			47,851				—				7,851				—				55,702
Owner-occupied commercial			325,628				—				11,430				—				337,058
Nonowner-occupied commercial			252,641				—				3,478				—				256,119
Total real estate loans			694,584				—				24,263				—				718,847
Construction
Multi-family residential			7,318				—				—				—				7,318
Residential 1-4 family			28,747				—				166				—				28,913
Commercial real estate			24,333				—				1,144				—				25,477
Commercial bare land and acquisition & development			11,697				—				290				—				11,987
Residential bare land and acquisition & development			5,765				—				507				—				6,272
Total construction loans			77,860				—				2,107				—				79,967
Commercial and other			439,566				—				13,969				—				453,535
Consumer			3,526				—				2				—				3,528
Totals		$	1,215,536			$	—			$	40,341			$	—			$	1,255,877

Credit Quality Indicators

As of December 31, 2014

 

		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Real estate loans
Multi-family residential		$	50,074			$	—			$	1,512			$	—			$	51,586
Residential 1-4 family			39,527				—				7,695				—				47,222
Owner-occupied commercial			254,166				—				5,639				—				259,805
Nonowner-occupied commercial			197,940				—				3,618				—				201,558
Total real estate loans			541,707				—				18,464				—				560,171
Construction
Multi-family residential			8,472				—				—				—				8,472
Residential 1-4 family			28,109				—				—				—				28,109
Commercial real estate			17,645				—				950				—				18,595
Commercial bare land and acquisition & development			11,917				—				242				—				12,159
Residential bare land and acquisition & development			5,954				—				678				—				6,632
Total construction loans			72,097				—				1,870				—				73,967
Commercial and other			395,918				—				12,093				—				408,011
Consumer			3,854				—				8				—				3,862
Totals		$	1,013,576			$	—			$	32,435			$	—			$	1,046,011

 

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Credit Quality Indicators

As of March 31, 2014

 

		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Real estate loans
Multi-family residential		$	49,648			$	—			$	1,534			$	—			$	51,182
Residential 1-4 family			38,433				—				8,124				—				46,557
Owner-occupied commercial			240,330				4,254				5,627				—				250,211
Nonowner-occupied commercial			163,401				—				5,487				—				168,888
Total real estate loans			491,812				4,254				20,772				—				516,838
Construction
Multi-family residential			22,717				—				—				—				22,717
Residential 1-4 family			25,425				—				434				—				25,859
Commercial real estate			33,398				—				1,538				—				34,936
Commercial bare land and acquisition & development			11,234				—				222				—				11,456
Residential bare land and acquisition & development			4,378				—				2,633				—				7,011
Total construction loans			97,152				—				4,827				—				101,979
Commercial and other			385,605				—				12,216				959				398,780
Consumer			3,499				—				19				—				3,518
Totals		$	978,068			$	4,254			$	37,834			$	959			$	1,021,115

At March 31, 2015, December 31, 2014, and March 31, 2014, the Company had $931, $562 and $420, respectively, in unfunded commitments on its classified loans, which is included in the calculation of our classified asset ratio.

 

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Past Due and Nonaccrual Loans

The Company uses the terms “past due” and “delinquent” interchangeably. Amortizing loans are considered past due or delinquent based upon the number of contractually required payments not made. Delinquency status for all contractually matured loans, commercial and commercial real estate loans with non-monthly amortization, and all other extensions of credit is determined based upon the number of calendar months past due.

The following tables present an aging analysis of past due and nonaccrual loans at March 31, 2015, December 31, 2014, and March 31, 2014:

Age Analysis of Loans Receivable

As of March 31, 2015

 

										Greater
		30-59 Days				60-89 Days				Than 90 days								Total Past
		Past Due				Past Due				Past Due								Due and				Total				Total Loans
		Still Accruing				Still Accruing				Still Accruing				Nonaccrual				Nonaccrual				Current				Receivable
Real estate loans
Multi-family residential		$	1,507			$	—			$	—			$	—			$	1,507			$	68,461			$	69,968
Residential 1-4 family			216				—				—				830				1,046				54,656				55,702
Owner-occupied commercial			1,624				—				—				1,117				2,741				334,317				337,058
Nonowner-occupied commercial			—				—				—				897				897				255,222				256,119
Total real estate loans			3,347				—				—				2,844				6,191				712,656				718,847
Construction
Multi-family residential			—				—				—				—				—				7,318				7,318
Residential 1-4 family			—				—				—				166				166				28,747				28,913
Commercial real estate			—				—				—				—				—				25,477				25,477
Commercial bare land and acquisition & development			—				—				—				—				—				11,987				11,987
Residential bare land and acquisition & development			144				—				—				—				144				6,128				6,272
Total construction loans			144				—				—				166				310				79,657				79,967
Commercial and other			831				495				—				1,067				2,393				451,142				453,535
Consumer			5				1				—				—				6				3,522				3,528
Total		$	4,327			$	496			$	—			$	4,077			$	8,900			$	1,246,977			$	1,255,877

Age Analysis of Loans Receivable

As of December 31, 2014

 

										Greater
		30-59 Days				60-89 Days				Than 90 days								Total Past
		Past Due				Past Due				Past Due								Due and				Total				Total Loans
		Still Accruing				Still Accruing				Still Accruing				Nonaccrual				Nonaccrual				Current				Receivable
Real estate loans
Multi-family residential		$	—			$	—			$	—			$	—			$	—			$	51,586			$	51,586
Residential 1-4 family			568				—				—				320				888				46,334				47,222
Owner-occupied commercial			—				—				—				599				599				259,206				259,805
Nonowner-occupied commercial			605				—				—				906				1,511				200,047				201,558
Total real estate loans			1,173				—				—				1,825				2,998				557,173				560,171
Construction
Multi-family residential			—				—				—				—				—				8,472				8,472
Residential 1-4 family			—				—				—				—				—				28,109				28,109
Commercial real estate			—				—				—				—				—				18,595				18,595
Commercial bare land and acquisition & development			—				—				—				—				—				12,159				12,159
Residential bare land and acquisition & development			—				—				—				—				—				6,632				6,632
Total construction loans			—				—				—				—				—				73,967				73,967
Commercial and other			327				—				—				870				1,197				406,814				408,011
Consumer			4				1				—				—				5				3,857				3,862
Total		$	1,504			$	1			$	—			$	2,695			$	4,200			$	1,041,811			$	1,046,011

 

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Age Analysis of Loans Receivable

As of March 31, 2014

 

										Greater
		30-59 Days				60-89 Days				Than 90 days								Total Past
		Past Due				Past Due				Past Due								Due and				Total				Total Loans
		Still Accruing				Still Accruing				Still Accruing				Nonaccrual				Nonaccrual				Current				Receivable
Real estate loans
Multi-family residential		$	—			$	—			$	—			$	—			$	—			$	51,182			$	51,182
Residential 1-4 family			198				—				—				752				950				45,607				46,557
Owner-occupied commercial			—				—				—				1,651				1,651				248,560				250,211
Nonowner-occupied commercial			1,068				—				—				136				1,204				167,684				168,888
Total real estate loans			1,266				—				—				2,539				3,805				513,033				516,838
Construction
Multi-family residential			—				—				—				—				—				22,717				22,717
Residential 1-4 family			—				—				—				—				—				25,859				25,859
Commercial real estate			—				—				—				—				—				34,936				34,936
Commercial bare land and acquisition & development			—				—				—				—				—				11,456				11,456
Residential bare land and acquisition & development			—				—				—				—				—				7,011				7,011
Total construction loans			—				—				—				—				—				101,979				101,979
Commercial and other			747				—				—				2,623				3,370				395,410				398,780
Consumer			1				5				—				—				6				3,512				3,518
Total		$	2,014			$	5			$	—			$	5,162			$	7,181			$	1,013,934			$	1,021,115

Impaired Loans

Regular credit reviews of the portfolio are performed to identify loans that are considered potentially impaired. A loan is considered impaired when, based on current information and events, the Company is unlikely to collect all principal and interest due according to the terms of the loan agreement. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. Impaired loans are often reported net of government guarantees to the extent that the guarantees are expected to be collected. Impaired loans generally include all loans classified as nonaccrual and troubled debt restructurings. Impaired loans are included in the specific calculation of allowance for loan losses.

Accrual of interest is discontinued on impaired loans when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal or interest is doubtful. Accrued but uncollected interest is generally reversed when loans are placed on nonaccrual status. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized. Interest income may be recognized on impaired loans that are not on nonaccrual status.

 

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The following tables display an analysis of the Company’s impaired loans at March 31, 2015, December 31, 2014, and March 31, 2014:

Impaired Loan Analysis

As of March 31, 2015

 

		Recorded				Recorded
		Investment				Investment																Related
		With No Specific				With Specific								Unpaid				Average				Specific
		Allowance				Allowance				Recorded				Principal				Recorded				Allowance
		Valuation				Valuation				Investment				Balance				Investment				Valuation
Real estate
Multi-family residential		$	—			$	—			$	—			$	—			$	—			$	—
Residential 1-4 family			1,025				312				1,337				1,850				1,031				1
Owner-occupied commercial			2,153				—				2,153				2,439				1,817				—
Nonowner-occupied commercial			2,434				54				2,488				2,585				2,467				54
Total real estate loans			5,612				366				5,978				6,874				5,315				55
Construction
Multi-family residential			—				—				—				—				—				—
Residential 1-4 family			166				—				166				166				57				—
Commercial real estate			—				—				—				—				—				—
Commercial bare land and acquisition & development			—				—				—				—				—				—
Residential bare land and acquisition & development			—				352				352				352				354				113
Total construction loans			166				352				518				518				411				113
Commercial and other			1,774				721				2,495				2,865				2,541				58
Consumer			—				—				—				—				—				—
Total impaired loans		$	7,552			$	1,439			$	8,991			$	10,257			$	8,267			$	226

Impaired Loan Analysis

As of December 31, 2014

 

		Recorded				Recorded
		Investment				Investment																Related
		With No Specific				With Specific								Unpaid				Average				Specific
		Allowance				Allowance				Recorded				Principal				Recorded				Allowance
		Valuation				Valuation				Investment				Balance				Investment				Valuation
Real estate
Multi-family residential		$	—			$	—			$	—			$	—			$	—			$	—
Residential 1-4 family			564				313				877				1,181				1,123				2
Owner-occupied commercial			1,645				—				1,645				1,878				2,372				—
Nonowner-occupied commercial			2,449				54				2,503				2,523				1,927				54
Total real estate loans			4,658				367				5,025				5,582				5,422				56
Construction
Multi-family residential			—				—				—				—				—				—
Residential 1-4 family			—				—				—				—				—				—
Commercial real estate			—				—				—				—				—				—
Commercial bare land and acquisition & development			—				—				—				—				—				—
Residential bare land and acquisition & development			—				357				357				357				365				118
Total construction loans			—				357				357				357				365				118
Commercial and other			2,025				572				2,597				2,946				3,924				71
Consumer			—				—				—				—				—				—
Total impaired loans		$	6,683			$	1,296			$	7,979			$	8,885			$	9,711			$	245

 

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Impaired Loan Analysis

As of March 31, 2014

 

		Recorded Investment With No Specific Allowance Valuation				Recorded Investment With Specific Allowance Valuation				Recorded Investment				Unpaid Principal Balance				Average Recorded Investment				Related Specific Allowance Valuation
Real estate
Multi-family residential		$	—			$	—			$	—			$	—			$	—			$	—
Residential 1-4 family			1,019				317				1,336				1,764				1,260				—
Owner-occupied commercial			2,723				—				2,723				2,956				2,737				—
Nonowner-occupied commercial			828				—				828				830				829				—
Total real estate loans			4,570				317				4,887				5,550				4,826				—
Construction
Multi-family residential			—				—				—				—				—				—
Residential 1-4 family			—				—				—				—				—				—
Commercial real estate			—				—				—				—				—				—
Commercial bare land and acquisition & development			—				—				—				—				—				—
Residential bare land and acquisition & development			—				370				370				370				372				126
Total construction loans			—				370				370				370				372				126
Commercial and other			4,320				1,484				5,804				11,523				5,394				117
Consumer			—				—				—				—				—				—
Total impaired loans		$	8,890			$	2,171			$	11,061			$	17,443			$	10,592			$	243

The impaired balances reported above are not adjusted for government guarantees of $1,607, $1,123, and $2,194 at March 31, 2015, December 31, 2014, and March 31, 2014, respectively. The recorded investment in impaired loans, net of government guarantees, totaled $7,384, $6,856 and $8,867 at March 31, 2015, December 31, 2014, and March 31, 2014, respectively.

 

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Troubled Debt Restructurings

In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties.

The following table displays the Company’s TDRs by class at March 31, 2015, December 31, 2014, and March 31, 2014:

 

		Troubled Debt Restructurings as of
		March 31, 2015								December 31, 2014								March 31, 2014
		Number of Contracts				Post-Modification Outstanding Recorded Investment				Number of Contracts				Post-Modification Outstanding Recorded Investment				Number of Contracts				Post-Modification Outstanding Recorded Investment
Real estate
Multifamily residential			—			$	—				—			$	—				—			$	—
Residential 1-4 family			6				713				7				768				7				805
Owner-occupied commercial			2				1,037				2				1,046				5				1,925
Non owner-occupied commercial			7				2,438				7				2,503				2				714
Total real estate loans			15				4,188				16				4,317				14				3,444
Construction
Multifamily residential			—				—				—				—				—				—
Residential 1-4 family			—				—				—				—				—				—
Commercial real estate			—				—				—				—				—				—
Commercial bare land and acquisition & development			—				—				—				—				—				—
Residential bare land and acquisition & development			—				—				—				—				—				—
Total construction loans			—				—				—				—				—				—
Commercial and other			12				2,189				12				2,259				10				2,488
Consumer			—				—				—				—				—				—
Total			27			$	6,377				28			$	6,576				24			$	5,932

The recorded investment in TDRs on nonaccrual status totaled $1,814, $1,649, and $1,475 at March 31, 2015, December 31, 2014, and March 31, 2014, respectively. The Company’s policy is that loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Company’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

For the three months ended March 31, 2015, the Company identified no TDRs that were newly considered impaired for which impairment was previously measured under the Company’s general loan loss allowance methodology.

The types of modifications offered can generally be described in the following categories:

Rate Modification - A modification in which the interest rate is modified.

Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest-only Modification - A modification in which the loan is converted to interest-only payments for a period of time.

Combination Modification - Any other type of modification, including the use of multiple types of modifications.

 

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There were no newly restructured loans identified in the three months ended March 31, 2015. Below is a table of the newly restructured loans identified in the three months ended March 31, 2014.

 

		Troubled Debt Restructurings Identified During the Three Months ended March 31, 2014
		Rate Modification				Term Modification				Interest-only Modification				Combination Modification
Real estate
Multi-family residential		$	—			$	—			$	—			$	—
Residential 1-4 family			—				—				—				—
Owner-occupied commercial			—				—				—				—
Nonowner-occupied commercial			—				—				—				—
Total real estate loans			—				—				—				—
Construction
Multi-family residential			—				—				—				—
Residential 1-4 family			—				—				—				—
Commercial real estate			—				—				—				—
Commercial bare land and acquisition & development			—				—				—				—
Residential bare land and acquisition & development			—				—				—				—
Total construction loans			—				—				—				—
Commercial and other			—				285				496				—
Consumer			—				—				—				—
Total		$	—			$	285			$	496			$	—

Subsequent to a loan being classified as a TDR, a borrower may become unwilling or unable to abide by the terms of the modified agreement. In such cases of default, the Company takes appropriate action to recover principal and interest payments including the use of foreclosure proceedings. There were no TDRs that subsequently defaulted within the first twelve months of restructure during the periods ended March 31, 2015 and 2014.

At March 31, 2015, December 31, 2014, and March 31, 2014, the Company had no commitments to lend additional funds on loans restructured as TDRs.

NOTE 5 – DENTAL LOAN PORTFOLIO

Dental lending is not operated as a business segment, and dental loans are made in the normal course of commercial lending activities throughout the Company. However, to assist in understanding the concentrations and risks associated with the Company’s loan portfolio, the following Note has been included to provide additional information relating to the Company’s dental loan portfolio. At March 31, 2015, December 31, 2014, and March 31, 2014, loans to dental professionals totaled $311,006, $306,391, and $305,755, respectively, and represented 24.76%, 29.29% and 29.94% in principal amount of total outstanding loans, respectively. As of March 31, 2015, December 31, 2014, and March 31, 2014, the dental loans were supported by government guarantees totaling $11,916, $12,700 and $15,210, respectively. These guarantees represented 3.83%, 4.15% and 4.97% in principal amount of the outstanding dental loan balances as of such respective dates. The Company defines a “dental loan” as a loan to dental professionals for the purpose of practice expansion, acquisition or other purpose supported by the cash flows of a dental practice.

 

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Loan Classification

Major classifications of dental loans at March 31, 2015, December 31, 2014, and March 31, 2014, were as follows:

 

		March 31, 2015				December 31, 2014				March 31, 2014
Real estate secured loans:
Owner-occupied commercial		$	60,492			$	60,092			$	60,220
Other dental real estate loans			2,642				2,785				2,994
Total permanent real estate loans			63,134				62,877				63,214
Dental construction loans			744				604				4,058
Total real estate loans			63,878				63,481				67,272
Commercial loans			247,128				242,910				238,483
Gross loans		$	311,006			$	306,391			$	305,755

Market Area

The Bank’s defined “local market area” is within the states of Oregon and Washington, west of the Cascade Mountain Range. This area is serviced by branch locations in Eugene, Oregon; Portland, Oregon; and Seattle, Washington. The Company also makes national dental loans throughout the United States. National loan relationships are maintained and serviced by Bank personnel primarily located in Portland. The following table summarizes the Company’s dental lending by borrower location:

 

		March 31, 2015				December 31, 2014				March 31, 2014
Local		$	159,726			$	159,425			$	172,022
National			151,280				146,966				133,733
Total		$	311,006			$	306,391			$	305,755

Allowance

The allowance for loan losses identified for the dental loan portfolio is established as an amount that management considers adequate to absorb possible losses on existing loans within the dental loan portfolio. The allowance related to the dental loan portfolio consists of general and specific components. The general component is based upon all dental loans collectively evaluated for impairment, including qualitative conditions associated with loan type, national location, start-up financing, practice acquisition financing, and specialty practice financing. The specific component is based upon dental loans individually evaluated for impairment.

 

		Three months ended March 31,
		2015				2014
Balance, beginning of period		$	4,187			$	3,730
Provision (reclassification)			(241	)			578
Loans charged against allowance			(42	)			(416	)
Recoveries credited to allowance			8				9
Balance, end of period		$	3,912			$	3,901

 

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Credit Quality

Please refer to Note 4 for additional information on the definitions of the credit quality indicators.

The following tables present the Company’s dental loan portfolio by market and credit grade at March 31, 2015, December 31, 2014, and March 31, 2014:

 

As of March 31, 2015
		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Local		$	156,986			$	—			$	2,740			$	—			$	159,726
National			148,488				—				2,792				—				151,280
Total		$	305,474			$	—			$	5,532			$	—			$	311,006
As of December 31, 2014
		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Local		$	156,589			$	—			$	2,836			$	—			$	159,425
National			144,120				—				2,846				—				146,966
Total		$	300,709			$	—			$	5,682			$	—			$	306,391
As of March 31, 2014
		Loan Grade
		Pass				Special Mention				Substandard				Doubtful				Totals
Local		$	167,172			$	—			$	4,850			$	—			$	172,022
National			131,999				—				1,734				—				133,733
Total		$	299,171			$	—			$	6,584			$	—			$	305,755

 

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Past Due and Nonaccrual Loans

The following tables present an aged analysis of the dental loan portfolio by market, including nonaccrual loans, as of March 31, 2015, December 31, 2014, and March 31, 2014:

As of March 31, 2015

 

		30-59 Days Past Due Still Accruing				60-89 Days Past Due Still Accruing				Greater Than 90 Days Past Due Still Accruing				Nonaccrual				Total Past Due and Nonaccrual				Total Current				Total Loans Receivable
Local		$	319			$	—			$	—			$	542			$	861			$	158,865			$	159,726
National			—				—				—				—				—				151,280				151,280
Total		$	319			$	—			$	—			$	542			$	861			$	310,145			$	311,006
As of December 31, 2014
		30-59 Days Past Due Still Accruing				60-89 Days Past Due Still Accruing				Greater Than 90 Days Past Due Still Accruing				Nonaccrual				Total Past Due and Nonaccrual				Total Current				Total Loans Receivable
Local		$	327			$	—			$	—			$	597			$	924			$	158,501			$	159,425
National			—				—				—				—				—				146,966				146,966
Total		$	327			$	—			$	—			$	597			$	924			$	305,467			$	306,391
As of March 31, 2014
		30-59 Days Past Due Still Accruing				60-89 Days Past Due Still Accruing				Greater Than 90 Days Past Due Still Accruing				Nonaccrual				Total Past Due and Nonaccrual				Total Current				Total Loans Receivable
Local		$	601			$	—			$	—			$	1,924			$	2,525			$	169,497			$	172,022
National			—				—				—				224				224				133,509				133,733
Total		$	601			$	—			$	—			$	2,148			$	2,749			$	303,006			$	305,755

 

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NOTE 6 – FEDERAL FUNDS AND OVERNIGHT FUNDS PURCHASED

At March 31, 2015, the Company had unsecured federal funds borrowing lines with various correspondent banks totaling $129,000. At March 31, 2015, December 31, 2014, and March 31, 2014 there was $0, $0, and $5,620 outstanding on these lines, respectively.

The Company also has a secured overnight borrowing line available from the Federal Reserve Bank of San Francisco (“FRB”) that totaled $68,359, $65,084 and $96,615 at March 31, 2015, December 31, 2014, and March 31, 2014, respectively. At March 31, 2015, the FRB borrowing line was secured by the pledge of approximately $145,186 of commercial loans under the Company’s Borrower-In-Custody program. At March 31, 2015, December 31, 2014, and March 31, 2014, there were no outstanding borrowings on this line.

NOTE 7 – FEDERAL HOME LOAN BANK BORROWINGS

The Company has a borrowing limit with the Federal Home Loan Bank of Seattle (“FHLB”) equal to 30% of total assets, subject to the value of discounted collateral pledged. On January 12, 2015, the FHLB Seattle announced that the Federal Housing Finance Agency has approved the merger application of the FHLB Seattle and the FHLB Des Moines. On February 27, 2015, the FHLB Seattle announced that the members of both banks ratified the Agreement and Plan of Merger approved by their respective boards. The merger is expected to close May 31, 2015. At that time, the combined entity will be buying back excess stock above what is needed to support borrowings. If the merger is completed, this has the potential to result in a decrease of the Bank’s outstanding FHLB stock.

The Company does have the ability to access the FHLB excess stock pool, thus borrowing is not limited by FHLB stock held. At March 31, 2015, the maximum borrowing line was $534,255; however, the FHLB borrowing line was limited by the discounted value of collateral pledged. The Company had pledged $617,623 in real estate loans to the FHLB that had a discounted value of $403,638. There was $61,000 borrowed on this line at March 31, 2015.

At December 31, 2014, the maximum FHLB borrowing line was $451,298, and the Company had pledged real estate loans and securities to the FHLB with a discounted value of $318,854. There was $96,000 borrowed on this line at December 31, 2014.

At March 31, 2014, the maximum FHLB borrowing line was $441,477, and the Company had pledged real estate loans and securities to the FHLB with a discounted collateral value of $237,868. There was $175,000 borrowed on this line at March 31, 2014.

 

		Current		March 31,				December 31,				March 31,
		Rates		2015				2014				2014
Cash management advance		NA		$	—			$	—			$	—
2014		—			—				—				134,000
2015		0.28% - 1.60%			33,500				68,500				13,500
2016		1.84% - 2.36%			22,500				22,500				22,500
2017		2.28%			3,000				3,000				3,000
2018					—				—				—
2019					—				—				—
Thereafter		3.85%			2,000				2,000				2,000
				$	61,000			$	96,000			$	175,000

 

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NOTE 8 – SHARE-BASED COMPENSATION

The Company’s 2006 Stock Option and Equity Compensation Plan (the “2006 SOEC Plan”) authorizes the award of up to 1,550,000 shares in share-based awards. The awards granted under this plan are performance-based and are subject to vesting. The Compensation Committee of the Board of Directors may impose any terms or conditions on the vesting of an award that it determines to be appropriate. Awards granted generally vest over four years and have a maximum life of ten years. Awards may be granted at exercise prices of not less than 100% of the fair market value of the Company’s common stock at the grant date.

Pursuant to the 2006 SOEC Plan, incentive stock options (“ISOs”), nonqualified stock options, restricted stock, restricted stock units (“RSUs”), or stock appreciation rights (“SARs”) may be awarded to attract and retain the best available personnel to the Company and its subsidiaries. SARs may be settled in common stock or cash as determined at the date of issuance. Liability-based awards (including all cash-settled SARs) have no impact on the number of shares available to be issued within the plan. Additionally, non-qualified option awards and restricted stock awards may be granted to directors under the terms of this plan.

Prior to April 2006, ISO and non-qualified option awards were granted to employees and directors under the Company’s 1999 Employees’ Stock Option Plan and the Company’s 1999 Directors’ Stock Option Plan. The Company has stock options outstanding under both of these plans. Subsequent to the annual shareholders’ meeting in April 2006, all shares available under these plans were deregistered and are no longer available for future grants.

For the three months ended March 31, 2015, 7,052 RSUs were granted, these RSUs cliff vest January 1, 2019. Shares of common stock will be issued as soon as practicable upon vesting. There were no grants made during the three months ended March 31, 2014.

The following table summarizes the shares and the aggregate grant-date fair market values of the equity-based awards granted during the three months ended March 31, 2015:

 

		Three months ended March 31, 2015
		Shares				Grant Date Fair Market Value
Equity-based awards:
Director restricted stock			—			$	—
Employee stock options			—				—
Employee stock SARs			—				—
Employee RSUs			7,052				100
			7,052			$	100

There were no equity-based awards granted during the three months ended March 31, 2014.

 

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The following table provides a summary of the Company’s RSU activity, including the weighted average grant date fair value per share, for the three months ended March 31, 2015:

 

		Three months ended
		March 31, 2015
		Non-Vested Restricted Stock Units				Weighted Average Grant Date Fair Value
Balance, beginning of period			306,532			$	11.18
Granted			7,052				14.18
Vested shares issued			—				—
Vested shares surrendered for taxes			—				—
Forfeited or expired			(3,138	)			11.61
Balance, end of period			310,446			$	11.25

The following table identifies the compensation expense recorded and tax benefits received by the Company on its share-based compensation plans for the three months ended March 31, 2015, and 2014:

 

		Three months ended
		March 31,
		2015								2014
		Compensation Expense				Tax Benefit				Compensation Expense				Tax Benefit
Equity-based awards:
Director restricted stock		$	—			$	—			$	—			$	—
Employee stock options			—				—				13				—
Employee stock SARs			—				—				27				10
Employee RSUs			332				126				229				87
Liability-based awards:
Employee cash SARs			—				—				55				21
		$	332			$	126			$	324			$	118

The following table identifies stock options, employee stock SARs, and employee cash SARs exercised during the three months ended March 31, 2015:

 

		Three months ended
		March 31, 2015
		Number Exercised				Weighted Average Exercise Price				Intrinsic Value				Number of Shares Issued				Net Cash Payment to Employees
Stock options			1,102			$	12.25			$	2				1,102				NA
Employee stock SARs			613			$	11.69			$	1				—				NA
Employee cash SARs			208			$	12.07				NA				NA			$	—

No liability-based or equity-based awards vested during the three months ended March 31, 2015.

 

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The following table identifies stock options, employee stock SARs, and employee cash SARs exercised during the three months ended March 31, 2014:

 

		Three months ended
		March 31, 2014
		Number Exercised				Weighted Average Exercise Price				Intrinsic Value				Number of Shares Issued				Net Cash Payment to Employees
Stock options			16,779			$	11.29			$	57				—				NA
Employee stock SARs			12,179			$	11.92			$	22				1,440				NA
Employee cash SARs			4,226			$	12.28				NA				NA			$	5

No liability-based or equity-based awards vested during the three months ended March 31, 2014.

At March 31, 2015, the Company had estimated unrecognized compensation expense of approximately $2,142 for unvested RSUs. These amounts are based on historical forfeiture rates of 13.00% for all RSUs granted to employees. The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested RSUs was approximately 2.45 years as of March 31, 2015.

NOTE 9 – FAIR VALUE

The following table presents estimated fair values of the Company’s financial instruments as of March 31, 2015, December 31, 2014, and March 31, 2014, in accordance with the provisions of FASB ASC 825 “Financial Instruments.” The use of different assumptions and estimation methods could have a significant effect on the reported fair value amounts. Accordingly, the estimates of fair value herein are not necessarily indicative of the amounts that might be realized in a current market exchange.

 

		March 31, 2015								December 31, 2014								March 31, 2014
		Carrying								Carrying								Carrying
		Amount				Fair Value				Amount				Fair Value				Amount				Fair Value
Financial assets:
Cash and cash equivalents		$	38,209			$	38,209			$	25,787			$	25,787			$	27,584			$	27,584
Securities available-for-sale			379,497				379,497				351,946				351,946				341,992				341,992
Loans			1,254,706				1,239,718				1,045,021				1,033,254				1,020,145				1,005,718
Federal Home Loan Bank stock			10,531				10,531				10,019				10,019				10,327				10,327
Interest receivable			5,387				5,387				4,773				4,773				4,693				4,693
Bank-owned life insurance			22,401				22,401				16,609				16,609				16,253				16,253
Swap derivative			53				53				176				176				325				325
Financial liabilities:
Deposits		$	1,496,747			$	1,496,762			$	1,209,093			$	1,209,240			$	1,097,355			$	1,097,614
Federal funds and overnight funds purchased			—				—				—				—				5,620				5,620
Federal Home Loan Bank borrowings			61,000				61,710				96,000				96,721				175,000				175,978
Junior subordinated debentures			8,248				2,453				8,248				2,410				8,248				2,254
Accrued interest payable			197				197				176				176				201				201

 

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Cash and cash equivalents – The carrying amount approximates fair value.

Securities available-for-sale – Fair value is based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans – For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying values. Fair value of fixed rate loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable, and consider credit risk. The Company uses an independent third-party to establish the fair value of loans.

Federal Home Loan Bank stock – The carrying amount approximates fair value.

Interest receivable and payable – The carrying amounts of accrued interest receivable and payable approximate their fair value.

Bank-owned life insurance – The carrying amount is based on cash surrender value which approximates fair value.

Swap derivative – Fair value is based on quoted market prices.

Deposits – Fair value of demand, interest bearing demand and savings deposits is the amount payable on demand at the reporting date. Fair value of time deposits is estimated using the interest rates currently offered for deposits of similar remaining maturities. The Company uses an independent third-party to establish the fair value of time deposits.

Federal funds and overnight funds purchased – The carrying amount is a reasonable estimate of fair value because of the short-term nature of these borrowings.

Federal Home Loan Bank borrowings – Fair value of Federal Home Loan Bank borrowings is estimated by discounting future cash flows at rates currently available for debt with similar terms and remaining maturities.

Junior subordinated debentures – Fair value of junior subordinated debentures is estimated by discounting future cash flows at rates currently available for debt with similar credit risk, terms and remaining maturities.

Off-balance sheet financial instruments – The carrying amount and fair value are based on fees charged for similar commitments and are not material.

The Company also adheres to the FASB guidance with regards to ASC 820, “Fair Value Measures.” This guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The statement requires fair value measurement disclosure of all assets and liabilities that are carried at fair value on either a recurring or nonrecurring basis. The Company determines fair value based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available. The valuation techniques used are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:

 

•

Level 1 – Quoted prices for identical instruments in active markets.

 

•

Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active or model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

•

Level 3 – Unobservable inputs are used to measure fair value to the extent that observable inputs are not available. The Company’s own data used to develop unobservable inputs is adjusted for market consideration when reasonably available.

 

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Financial instruments, measured at fair value, are broken down in the tables below by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.

The following table presents information about the level in the fair value hierarchy for the Company’s assets and liabilities not measured and carried at fair value as of March 31, 2015, December 31, 2014, and March 31, 2014:

 

		Carrying Amount				Fair Value at March 31, 2015
						Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	38,209			$	38,209			$	—			$	—
Loans			1,254,706				—				—				1,239,718
Federal Home Loan Bank stock			10,531				10,531				—				—
Interest receivable			5,387				5,387				—				—
Financial liabilities:
Deposits		$	1,496,747			$	—			$	1,496,762			$	—
Federal funds and overnight funds purchased			—				—				—				—
Federal Home Loan Bank borrowings			61,000				—				61,710				—
Junior subordinated debentures			8,248				—				2,453				—
Accrued interest payable			197				197				—				—

 

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		Carrying Amount				Fair Value at December 31, 2014
						Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	25,787			$	25,787			$	—			$	—
Loans			1,045,021				—				—				1,033,254
Federal Home Loan Bank stock			10,019				10,019				—				—
Accrued interest receivable			4,773				4,773				—				—
Financial liabilities:
Deposits		$	1,209,093			$	—			$	1,209,240			$	—
Federal funds and overnight funds purchased			—				—				—				—
Federal Home Loan Bank borrowings			96,000				—				96,721				—
Junior subordinated debentures			8,248				—				2,410				—
Accrued interest payable			176				176				—				—

 

		Carrying Amount				Fair Value at March 31, 2014
						Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	27,584			$	27,584			$	—			$	—
Loans			1,020,145				—				—				1,005,718
Federal Home Loan Bank stock			10,327				10,327				—				—
Accrued interest receivable			4,693				4,693				—				—
Financial liabilities:
Deposits		$	1,097,355			$	—			$	1,097,614			$	—
Federal funds and overnight funds purchased			5,620				5,620				—				—
Federal Home Loan Bank borrowings			175,000				—				175,978				—
Junior subordinated debentures			8,248				—				2,254				—
Accrued interest payable			201				201				—				—

 

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The tables below show assets measured at fair value on a recurring basis as of March 31, 2015, December 31, 2014, and March 31, 2014:

 

		Carrying				Fair Value at March 31, 2015
		Value				Level 1				Level 2				Level 3
Available-for-sale securities
Obligations of U.S. government agencies		$	46,892			$	—			$	46,892			$	—
Obligations of states and political subdivisions			86,230				—				86,230				—
Mortgage-backed securities			208,017				—				208,017				—
Private-label mortgage-backed securities			3,600				—				2,056				1,544
SBA variable rate pools			33,859				—				33,859				—
Corporate securities			899				—				899				—
Swap derivative			53				53				—				—
Total assets measured on a recurring basis		$	379,550			$	53			$	377,953			$	1,544
		Carrying				Fair Value at December 31, 2014
		Value				Level 1				Level 2				Level 3
Available-for-sale securities
Obligations of U.S. government agencies		$	39,185			$	—			$	39,185			$	—
Obligations of states and political subdivisions			83,981				—				83,981				—
Mortgage-backed securities			205,390				—				205,390				—
Private-label mortgage-backed securities			3,816				—				2,248				1,568
SBA variable rate pools			19,574				—				19,574				—
Swap derivative			176				176				—				—
Total assets measured on a recurring basis		$	352,122			$	176			$	350,378			$	1,568
						Fair Value at March 31, 2014
		Value				Level 1				Level 2				Level 3
Available-for-sale securities
Obligations of U.S. government agencies		$	36,470			$	—			$	36,470			$	—
Obligations of states and political subdivisions			78,221				—				78,221				—
Mortgage-backed securities			213,238				—				213,238				—
Private-label mortgage-backed securities			5,061				—				3,287				1,774
SBA variable rate pools			9,002				—				9,002				—
Swap derivative			325				325				—				—
Total assets measured on a recurring basis		$	342,317			$	325			$	340,218			$	1,774

No transfers to or from Levels 1 and 2 occurred on assets measured at fair value on a recurring basis during the three months ended March 31, 2015, and 2014, or during the year ended December 31, 2014.

 

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The following is a description of the inputs and valuation methodologies used for assets recorded at fair value on a recurring basis. Fair value for all classes of available-for-sale securities is estimated by obtaining quoted market prices for identical assets, where available. If such prices are not available, fair value is based on independent asset pricing services and models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, prepayments, defaults, cumulative loss projections, and cash flows. Fair value of the swap derivative is determined by FTN Financial, and represents an active price quote which it would pay or the Bank would be charged to leave the swap early. There have been no significant changes in the valuation techniques during the periods reported.

The following table provides a reconciliation of assets measured at fair value on a recurring basis using unobservable inputs (Level 3) for the three months ended March 31, 2015, and 2014:

 

		Three months ended
		March 31,
		2015				2014
Beginning balance		$	1,568			$	1,786
Transfers to Level 3			—				—
Transfers out of Level 3			—				—
Total gains or losses
Included in earnings			—				—
Included in other comprehensive income			13				50
Paydowns			(37	)			(62	)
Purchases, issuances, sales and settlements
Purchases			—				—
Issuances			—				—
Sales			—				—
Settlements			—				—
Ending balance		$	1,544			$	1,774

The Company utilizes FTN Financial as a third-party pricing service to estimate fair value on all of its available-for-sale securities. The inputs used to value all securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data, including market research, market indicators, and industry and economic trends. Additional inputs specific to each asset type are as follows:

 

•

Obligations of U.S. government agencies – TRACE reported trades.

 

•

Obligations of states and political subdivisions – MSRB reported trades, material event notices, and Municipal Market Data (MMD) benchmark yields.

 

•

Private-label mortgage-backed securities – new issue data, monthly payment information, and collateral performance (whole loan collateral).

 

•

Mortgage-backed securities – TBA prices and monthly payment information.

 

•

SBA variable pools – TBA prices and monthly payment information.

Inputs may be prioritized differently on any given day for any security and not all inputs listed are available for use in the evaluation process on any given day for each security evaluation.

 

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The valuation methodology used by asset type includes:

 

•

Obligations of U.S. government agencies – security characteristics, defined sector break-down, benchmark yields, applied base spread, yield to maturity (bullet structures), corporate action adjustment, and evaluations based on T+3 settlement.

 

•

Obligations of states and political subdivisions – security characteristics, benchmark yields, applied base spread, yield to worst or market convention, ratings updates, prepayment schedules (housing bonds), material event notice adjustments, and evaluations based on T+3 settlement.

 

•

Private-label mortgage-backed securities – security characteristics, prepayment speeds, cash flows, TBA, Treasury and swap curves, IO/PO strips or floating indexes, applied base spread, spread adjustments, yield to worst or market convention, ratings updates (whole-loan collateral), and evaluations based on T+0 settlement.

 

•

Mortgage-backed securities – security characteristics, TBA, Treasury, or floating index benchmarks, spread to TBA levels, prepayment speeds, applied spreads, and evaluations based on T+0 settlement.

 

•

SBA variable pools – security characteristics, TBA, Treasury, or floating index benchmarks, spread to TBA levels, prepayment speeds, applied spreads, and evaluations based on T+0 settlement.

The third-party pricing service follows multiple review processes to assess the available market, credit and deal-level information to support its valuation estimates. If sufficient objectively verifiable information is not available to support a security’s valuation, an alternate independent evaluation source will be used.

The Company’s securities portfolio was valued through its independent third-party pricing service using evaluated pricing models and quoted prices based on market data. For further assurance, the Company’s estimate of fair value was compared to an additional independent third-party estimate at June 30, 2014, and the Company obtained key inputs for a sample of securities across sectors and evaluated those inputs for reasonableness. This analysis was performed at the individual security level and no material variances were noted.

There have been no significant changes in the valuation techniques during the periods reported.

 

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The tables below show assets measured at fair value on a nonrecurring basis as of March 31, 2015, December 31, 2014, and March 31, 2014:

 

		Carrying				Fair Value
March 31, 2015		Value				Level 1				Level 2				Level 3
Loans measured for impairment (net of government guarantees and specific reserves)		$	3,310			$	—			$	—			$	3,310
Other real estate owned			14,167				—				—				14,167
Total		$	17,477			$	—			$	—			$	17,477
		Carrying				Fair Value
December 31, 2014		Value				Level 1				Level 2				Level 3
Loans measured for impairment (net of government guarantees and specific reserves)		$	3,110			$	—			$	—			$	3,110
Other real estate owned			13,374				—				—				13,374
Total		$	16,484			$	—			$	—			$	16,484
		Carrying				Fair Value
March 31, 2014		Value				Level 1				Level 2				Level 3
Loans measured for impairment (net of government guarantees and specific reserves)		$	5,452			$	—			$	—			$	5,452
Other real estate owned			11,531				—				—				11,531
Total		$	16,983			$	—			$	—			$	16,983

 

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The following is a description of the inputs and valuation methodologies used for assets recorded at fair value on a nonrecurring basis.

Loans measured for impairment (net of government guarantees and specific reserves) include the estimated fair value of collateral-dependent loans, less collectible government guarantees, as well as certain noncollateral-dependent loans measured for impairment with an allocated specific reserve. When a collateral-dependent loan is identified as impaired, the value of the loan is measured using the current fair value of the collateral less selling costs. The fair value of collateral is generally estimated by obtaining external appraisals which are usually updated every 6 to 12 months based on the nature of the impaired loans. Certain noncollateral-dependent loans measured for impairment with an allocated specific reserve are valued based upon the estimated net realizable value of the loan. If the estimated fair value of the impaired loan, less collectible government guarantees, is less than the recorded investment in the loan, impairment is recognized as a charge-off through the allowance for loan losses. The carrying value of the loan is adjusted to the estimated fair value. The carrying value of loans fully charged off is zero.

Other real estate owned represents real estate which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically orders appraisals or performs valuations to ensure that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Appraisals are generally updated every 6 to 12 months on other real estate owned. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on other real estate owned for fair value adjustments based on the fair value of the real estate.

There have been no significant changes in the valuation techniques during the periods reported.

NOTE 10 – DERIVATIVE INSTRUMENTS

Derivative instruments are entered into primarily as a risk management tool of the Company to help manage its interest rate risk position. Financial derivatives are recorded at fair value as other assets and other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability are recognized currently in earnings. For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, are recorded in accumulated other comprehensive income and subsequently reclassified to earnings as the hedged transaction impacts net income. Any ineffective portion of a cash flow hedge is recognized currently in earnings.

During the second quarter 2013, the Company entered into an interest rate swap agreement with an $8,000 notional amount to convert its variable-rate Junior Subordinated Debenture debt into a fixed rate for a term of seven years at a rate of 2.73%. The derivative is designated as a cash flow hedge. The hedge meets the definition of highly effective and the Company expects the hedge to be highly effective throughout the remaining term of the swap. The fair value of the derivative instrument at March 31, 2015, was a $53 unrealized gain, which is recorded in the other asset section of the consolidated balance sheet, net of the tax effect. No gain or loss was recognized in earnings for the three months ended March 31, 2015, related to interest rate swaps.

The Company maintains written documentation for the hedge. This documentation identifies the hedging objective and strategy, the hedging instrument, the instrument being hedged, the reasoning behind the assertion that the hedge is highly effective and the methodology for measuring ongoing hedge effectiveness and ineffectiveness. The Company pledged $400 under collateral arrangements to satisfy collateral requirements associated with the interest rate swap contract.

 

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NOTE 11 – REGULATORY MATTERS

The Company and the Bank are subject to the regulations of certain federal and state agencies and receive periodic examinations by those regulatory authorities. In addition, they are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

In July 2013, the Federal Reserve Board and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the Basel Committee’s current international regulatory capital accord (Basel III). These rules were effective January 1, 2015 and replaced the federal banking agencies’ general risk-based capital rules, advanced approaches rule, market-risk rule, and leverage rules, in accordance with certain transition provisions. The new rules implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. When fully phased in, the final rules will provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.50%; (b) a Tier 1 capital ratio of 6.00% (which is an increase from 4.00%); (c) a total capital ratio of 8.00%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4.00%. The new rules permit depository institution holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, to include trust preferred securities in Tier 1 capital.

The new rules made it optional for banks and bank holding companies to include accumulated other comprehensive income in their calculations of Tier 1 capital. The Company’s accumulated other comprehensive income consists primarily of the unrealized gain or loss on the securities portfolio as a result of marking securities available-for-sale to market. The Company opted to exclude accumulated other comprehensive income from its calculation of Tier 1 capital. Overall, the new rules did not materially impact the Company’s reported capital ratios for first quarter 2015. The Company continues to evaluate the impact of the rules as they are phased in over the next few years.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to leverage assets. Management believes that, as of March 31, 2015, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of March 31, 2015, and according to Federal Reserve and FDIC guidelines, the Bank was considered to be well-capitalized. To be categorized as well-capitalized, the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table.

 

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																		To Be Well
																		Capitalized Under
										For Capital								Prompt Corrective
		Actual								Adequacy Purposes								Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of March 31, 2015:
Total capital (to risk weighted assets)
Bank:		$	188,054				13.02	%		$	115,569				8.00	%		$	144,462				10.00	%
Company:		$	189,053				13.08	%			NA								NA
Tier 1 capital (to risk (to risk weighted assets)
Bank:		$	171,920				11.90	%		$	86,677				6.00	%		$	115,569				8.00	%
Company:		$	172,919				11.97	%			NA								NA
Common Equity Tier 1 (to risk weighted assets)
Bank:		$	171,920				11.90	%		$	65,008				4.50	%		$	93,900				6.50	%
Company:		$	164,919				11.41	%			NA								NA
Tier 1 leverage ratio (to leverage assets)
Bank:		$	171,920				11.26	%		$	61,079				4.00	%		$	72,231				5.00	%
Company:		$	172,919				11.31	%			NA								NA
As of December 31, 2014:
Total capital (to risk weighted assets)
Bank:		$	176,199				15.48	%		$	91,040				8.00	%		$	113,800				10.00	%
Company:		$	179,109				15.73	%			NA								NA
Tier 1 capital (to risk weighted assets)
Bank:		$	161,954				14.23	%		$	45,520				4.00	%		$	68,280				6.00	%
Company:		$	164,864				14.48	%			NA								NA
Tier 1 capital (to leverage assets)
Bank:		$	161,954				11.13	%		$	58,193				4.00	%		$	72,741				5.00	%
Company:		$	164,864				11.33	%			NA								NA
As of March, 2014:
Total capital (to risk weighted assets)
Bank:		$	174,838				15.93	%		$	87,806				8.00	%		$	109,757				10.00	%
Company:		$	177,952				16.21	%			NA								NA
Tier 1 capital (to risk weighted assets)
Bank:		$	161,095				14.68	%		$	43,903				4.00	%		$	65,854				6.00	%
Company:		$	164,209				14.95	%			NA								NA
Tier 1 capital (to leverage assets)
Bank:		$	161,095				11.22	%		$	57,429				4.00	%		$	71,786				5.00	%
Company:		$	164,209				11.44	%			NA								NA

 

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ITEM 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition than can be obtained from reading the Consolidated Financial Statements alone. The discussion should be read in conjunction with the consolidated financial statements and the notes included in this report. Please refer also to our Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in the Company’s 2014 Form 10-K. All dollar amounts, except share and per share data, are expressed in thousands of dollars.

In addition to historical information, this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements regarding projected results, the expected interest rate environment and its impact on our business, loan yields and expected prepayments, net interest margin, expectations regarding nonperforming assets, loan growth, earning asset mix, expected cash flows from the securities portfolio, expectations regarding the Company’s securities portfolio and the sale of securities, their value and yields, growth in core deposits and cost, capital levels, liquidity and dividends, expectations regarding certain large depositor relationships, the outcome of legal proceedings, management’s plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations in the forward-looking statements, including those set forth in this report, and our other reports filed with the SEC:

 

•

Local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets.

 

•

The local housing or real estate market could decline.

 

•

The risks presented by an economic recession, which could adversely affect credit quality, collateral values, including real estate collateral, investment values, liquidity and loan originations, and loan portfolio delinquency rates.

 

•

Our concentration in loans to dental professionals exposes us to the risks affecting dental practices in general.

 

•

Interest rate changes could significantly reduce net interest income and negatively affect funding sources.

 

•

Projected business increases following any future strategic expansion or opening of new branches could be lower than expected.

 

•

Competition among financial institutions could increase significantly.

 

•

The goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings and capital.

 

•

The reputation of the financial services industry could deteriorate, which could adversely affect our ability to access markets for funding and to acquire and retain customers.

 

•

The efficiencies we may expect to receive from any investments in personnel, acquisitions, and infrastructure may not be realized.

 

•

The level of nonperforming assets and charge-offs or changes in the estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements may increase.

 

•

Changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, executive compensation, and insurance) could have a material adverse effect on our business, financial condition and results of operations.

 

•

Acts of war or terrorism, or natural disasters, such as the effects of pandemic flu, may adversely impact our business.

 

•

The timely development and acceptance of new banking products and services and perceived overall value of these products and services by users may adversely impact our ability to increase market share and control expenses.

 

•

Changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters, may impact the results of our operations.

 

•

The costs and effects of legal, regulatory and compliance developments, including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews, may adversely impact our ability to increase market share and control expenses, or may result in substantial uninsured liabilities, which could adversely affect our business, prospects, results of operations and financial condition.

 

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•

Our success at managing the risks involved in the foregoing items will have a significant impact on our results of operations and future prospects.

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Part I, Item 1A “Risk Factors” in the Company’s 2014 Form 10-K and Part II, Item 1A, “Risk Factors” in this report and elsewhere in this report or in our other reports with the SEC, include risks and uncertainties described or referred to in Part I, Item 1 “Business” under the captions “Competition” and “Supervision and Regulation” in the Company’s 2014 Form 10-K and Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. Please take into account that forward-looking statements speak only as of the date of this report or documents incorporated by reference. The Company does not undertake any obligation to publicly correct or update any forward-looking statement whether as a result of new information, future events or otherwise.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

We follow accounting standards set by the Financial Accounting Standards Board, commonly referred to as the “FASB.” The FASB sets generally accepted accounting principles (“GAAP”) that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in this report are to the “FASB Accounting Standards Codification,” sometimes referred to as the “Codification” or “ASC.”

The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2014 Form 10-K. Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements in the Company’s 2014 Form 10-K should be considered critical under the SEC definition:

Nonaccrual Loans

Accrual of interest is discontinued on contractually delinquent loans when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal or interest is doubtful. At a minimum, loans that are past due as to maturity or payment of principal or interest by 90 days or more are placed on nonaccrual status, unless such loans are well-secured and in the process of collection. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized.

Allowance for Loan Losses and Reserve for Unfunded Commitments

The allowance for loan losses on outstanding loans is classified as a contra-asset account offsetting outstanding loans, and the allowance for unfunded commitments is classified as an “other” liability on the balance sheet. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balances of the allowance for loan losses for outstanding loans and unfunded commitments are maintained at an amount management believes will be adequate to absorb known and inherent losses in the loan portfolio and commitments to loan funds. The appropriate balance of the allowance for loan losses is determined by applying loss factors to the credit exposure from outstanding loans and unfunded loan commitments. Estimated loss factors are based on subjective measurements, including management’s assessment of the internal risk classifications, changes in the nature of the loan portfolios, industry concentrations, and the impact of current local, regional, and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

 

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Troubled Debt Restructurings

In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties. Additional information regarding the Company’s TDRs can be found in Note 4 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report

Business Combinations

The Company applies the acquisition method of accounting for business combinations in accordance with ASC 805 “Business Combinations.” Under the acquisition method, the Company recognizes all assets acquired and liabilities assumed at their acquisition date fair values. Management uses industry accepted valuation techniques to determine these fair values, and when appropriate includes assistance from independent third-party appraisal firms. Any excess of the purchase price over amounts allocated to the assets acquired, including identifiable intangible assets, and liabilities assumed is recorded as goodwill. Additional information regarding the Company’s acquisition of Capital Pacific Bancorp can be found in Note 2 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

Goodwill and Intangible Assets

At March 31, 2015, the Company had $43,306 in goodwill and other intangible assets. In accordance with financial accounting standards, assets with indefinite lives are periodically tested for impairment. Management performs an impairment analysis of its goodwill and intangible assets with indefinite lives at least annually and has determined that there was no impairment as of December 31, 2014, the date the most recent analysis was performed.

Share-based Compensation

In accordance with FASB ASC 718, “Stock Compensation,” we recognize expense in the income statement for the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period). The requisite service period may be subject to performance conditions. The fair value of each grant is estimated as of the grant date using the Black-Scholes option-pricing model. Management assumptions utilized at the time of grant impact the fair value of the option calculated under the Black-Scholes methodology, and ultimately, the expense that will be recognized over the expected service period. Additional information is included in Note 8 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

Fair Value Measurements

GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820, “Fair Value Measurements,” establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources while unobservable inputs reflect our estimates about market data. In general, fair values determined by Level 1 inputs utilize quoted prices for identical assets or liabilities traded in active markets that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Additional information regarding the Company’s fair value measurements can be found in Note 9 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

 

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Recent Accounting Pronouncements

In January 2014, the FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. ASU 2014-01 permits an entity to make an accounting policy election to account for its investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014, and should be applied prospectively. The adoption of ASU No. 2014-01 did not have a material impact on the Company’s consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. ASU 2014-04 clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014, and can be applied with a modified retrospective transition method or prospectively. The adoption of ASU No. 2014-04 did not have a material impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-11, Transfers and Servicing Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. ASU 2014-11 improves the financial reporting of repurchase agreements and other similar transactions by introducing two accounting changes: (1) repurchase-to-maturity transactions will be accounted for as secured borrowing transactions on the balance sheet (previously, they were accounted for as sales when certain conditions were met), and (2) for repurchase financing arrangements, an entity will account separately for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. It also requires enhanced disclosures about repurchase agreements and other similar transactions. The amendments in this update will be effective for the first interim or annual period beginning after December 31, 2014, with the exception of the collateral disclosures which will be effective for interim periods beginning after March 15, 2015. Early application is not permitted. 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 was issued to clarify that a performance target in a share-based payment that affects vesting and that could be achieved after the requisite service period should be accounted for as a performance condition under Accounting Standards Codification (ASC) 718, Compensation — Stock Compensation. As a result, the target is not reflected in the estimation of the award’s grant date fair value. Compensation cost would be recognized over the required service period, if it is probable that the performance condition will be achieved. ASU 2014-12 becomes effective for annual and interim periods beginning after December 15, 2015 with early adoption permitted. As of December 31, 2014, the Company did not have any share-based payment awards that include performance targets that could be achieved after the requisite service period. As such, the adoption of ASU No. 2014-12 did have a material impact on the Company’s consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. ASU 2014-14 requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of ASU No. 2014-15 is not expected to have a material impact on the Company’s consolidated financial statements.

 

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FINANCIAL HIGHLIGHTS

 

		For the three months ended
		March 31,
		2015				2014				% Change
Net income		$	2,802			$	3,832				-26.88	%
Operating revenue (1)		$	16,248			$	15,367				5.73	%
Earnings per share
Basic		$	0.15			$	0.21				-28.57	%
Diluted		$	0.15			$	0.21				-28.57	%
Assets, period-end		$	1,780,849			$	1,471,591				21.02	%
Gross loans, period-end		$	1,255,877			$	1,021,115				22.99	%
Core deposits, period end (2)		$	1,417,397			$	990,933				43.04	%
Deposits, period-end		$	1,496,747			$	1,097,355				36.40	%
Return on average assets (3)			0.72	%			1.06	%
Return on average equity (3)			5.91	%			8.61	%
Return on average tangible equity (3) (4)			7.05	%			9.90	%

 

(1)	Operating revenue is defined as net interest income plus noninterest income.

(2)	Defined by the Company as demand, interest checking, money market, savings, and local nonpublic time deposits, including local nonpublic time deposits in excess of $100.

(3)	Amounts annualized.

(4)	Tangible equity excludes goodwill and core deposit intangibles related to acquisitions.

On March 6, 2015, the Company completed the acquisition of Capital Pacific Bank. During the weekend of March 20, 2015, the Company successfully converted the Capital Pacific core systems to the Company’s core operating system. A summary of the assets and liabilities acquired through this transaction is provided in Note 2 of the Notes to Consolidated Financial Statements in Item 1 of Part I of this report.

The Company earned $2,802 or $0.15 per diluted share in first quarter 2015, compared to $3,832 or $0.21 per diluted share in first quarter 2014. The decline in net income was primarily due to $1,836 of pre-tax merger expense related to the Capital Pacific acquisition, which lowered first quarter 2015 net income by $1,203 or $0.07 per share.

During first quarter 2015, the Company continued to experience organic growth in outstanding loans. Outstanding loans at March 31, 2015, were $1,255,877, up $209,866 over December 31, 2014, outstanding loans. At March 31, 2015 the remaining outstanding balance of loans acquired in the Capital Pacific transaction totaled $199,860, with the additional $10,006 attributable to organic growth.

Organic core deposit growth accelerated during the first quarter 2015, which is atypical when compared to prior year’s seasonal patterns, as typically core deposits are flat with or down from year-end deposits. Outstanding core deposits at March 31, 2015, were $1,417,397, up $306,536 over December 31, 2014. Core deposits at March 31, 2015 included $223,043 of deposits acquired in the Capital Pacific transaction, while organic growth in core deposits accounted for the remaining $83,493 of the increase.

 

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Reconciliation of non-GAAP financial information

Management utilizes certain non-GAAP financial measures to monitor the Company’s performance. While we believe the presentation of non-GAAP financial measures provides additional insight into our operating performance, readers of this report are urged to review the GAAP results as presented in the Financial Statements in Item 1 of Part I of this report.

The Company presents a computation of tangible equity along with tangible book value and return on average tangible equity. The Company defines tangible equity as total shareholders’ equity before goodwill and core deposit intangible assets. Tangible book value is calculated as tangible equity divided by total shares outstanding. Return on average tangible equity is calculated as net income divided by average tangible equity. We believe that tangible equity and certain tangible equity ratios are meaningful measures of capital adequacy which may be used when making period-to-period and company-to-company comparisons. Tangible equity and tangible equity ratios are considered to be non-GAAP financial measures and should be viewed in conjunction with total shareholders’ equity, book value and return on average equity. The following table presents a reconciliation of total shareholders’ equity to tangible equity.

 

		March 31,				December 31,				March 31,
		2015				2014				2014
Total shareholders’ equity		$	210,651			$	184,161			$	181,398
Subtract:
Goodwill			(39,032	)			(22,881	)			(22,881	)
Core deposit intangible assets			(4,274	)			(614	)			(704	)
Tangible shareholders’ equity (non-GAAP)		$	167,345			$	160,666			$	157,813
Book value per share		$	10.80			$	10.39			$	10.13
Tangible book value per share (non-GAAP)		$	8.58			$	9.07			$	8.81
Year-to-date return on average equity			5.91	%			8.83	%			8.61	%
Year-to-date return on average tangible equity (non-GAAP)			7.05	%			10.14	%			9.90	%

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of a company, they have limitations as analytical tools, and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the primary source of the Company’s revenue. Net interest income is the difference between interest income derived from earning assets, principally loans, and interest expense associated with interest-bearing liabilities, principally deposits. The volume and mix of earning assets and funding sources, market rates of interest, demand for loans, and the availability of deposits affect net interest income.

Net interest margin as a percentage of average earning assets for first quarter 2015 was 4.27%, an improvement of 3 basis points over the prior quarter, and down 5 basis points from first quarter 2014. The linked-quarter increase in the net interest margin was primarily due to an improvement in the yield on earning assets as the yield on average loans increased by 1 basis point. The increase in loan yield in first quarter 2015 when compared to fourth quarter 2014 was primarily due to an increase in accretion of fair value marks on acquired loans. During the first quarter 2015, accretion of loan fair value marks was $387 and added 11 basis points to the net interest margin, compared to loan fair value accretion of $90 in fourth quarter 2014 that added 4 basis points to the net interest margin. The decline in year-over-year net interest margin of 5 basis points was primarily due to a drop in the yield of earning assets as the yield on average loans in first quarter 2015 was down 4 basis points from first quarter 2014, and the yield on taxable securities was down 24 basis points for the same period. Below is a summary of the core net interest margin, which excludes nonrecurring items and accretion of fair value marks, for first quarter 2015,

 

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fourth quarter 2014 and first quarter 2014. This summary presents a reconciliation of the net interest margin to adjusted net interest margin for the period:

Reconciliation of Adjusted Net Interest Income to Net Interest Income

 

		Three months ended
		March 31,				December 31,				March 31,
		2015				2014				2014
Tax equivalent net interest income (1)		$	15,243			$	14,643			$	14,304
Subtract
Century Bank accretion			138				90				225
Capital Pacific Bank accretion			249				—				—
Interest recoveries on nonaccrual loans			—				—				—
Prepayment penalties			—				46				—
Adjusted net interest income (non-GAAP)		$	14,856			$	14,507			$	14,079
Average earnings assets		$	1,448,767			$	1,369,439			$	1,343,429
Net interest margin			4.27	%			4.24	%			4.32	%
Core net interest margin (non-GAAP)			4.16	%			4.20	%			4.25	%

 

(1)	Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of $271, $269, and $260 for the three months ended March 31, 2015, December 31, 2014, and March 31, 2014, respectively.

 

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The following table presents condensed balance sheet information, together with interest income and yields on average interest earning assets, and interest expense and rates on interest-bearing liabilities, for the quarter ended March 31, 2015, compared to the quarter ended March 31, 2014:

Table I

Average Balance Analysis of Net Interest Income

(dollars in thousands)

 

		Three months ended												Three months ended
		March 31, 2015												March 31, 2014
		Average Balance				Interest Income or (Expense)				Average Yields or Rates				Average Balance				Interest Income or (Expense)				Average Yields or Rates
Interest earning assets
Federal funds sold and interest-bearing deposits		$	10,662			$	5				0.19	%		$	3,059			$	2				0.27	%
Securities available-for-sale:
Taxable			285,802				1,375				1.95	%			278,634				1,532				2.23	%
Tax-exempt(1)			74,597				774				4.21	%			69,081				743				4.36	%
Loans, net of deferred fees and allowance(2)			1,077,706				14,185				5.34	%			992,655				13,174				5.38	%
Total interest-earning assets(1)			1,448,767				16,339				4.57	%			1,343,429				15,451				4.66	%
Non earning assets
Cash and due from banks			20,349												17,995
Property and equipment			17,812												18,735
Goodwill & intangible assets			31,093												23,601
Interest receivable and other assets			55,746												57,335
Total nonearning assets			125,000												117,666
Total assets		$	1,573,767											$	1,461,095
Interest-bearing liabilities
Money market and NOW accounts		$	642,401			($	431	)			-0.27	%		$	536,309			$	(383	)			-0.29	%
Savings deposits			56,201				(18	)			-0.13	%			48,029				(17	)			-0.14	%
Time deposits - core (3)			62,236				(73	)			-0.48	%			62,776				(90	)			-0.58	%
Total interest-bearing core deposits			760,838				(522	)			-0.28	%			647,114				(490	)			-0.31	%
Time deposits - noncore			82,986				(288	)			-1.41	%			101,421				(316	)			-1.26	%
Federal funds purchased			894				(2	)			-0.91	%			2,947				(5	)			-0.69	%
FHLB & FRB borrowings			81,909				(228	)			-1.13	%			170,186				(280	)			-0.67	%
Junior subordinated debenture			8,248				(56	)			-2.75	%			8,248				(56	)			-2.75	%
Total interest-bearing wholesale funding			174,037				(574	)			-1.34	%			282,802				(657	)			-0.94	%
Total interest-bearing liabilities			934,875				(1,096	)			-0.48	%			929,916				(1,147	)			-0.50	%
Noninterest-bearing liabilities
Demand deposits			439,780												345,369
Interest payable and other			6,772												5,280
Total noninterest liabilities			446,552												350,649
Total liabilities			1,381,427												1,280,565
Shareholders’ equity			192,340												180,530
Total liabilities and shareholders’ equity		$	1,573,767											$	1,461,095
Net interest income						$	15,243											$	14,304
Net interest margin(1)							4.27	%											4.32	%

 

(1)	Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $271 and $260 for the three months ended March 31, 2015, and March 31, 2014, respectively.

Net interest margin was positively impacted by 8 basis points for the three months ended March 31, 2015, and March 31, 2014, respectively.

 

(2)	Interest income includes recognized loan origination fees of $147 and $129 for the three months ended March 31, 2015, and March 31, 2014, respectively.

(3)	Defined by the Company as interest checking, money market, savings and local non-public time deposits, including local non-public time deposits in excess of $100.

 

 

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First quarter 2015 average volumes in Table I include the impact of assets and liabilities added from the Capital Pacific transaction for the period March 6, 2015 through March 31, 2015 or 25 days. The acquisition of Capital Pacific Bank added approximately $52,000 to average assets in the first quarter 2015. Table I shows that earning asset yields in first quarter 2015 were 4.57%, down 9 basis points from the 4.66% recorded in first quarter 2014. Lower yields on both the securities and loan portfolio were primarily responsible for the decline in earning asset yields. New loans continue to be booked at rates lower than the average portfolio rate, which continued to slowly reduce the overall portfolio yield. The decline in the yield on securities reflects more recent purchases, which have been defensive in nature against rising rates, thus are also being booked at lower rates than the average portfolio.

The cost of interest-bearing liabilities decreased by 2 basis points from 0.50% in first quarter 2015 compared to 0.48% in first quarter 2014. The rate on interest-bearing core deposits declined by 3 basis points, while the cost of wholesale funding increased by 40 basis points. However, wholesale funding volumes in first quarter 2015 were proportionally much less of total funding than first quarter 2014 due to the growth in core deposit average volumes, thus the increase of 40 basis points in cost of wholesale funding had much less influence on the overall cost of funds and net interest margin. Average wholesale funding volumes were down $108,765 in first quarter 2015 from first quarter 2014. The first quarter 2015 net interest margin also benefitted from a significant increase in average non-interest bearing deposits. First quarter 2015 average non-interest bearing deposits were up $94,411 or 27.34% over first quarter 2014.

 

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The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the three months ended March 31, 2015, compared to March 31, 2014.

Table II

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

 

		Three months ended March 31, 2015 compared to March 31, 2014 Increase (decrease) due to
		Volume				Rate				Net
Interest earned on:
Federal funds sold and interest-bearing deposits		$	5			$	(2	)		$	3
Securities available-for-sale:
Taxable			39				(196	)			(157	)
Tax-exempt(1)			60				(29	)			31
Loans, net of deferred fees and allowance			1,129				(118	)			1,011
Total interest-earning assets(1)			1,233				(345	)			888
Interest paid on:
Money market and NOW accounts			76				(28	)			48
Savings deposits			3				(2	)			1
Time deposits - core (2)			(1	)			(16	)			(17	)
Total interest-bearing core deposits			78				(46	)			32
Time deposits - noncore			(57	)			29				(28	)
Federal funds purchased			(3	)			—				(3	)
FHLB & FRB borrowings			(145	)			93				(52	)
Junior subordinated debenture			—				—				—
Total interest-bearing wholesale funding			(205	)			122				(83	)
Total interest-bearing liabilities			(127	)			76				(51	)
Net interest income(1)		$	1,360			$	(421	)		$	939

 

(1)	Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $271 and $260 for the three months ended March 31, 2015 and March 31, 2014, respectively.

(2)	Interest income includes recognized loan origination fees of $147 and $129 for the three months ended March 31, 2015, and March 31, 2014, respectively.

The first quarter 2015 rate/volume analysis shows that net interest income increased by $939 over first quarter 2014. Interest income increased $888, while interest expense decreased $51. The increase in interest income was due to higher volumes, which generated an additional $1,233 in income, which was partially offset by a decline in interest income of $345 due to lower rates. The acquisition of Capital Pacific, which moved a greater portion of our assets into loans, contributed to improvement in interest income during the quarter

 

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The decrease in interest expense in first quarter 2015, when compared to first quarter 2014, was primarily due to a change in the mix of interest-bearing liability volumes. Higher volumes of interest-bearing core deposits increased interest expense, but a corresponding decrease in interest-bearing wholesale funding balances more than offset the effect of core deposits. In addition, lower rates on non-interest core deposits also contributed to the decline in interest expense in the first quarter 2015.

Loan Loss Provision and Allowance

Below is a summary of the Company’s allowance for loan losses for the three months ended March 31, 2015, and 2014:

 

		Three months ended March 31,
		2015				2014
Balance, beginning of period		$	15,637			$	15,917
Provision charged to income			—				—
Loans charged against allowance			(73	)			(601	)
Recoveries credited to allowance			160				78
Balance, end of period		$	15,724			$	15,394

The Company booked no provision for loan losses in first quarter 2015, nor was any provision for loan losses booked in first quarter 2014. The Company has now booked no provision for loan losses for eight consecutive quarters. The lack of provision over the past eight quarters reflected low levels of net loan charge offs and improvement in the overall credit quality of the portfolio during the period. The Company’s classified assets at March 31, 2015, were 27.60% of regulatory capital, compared to 24.54% and 26.82% of regulatory capital at December 31, 2014, and March 31, 2014, respectively. The small increase in classified assets at March 31, 2015 when compared to December 31, 2014 was primarily due to the acquisition of Capital Pacific. During the first quarter 2015, the Company recorded net loan recoveries of $87 or -0.03% of average outstanding loans, compared to net loan charge offs of $523 or 0.03% of average loans during first quarter 2014. The allowance for loan losses for outstanding loans at March 31, 2015, was $15,724, or 1.25% of outstanding loans, compared to 1.49% and 1.51% of outstanding loans at December 31, 2014, and March 31, 2014, respectively. The decline in the allowance as a percentage of outstanding loans was primarily due to loans acquired in the Capital Pacific transaction, which were assigned credit allocation of $3,316 as part of the fair value mark on the date of acquisition. At March 31, 2015, the Company had a total of $3,017 of credit fair value adjustment assigned to acquired loans, which totaled $204,987. When acquired loans assigned a credit allowance fair value mark are excluded from outstanding loans, the allowance for loan losses of $15,724 as a percentage of non-covered outstanding loans was 1.49%. The allowance as a percentage of net nonperforming loans was 596.74% at March 31, 2015, compared to 786.17% and 339.15% at December 31, 2014, and March 31, 2014, respectively. The decline in the allowance coverage ratio over nonperforming loans during first quarter 2015 when compared to year-end was primarily due to the acquisition of Capital Pacific loans, which were booked net of their credit fair value discount.

At March 31, 2015, $7,384 of loans (net of government guarantees) were classified as impaired. A specific allowance of $226 (included in the ending allowance at March 31, 2015) was assigned to these loans. That compares to impaired loans of $6,856 and a specific allowance assigned of $245 at December 31, 2014.

Total nonperforming assets, net of government guarantees, were $16,802, or 0.94% of total assets, at March 31, 2015, up $1,439 over the prior quarter end primarily due to the acquisition of Capital Pacific Bank. At March 31, 2015, nonperforming assets consisted of $2,635 in nonaccrual loans (net of government guarantees), no loans were 90 days past due and still accruing interest, and there was $14,167 of other real estate owned.

 

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The following table shows a summary of nonaccrual loans, loans past due 90 days or more, and other real estate owned for the periods covered in this report:

Nonperforming Assets and Asset Quality Ratios

 

		March 31, 2015				December 31, 2014				March 31, 2014
NONPERFORMING ASSETS
Nonaccrual loans
Real estate loans
Multi-family residential		$	—			$	—			$	—
Residential 1-4 family			830				321				752
Owner-occupied commercial			1,117				599				1,651
Nonowner-occupied commercial			897				906				136
Total permanent real estate loans			2,844				1,826				2,539
Construction loans
Multi-family residential			—				—				—
Residential 1-4 family			166				—				—
Commercial real estate			—				—				—
Commercial bare land and acquisition & development			—				—				—
Residential bare land and acquisition & development			—				—				—
Total construction real estate loans			166				—				—
Total real estate loans			3,010				1,826				2,539
Commercial loans			1,067				869				2,623
Total nonaccrual loans			4,077				2,695				5,162
90-days past due and accruing interest			—				—				—
Total nonperforming loans			4,077				2,695				5,162
Nonperforming loans guaranteed by government			(1,442	)			(706	)			(623	)
Net nonperforming loans			2,635				1,989				4,539
Other real estate owned			14,167				13,374				11,531
Total nonperforming assets, net of guaranteed loans		$	16,802			$	15,363			$	16,070
ASSET QUALITY RATIOS
Allowance for loan losses as a percentage of total loans outstanding			1.25	%			1.50	%			1.51	%
Allowance for loan losses as a percentage of total nonperforming loans, net of government guarantees			596.74	%			786.17	%			339.15	%
Net loan charge offs as a percentage of average loans, annualized			-0.03	%			0.03	%			0.21	%
Net nonperforming loans as a percentage of total loans			0.21	%			0.19	%			0.44	%
Nonperforming assets as a percentage of total assets			0.94	%			1.02	%			1.09	%
Consolidated classified asset ratio(1)			27.60	%			24.54	%			26.82	%

 

(1)

Consolidated classified asset ratio is defined as the sum of all loan-related contingent liabilities and loans internally graded substandard or worse (net of government guarantees), adversely classified securities, and other real estate owned, divided by total consolidated Tier 1 capital plus the allowance for loan losses.

Other real estate owned at March 31, 2015, consisted of nine properties. Two of the properties, a commercial land development project valued at $10,040 and a commercial real estate property valued at $1,244, comprised 79.65% of the total other real estate owned category. The Company is actively marketing these properties; however the location and nature of the commercial land development property makes it susceptible to possible future valuation write-downs as new appraisals become available.

 

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Noninterest Income

First quarter 2015 noninterest income was $1,276, down $47 or 3.55% from the same period last year. The decline in noninterest income in first quarter 2015 when compared to first quarter 2014 was primarily due to a $66 drop in the other income category, which was due to rental income booked in first quarter 2014 on other real estate property that was sold during the second quarter 2014. In addition, merchant bankcard processing fees were down $20 due to lower transaction volume. Partially offsetting the decline in other income and merchant processing fees was an increase of $57 in service charges on deposit accounts, which included the impact of deposit accounts acquired in the Capital Pacific transaction beginning March 6^th, 2015.

Noninterest Expense

First quarter 2015 noninterest expense was $11,972, an increase of $2,461 or 25.88% over first quarter 2014. Merger expense of $1,836 related to the Capital Pacific transaction accounted for the majority of the increase in noninterest expense. Excluding merger expense of $1,836 in first quarter 2015, total noninterest expense was up $625 or 6.57%. The increase in noninterest expense, excluding merger expense, was primarily attributable to a $590 or 10.14% increase in salaries and employee benefits.

Within the salaries and benefits category, the primary areas of increase were base salaries and related payroll taxes and group insurance expense. An increase of $340 or 7.87% in base salaries was mostly attributable to performance increases for existing employees, cost of staff additions, and effect of base salaries from March 6 through March 31, 2015 for former Capital Pacific employees who will continue on with the Company.

BALANCE SHEET

Loans

At March 31, 2015, outstanding loans were $1,255,877, up $209,866 from December 31, 2014, and up $234,762 from March 31, 2014. The acquisition of Capital Pacific added $199,860 to outstanding loans during the first quarter 2015, and organic loan growth of $10,006 in first quarter 2015 accounted for the remainder of the growth in outstanding loans in the current quarter over year-end December 31, 2014. All loans acquired in the Capital Pacific acquisition are included in the Portland market gross loan totals below. A summary of outstanding loans by market at March 31, 2015, December 31, 2014, and March 31, 2014, follows:

 

		Period Ended
		March 31, 2015				December 31, 2014				March 31, 2014
Eugene market gross loans, period-end		$	358,129			$	363,953			$	347,233
Portland market gross loans, period-end			612,762				407,466				400,537
Seattle market gross loans, period-end			119,306				119,095				131,492
National healthcare gross loans, period-end			165,680				155,497				141,853
Total gross loans, period-end		$	1,255,877			$	1,046,011			$	1,021,115

Organic growth of $10,006 during the first quarter 2015 was centered in the Portland market and national healthcare lending, while the Eugene market contracted and the Seattle market outstanding loans at March 31, 2015 were relatively flat with December 31, 2014 outstanding loans. Excluding the acquired loans, the Portland market showed $5,436 in growth in outstanding loans over December 31, 2014, primarily centered in commercial and industrial loan and real estate construction. National healthcare lending accelerated in first quarter 2015 when compared to the previous three quarters, increasing $10,183 during the first quarter 2015. Growth in Portland market and national healthcare lending was partially offset by a $5,824 contraction in outstanding loans in the Eugene market. The decline in outstanding loans in the Eugene market was largely due to a high level of early pay offs on loans as production in this market continued to be strong during the period. Net loan growth is expected to continue during the remainder of 2015 due to the addition of experienced market lenders, solid pipelines in all markets, improved regional economy, and the fact that during the first quarter 2015, the Company booked approximately $52,900 of new unfunded loan commitments that are expected to fund during the next three quarters.

 

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Outstanding loans to dental professionals, which are comprised of both local and national loans, at March 31, 2015, totaled $311,006 or 24.76% of the loan portfolio, compared to $306,392 or 29.29% of the loan portfolio at December 31, 2014. While the Company’s national dental loans increased by $4,314 since December 31, 2014 and are now represented in 37 states, local dental loans remained flat due to amortization of the existing portfolio, early pay offs and intense pricing competition during the same period. At March 31, 2015, $11,916 or 3.83% of the outstanding dental loans were supported by government guarantees. Loans to dental professionals include loans for such purposes as starting up a practice, acquisition of a practice, equipment financing, owner-occupied facilities, and working capital. National dental loans are limited only to acquisition of a seasoned practice by experienced dental professionals, practice refinances and owner-occupied real estate loans.

In addition to loan growth in the dental industry, growth was also experienced in the wider healthcare field, with loans to physicians, veterinarians, optometrists, and medical specialists. The healthcare portfolio, other than dental, experienced growth during the quarter. This segment grew by $20,028 over year-end 2014 to $90,357 as of March 31, 2015. The majority of the expansion was in veterinary lending in both practice acquisition and owner-occupied real estate financing. Additional data on the Company’s dental loan portfolio and the credit quality of this portfolio can be found in Note 5 of the Notes to Consolidated Financial Statements in this report.

All loans to related parties were made in the ordinary course of business and on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable loans with persons not related to the Company.

Detailed credit quality data on the entire loan portfolio can be found in Note 4 of the Notes to Consolidated Financial Statements in this report.

Securities

At March 31, 2015, the balance of securities available-for-sale was $379,497, up $27,551 over December 31, 2014. The increase in the securities portfolio during the first quarter was due to the increase in the unrealized gain on the portfolio and the acquisition of Capital Pacific Bank, which added $26,010 to the securities portfolio. At March 31, 2015, the portfolio had an unrealized pre-tax gain of $8,700 compared to an unrealized pre-tax gain of $6,057, at December 31, 2014. The improvement in the unrealized gain or market value of the securities portfolio during the first quarter 2015 was largely due to a decline in longer-term interest rates and tightening of spreads. The average life and duration of the portfolio at March 31, 2015, was 3.8 years and 3.5, respectively, both relatively unchanged from December 31, 2014. At March 31, 2015, $38,603 of the securities portfolio were pledged as collateral for public deposits in Oregon and Washington and for repurchase agreements.

The Company continued to structure the portfolio to provide consistent cash flow and reduce the market value volatility of the portfolio in a rising rate environment in light of the Company’s current liability sensitive position. The portfolio is structured to generate sufficient cash flow to allow reinvestment at higher rates should interest rates move up or to fund loan growth in future periods. In a stable rate environment, approximately $61,000 in cash flow is anticipated over the next twelve months. Going forward, purchases will be dependent upon core deposit growth, loan growth, and the Company’s interest rate risk position.

At March 31, 2015, $3,600, or 0.95% of the total securities portfolio, was composed of private-label mortgage-backed securities. In previous reporting periods, management has booked OTTI on this portion of the portfolio totaling approximately $227. Management reviews monthly all available information, including current and projected default rates and current and projected loss severities, related to the collectability of its potentially impaired investment securities to determine if an additional OTTI is required. No additional OTTI was recorded during the first quarter 2015. Recognition of additional OTTI on the private-label mortgage-backed portion of the portfolio is possible in future quarters depending upon economic conditions, default rates on home mortgages, loss severities on foreclosed homes, unemployment levels, and home values.

In management’s opinion, the remaining securities in the portfolio in an unrealized loss position are considered only temporarily impaired. The Company has no intent, nor is it more likely than not that it will be required, to sell its impaired securities before their recovery. The impairment is due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal is expected.

 

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Goodwill and Intangible Assets

At March 31, 2015, the Company had a recorded balance of $39,032 in goodwill from the November 30, 2005, acquisition of Northwest Business Financial Corporation (“NWBF”), the February 1, 2013, acquisition of Century Bank, and the March 6, 2015 acquisition of Capital Pacific Bank. In addition, at March 31, 2015, the Company had $4,274 of core deposit intangible assets resulting from the acquisition of Century Bank and Capital Pacific Bank. The core deposit intangible for Century Bank was determined to have an expected life of seven years, and is being amortized over that period using the straight-line method and will be fully amortized in January 2020. The core deposit intangible for Capital Pacific Bank was determined to have an expected life of ten years, and is being amortized over that period using the straight-line method and will be fully amortized in February 2025. The Company periodically tests these assets for impairment. Management performs an impairment analysis of the intangible assets with indefinite lives at least annually, but more frequently if an impairment triggering event is deemed to have occurred. The last impairment test was performed at December 31, 2014, at which time no impairment was determined to exist.

Deposits

Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and nonpublic local time deposits, including nonpublic local time deposits in excess of $100, were $1,417,397 and represented 94.70% of total deposits at March 31, 2015. Core deposits at March 31, 2015 were up $306,536 over December 31, 2014. Included in the March 31, 2015 balance were $223,043 in deposits acquired through the Capital Pacific acquisition, with organic growth accounting for the remaining $83,493 of the first quarter 2015 increase. The organic growth of core deposits during the first quarter 2015 was atypical of previous year’s seasonal patterns when core deposits are typically flat or down from year-end totals.

A key component of core deposits is noninterest-bearing demand deposits, which totaled $503,735 and represented 35.54% of core deposits at March 31, 2015. The weighted average cost of core deposits, when factoring in non-interest bearing core deposits, for the first quarter 2015 was 0.18%.

A summary of outstanding core deposits and average core deposits by market and other deposits classified as wholesale funding at March 31, 2015, December 31, 2014, and March 31, 2014, follows:

 

		Period ended
		March 31, 2015				December 31, 2014				March 31, 2014
Eugene market core deposits, period-end(1)		$	742,397			$	672,527			$	604,505
Portland market core deposits, period-end(1)			516,976				276,453				234,631
Seattle market core deposits, period-end(1)			158,024				161,881				151,797
Total core deposits, period-end(1)			1,417,397				1,110,861				990,933
Non-core deposits, period-end			79,350				98,232				106,422
Total deposits, period-end		$	1,496,747			$	1,209,093			$	1,097,355
		Three Months Ended
		March 31, 2015				December 31, 2014				March 31, 2014
Eugene market core deposits, average(1)		$	711,718			$	668,927			$	602,977
Portland market core deposits, average(1)			332,791				263,757				236,945
Seattle market core deposits, average(1)			156,109				150,266				152,561
Total core deposits, average(1)			1,200,618				1,082,950				992,483
Non-core deposits, average			82,986				93,988				101,421
Total deposits, average		$	1,283,604			$	1,176,938			$	1,093,904

 

(1)	Core deposits include all demand, savings, money market, interest checking accounts, plus all nonpublic local time deposits

including local time deposits in excess of $100.

 

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Other Deposits

The Company uses public and brokered deposits to provide short-term and long-term funding sources. The Company defines short-term as having a contractual maturity of less than one year. The Company uses brokered deposits to help mitigate interest rate risk in a rising rate environment. All long-term brokered deposits have a call feature, which provides the Company the option to redeem the deposits on a quarterly basis and allows the Company to refinance long-term funding at lower rates should market rates fall. During the first quarter 2015, the Company called $4,397 in brokered time deposits with a weighted average rate of 2.63% and refinanced them at a lower rate. Below is a schedule detailing public and brokered deposits by type, including weighted average rate (“WAR”) and weighted average maturity (“WAM”).

Non-Core Deposit Summary

 

		Balance March 31, 2015				WAR				WAM
Short-Term Public Time Deposits		$	32,775				0.03	%			35 days
Long-Term Public Time Deposits			453				0.55	%			6.07 years
		$	33,228
Short-Term Brokered Time Deposits		$	7,500				0.27	%			111 days
Long-Term Brokered Time Deposits			38,622				2.10	%			6.09 years
		$	46,122
Total non-core deposits		$	79,350

Borrowings

The Company has both secured and unsecured borrowing lines with the FHLB, FRB and various correspondent banks. The Federal Reserve and correspondent borrowings are generally short-term, with a maturity of less than 30 days. The FHLB borrowings can be either short-term or long-term in nature. See Note 7 of the Notes to Consolidated Financial Statements in Part I, Item 1 of this report for a full maturity and interest rate schedule for the FHLB borrowings.

The Company is currently a member of the FHLB of Seattle. The Company holds stock in the FHLB of Seattle to support its borrowings from the entity. On May 31, 2015, the FHLB of Seattle is expected to merge with the FHLB of Des Moines and the combined bank will be named the FHLB of Des Moines. The Company currently holds $10,531 of stock in the FHLB of Seattle that, upon effectiveness of the merger, will become stock in the FHLB of Des Moines. Based on the Company’s outstanding borrowings at March 31, 2015, it is estimated the amount of stock required to support those borrowings was approximately $4,500. Following the merger with the FHLB of Seattle, the FHLB of Des Moines will repurchase any excess stock, which, based on March 31, 2015 estimates, would be $6,000. The FHLB of Des Moines plans to repurchase any excess stock on June 1, 2015.

Junior Subordinated Debentures

The Company had $8,248 in junior subordinated debentures outstanding at March 31, 2015, which were issued in conjunction with the 2005 acquisition of NWBF. The junior subordinated debentures had an interest rate of 6.27% that was fixed through January 2011. In January 2011, the rate on the junior subordinated debentures changed to three-month LIBOR plus 135 basis points. On April 22, 2013, the Bank entered into a cash flow hedge on $8,000 of the trust preferred payment, swapping the variable interest rate for a fixed rate of 2.73% for approximately seven years. At March 31, 2015, the fair value of the interest rate swap on the Company’s subordinated debentures was $53. At March 31, 2015, the $8,000 of junior subordinated debentures qualified as Tier 1 capital under regulatory capital guidelines.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances, such as the Company’s junior subordinated debentures, as Tier 1 capital. Under final rules adopted by the Federal Reserve and the other U.S. Federal banking agencies, our trust preferred securities will remain as Tier 1 capital since total assets of the Company are less than $15 billion. Additional information regarding these final capital rules is included in Part I, Item 2,

 

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“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” of this report and in Part II, Item 1A “Risk Factors” of our 2014 Form 10-K under the heading “We operate in a highly regulated environment and the effects of recent and pending federal legislation or of changes in, or supervisory enforcement of, banking or other laws and regulations could adversely affect us.”

Additional information regarding the terms of the cash flow hedge is included in Note 10 of the Notes to Consolidated Financial Statements in Part I, Item 1 of this report.

Capital Resources

Capital is the shareholders’ investment in the Company. Capital grows through the retention of earnings and the issuance of new stock or other equity securities whether through stock offerings or through the exercise of equity awards. Capital formation allows the Company to grow assets and provides flexibility in times of adversity. Shareholders’ equity at March 31, 2015 was $210,651, up $26,490 from December 31, 2014. The increase in shareholders’ equity was primarily due to the issuance of 1,778,142 shares of Company stock valued at $23,578 in conjunction with the acquisition of Capital Pacific Bank during the first quarter 2015.

The Federal Reserve and the FDIC have in place guidelines for risk-based capital requirements applicable to U.S. bank holding companies and banks. In July 2013, the Federal Reserve Board and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the Basel Committee’s current international regulatory capital accord (Basel III). These rules were effective January 1, 2015 and replaced the federal banking agencies’ general risk-based capital rules, advanced approaches rule, market-risk rule, and leverage rules, in accordance with certain transition provisions. The new rules establish more restrictive capital definitions, create additional categories and higher risk-weightings for certain asset classes and off-balance sheet exposures, higher leverage ratios and capital conservation buffers that will be added to the minimum capital requirements and must be met for banking organizations to avoid being subject to certain limitations on dividends and discretionary bonus payments to executive officers. The new rules also implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. When fully phased in, the final rules will provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.50%; (b) a Tier 1 capital ratio of 6.00% (which is an increase from 4.00%); (c) a total capital ratio of 8.00%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4.00%. The new rules permit depository institution holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, to include trust preferred securities in Tier 1 capital. Under the new rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements (equal to 2.50% of total risk-weighted assets). The phase-in of the capital conservation buffer will begin January 1, 2016, and be completed by January 1, 2019. The new rules also provide for various adjustments and deductions to the definitions of regulatory capital that will phase in from January 1, 2014, to December 31, 2017. The new rules made it optional for banks and bank holding companies to include accumulated other comprehensive income in their calculations of Tier 1 capital. The Company’s accumulated other comprehensive income consists primarily of the unrealized gain or loss on the securities portfolio as a result of marking securities available-for-sale to market. The Company opted to exclude accumulated other comprehensive income from its calculation of Tier 1 capital. Overall, the new rules did not materially impact the Company’s reported capital ratios for first quarter 2015. The Company will continue to evaluate the impact of the rules as they are phased in over the next few years.

The Company’s common equity tier 1 capital ratio, tier 1 capital ratio, total capital ratio, and tier 1 leverage capital ratio were 11.41%, 11.97%, 13.08% and 11.31%, respectively, at March 31, 2015, with all capital ratios for the Company above the minimum regulatory designations. For additional information regarding the Company’s regulatory capital levels, see Note 11 in Notes to Consolidated Financial Statements in Part I, Item I of this report.

The Company has regularly paid cash dividends on a quarterly basis, typically in February, May, August and November of each year. The Board of Directors considers the dividend amount quarterly and takes a broad perspective in its dividend deliberations including a review of recent operating performance, capital levels, and concentrations of loans as a percentage of capital, and growth projections. The Board also considers dividend payout ratios, dividend yield, and other financial metrics in setting the quarterly dividend. There can be no assurance that dividends will be paid in the future.

 

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The Board of Directors, at its January 20, 2015 meeting approved a regular cash dividend to shareholders of $0.10 per share that was paid on February 11, 2015. Subsequent to the end of the first quarter 2015, on April 21, 2015, the Board of Directors approved a regular cash dividend of $0.10 per share payable to shareholders on May 15, 2015.

OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

In the normal course of business, the Company commits to extensions of credit and issues letters of credit. The Company uses the same credit policies in making commitments to lend funds and conditional obligations as it does for other credit products. In the event of nonperformance by the customer, the Company’s exposure to credit loss is represented by the contractual amount of the instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established by the contract. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At March 31, 2015, the Company had $248,805 in commitments to extend credit, up from $156,972 at December 31, 2014.

Letters of credit written are conditional commitments issued by the Company to guarantee performance of a customer to a third party. The credit risk involved is essentially the same as that involved in extending loan facilities to customers. At March 31, 2015, the Company had $3,603 in letters of credit and financial guarantees outstanding.

For additional information regarding the Company’s regulatory capital levels, see Note 11 in Notes to Consolidated Financial Statements in Part I, Item I of this report.

LIQUIDITY AND CASH FLOWS

Liquidity is the term used to define the Company’s ability to meet its financial commitments. The Company maintains sufficient liquidity to ensure funds are available for both lending needs and the withdrawal of deposit funds. The Company derives liquidity through core deposit growth, maturity of investment securities, and loan payments. Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $100. Additional liquidity and funding sources are provided through the sale of loans, sales of securities, access to national CD markets, and both secured and unsecured borrowings. The Company uses a number of measurements to monitor its liquidity position on a daily, weekly, and monthly basis, which includes its ability to meet both short-term and long-term obligations, and requires the Company to maintain a certain amount of liquidity on the asset side of its balance sheet. The Company also prepares projections of its liquidity position. In addition, the Company prepares a Liquidity Contingency Plan at least semi-annually that is strategic in nature and forward-looking to test the ability of the Company to fund a liquidity shortfall arising from various escalating events. The Liquidity Contingency Plan is presented and reviewed by the Company’s Asset and Liability Committee.

Core deposits at March 31, 2015, were $1,417,397 and represented 94.70% of total deposits. Core deposits at March 31, 2015, were up $306,536 over December 31, 2014. The acquisition of Capital Pacific Bank during the first quarter accounted for $223,043 of growth during the quarter, while organic growth accounted for the remaining $83,493 of the first quarter 2015 increase. The organic growth of core deposits during the first quarter 2015 was atypical of previous year’s seasonal patterns when core deposits are typically flat or down from year-end totals.

The Company experienced an increase in outstanding loans of $209,866 during the first quarter 2015, which included organic growth and loans acquired in the Capital Pacific acquisition. Loan growth was funded entirely by growth in core deposits. Core deposits not required to fund asset growth were used to pay down short-term borrowings. It is anticipated that core deposit growth and cash flows from the securities portfolio will provide a significant portion of the funding during the remainder of 2015, as loans are expected to continue to increase. The securities portfolio represented 21.31% of total assets at March 31, 2015. At March 31, 2015, $38,603 of the securities portfolio was pledged to support public deposits and repurchase agreements, leaving $340,894 of the securities portfolio unencumbered and available-for-sale. In addition, at March 31, 2015, the Company had $33,938 of government guaranteed loans that could be sold in the secondary market to support the Company’s liquidity position.

Due to its strategic focus to market to specific segments, the Company has been successful in developing deposit relationships with several large clients, which are generally defined as deposit relationships of $1,000 or more, which are closely monitored by management and Company officers. At March 31, 2015, 92 large deposit relationships with the Company accounted for $657,225 or 46.37% of total outstanding core deposits. The single largest client represented 6.52% of outstanding core deposits

 

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at March 31, 2015. The loss of this deposit relationship or other large deposit relationships could cause an adverse effect on short-term liquidity. The Company uses a 10-point risk-rating system to evaluate each of its large depositors in order to assist management in its daily monitoring of the volatility of this portion of its core deposit base. The Company maintains sufficient short-term liquidity to cover potential volatility of this portion of the core deposit base. The risk-rating system attempts to determine the stability of the deposits of each large depositor, evaluating, among other things, the length of time the depositor has been with the Company and the likelihood of loss of individual large depositor relationships. Risk ratings on large depositors are reviewed at least quarterly and adjusted if necessary. Company management and officers maintain close relationships and hold regular meetings with its large depositors to assist in management of these relationships. The Company expects to maintain these relationships, and believes it has sufficient sources of liquidity to mitigate the loss of one or more of these clients and regularly tests its ability to mitigate the loss of multiple large depositor relationships in its Liquidity Contingency Plan. There can be no assurance that these large depositor relationships will be maintained or that the loss of one or more of these clients will not adversely affect the Company’s liquidity.

At March 31, 2015, the Company had secured borrowing lines with the FHLB of Seattle and the FRB, along with unsecured borrowing lines with various correspondent banks totaling $600,997. The Company’s secured lines with the FHLB and FRB were limited by the amount of collateral pledged. At March 31, 2015, the Company had pledged $403,638 in discounted collateral value in commercial real estate loans, first and second lien single-family residential loans, multi-family loans, and securities to the FHLB. Additionally, certain commercial and commercial real estate loans with a discounted value of $68,359 were pledged to the FRB under the Company’s Borrower-In-Custody program. The Company’s unsecured correspondent bank lines totaled $129,000. At March 31, 2015, the Company had $61,000 in borrowings outstanding from the FHLB, no borrowings outstanding with the FRB, and no borrowings outstanding on its overnight correspondent bank lines, leaving a total of $539,997 available on its secured and unsecured borrowing lines as of such date.

Net cash used by operating activities was $2,848 during the first quarter 2015, which was primarily due to the payoff of liabilities acquired in the Capital Pacific acquisition. Net cash of $10,010 was used in investing activities, consisting principally of a net loan principal increase of $6,373 and cash consideration paid, net of cash acquired, in the Capital Pacific acquisition, of $3,249. Cash provided by financing activities during the first quarter 2015 was $19,584 and primarily consisted of an increase in deposits, which was offset by a decline in Federal Home Loan Bank borrowings.

ITEM 3 Quantitative and Qualitative Disclosures about Market Risk

There has been no material change in the Company’s exposure to market risk. Readers are referred to the Company’s 2014
Form 10-K and the Annual Report to Shareholders for the year ended December 31, 2014, for additional information.

ITEM 4 Controls and Procedures

Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

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Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the quarter ended March 31, 2015, that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1 Legal Proceedings

For a discussion of Cox et al v. Holcomb Family Limited Partnership et al., and the related adversary complaint filed by the court-appointed bankruptcy trustee for Berjac of Oregon in the U. S. Bankruptcy Court for the District of Oregon, refer to Item 3 of Part I of our 2014 Form 10-K.

We may from time to time be involved in claims, proceedings and litigation arising from our business and property ownership. We believe, based on currently available information, that the results of such proceedings, including the above-described proceeding, in the aggregate, will not have a material adverse effect on our financial condition.

ITEM 1A Risk Factors

For a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our 2014 Form 10-K, which is incorporated by reference herein, in addition to the following information:

Industry Factors

Fluctuating interest rates could adversely affect our profitability.

As is the case with many banks, our profitability is dependent to a large extent upon our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect, and has in past years, impacted, our net interest margin, and, in turn, our profitability. This impact could result in a decrease in our interest income relative to interest expense. Increases in interest rates may also adversely impact the value of our securities investment portfolio. At March 31, 2015, our balance sheet was liability sensitive, and an increase in interest rates could cause our net interest margin and our net interest income to decline. For the past several years, the banking industry has operated in an extremely low interest rate environment relative to historical averages, and the Federal Reserve has pursued highly accommodative monetary policies (including a very low Federal funds rate and substantial purchases of long-term U.S. Treasury and agency securities) in an effort to facilitate growth in the U.S. economy and a reduction in levels of unemployment. This environment has placed downward pressure on the net interest margins of U.S. banks, including Pacific Continental Bank. During 2014, the Federal Reserve began to gradually ease its accommodative monetary policies including discontinuing its asset purchase program in October 2014. We cannot predict with any certainty whether or to what extent the Federal Reserve will continue its accommodative monetary policies, nor the timing of future easing for these policies.

Company Factors

We have a significant concentration in loans to dental professionals, and loan concentrations within one industry may create additional risk.

Bank regulatory authorities and investors generally view significant loan concentrations within any particular industry as carrying higher inherent risk than a loan portfolio without any significant concentration in one industry. We have a significant concentration of loans to dental professionals which represented 24.76% in principal amount of our total loan portfolio at March 31, 2015 (see Note 5 in the Notes to Consolidated Financial Statements included in Item 1 of Part I of this report). While we apply credit practices which we believe to be prudent to these loans as well as all the other loans in our portfolio, due to our concentration in dental lending, we are exposed to the general risks of industry concentration, which include adverse market factors impacting that industry alone or disproportionately to other industries. In addition, bank regulatory authorities may in the future require us to limit additional lending in the dental industry if they have concerns that our concentration in that industry creates significant risks, which in turn could limit our ability to pursue new loans in an area where we believe we currently have a competitive advantage.

 

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Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.

At March 31, 2015, our nonperforming loans (which include all nonaccrual loans, net of government guarantees) were 0.21% of the loan portfolio. At March 31, 2015, our nonperforming assets (which include foreclosed real estate) were 0.94% of total assets. Nonperforming loans and assets adversely affect our net income in various ways. We generally do not record interest income on nonperforming loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, less estimated selling expenses, which may ultimately result in a loss. An increase in the level of nonperforming assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile. While we reduce problem assets through loan sales, workouts, and restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition, perhaps materially. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors which can be detrimental to the performance of their other responsibilities. Any significant future increase in nonperforming assets could have a material adverse effect on our business, financial condition and results of operations.

We may not have the ability to continue paying dividends on our common stock at current or historic levels.

On April 21, 2015, the board of directors approved a quarterly cash dividend of $0.10 per share, payable to shareholders of record on May 5, 2015. Our ability to pay dividends on our common stock depends on a variety of factors. It is possible in the future that we may not be able to continue paying quarterly dividends commensurate with historic levels, if at all. As a holding company, a substantial portion of our cash flow typically comes from dividends our bank subsidiary pays to us. Cash dividends will depend on sufficient earnings to support them and adherence to bank regulatory requirements. If the Bank is not able to pay dividends to the Company, the Company may not be able to pay dividends on its common stock. Consequently, the inability to receive dividends from the Bank could adversely affect the Company’s financial condition, results of operations and prospects.

We may be required, in the future, to recognize impairment with respect to investment securities, including the FHLB stock we hold.

Our securities portfolio contains whole loan private mortgage-backed securities and municipal securities and currently includes securities with unrecognized losses. We may continue to observe volatility in the fair market value of these securities. We evaluate the securities portfolio for any other than temporary impairment (“OTTI”) each reporting period, as required by GAAP. Future evaluations of the securities portfolio could require us to recognize impairment charges. The credit quality of securities issued by certain municipalities has deteriorated in recent quarters. Although management does not believe the credit quality of the Company’s municipal securities has similarly deteriorated, such deterioration could occur in the future. For example, it is possible that government-sponsored programs to allow mortgages to be refinanced to lower rates could materially adversely impact the yield on our portfolio of mortgage-backed securities, since a significant portion of our investment portfolio is composed of such securities.

In addition, as a condition to membership in the FHLB, we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. At March 31, 2015, we had stock in the FHLB totaling $10,531. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. As of March 31, 2015, we did not recognize an impairment charge related to our FHLB stock holdings. Future negative changes to the financial condition of the FHLB could require us to recognize an impairment charge with respect to such holdings. On January 12, 2015, the FHLB Seattle announced that the Federal Housing Finance Agency has approved the merger application of the FHLB Seattle and the FHLB Des Moines. On February 27, 2015, the FHLB Seattle announced that the members of both banks ratified the Agreement and Plan of Merger approved by their respective boards. The merger is expected to close May 31, 2015. At that time, the combined entity will be buying back excess stock above what is needed to support borrowings. If the merger is completed, this has the potential to result in a decrease of the Bank’s outstanding FHLB stock.

 

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If the goodwill we have recorded in connection with acquisitions becomes impaired, it could have an adverse impact on our reported earnings.

At March 31, 2015, we had $39,032 of goodwill on our balance sheet. Our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. Such evaluation is based on a variety of qualitative and quantitative factors, including macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, and other relevant entity-specific events. The last impairment test was performed at December 31, 2014. At December 31, 2014, we did not recognize an impairment charge related to our goodwill. Future evaluations of goodwill may result in findings of impairment and write-downs, which would impact our operating results and could be material.

A failure in our operational systems or infrastructure, or those of third-parties, could impair our liquidity, disrupt our businesses, result in the unauthorized disclosure of confidential information, damage our reputation and cause financial losses.

We are dependent on third-parties and their ability to process and monitor, on a daily basis, a large number of transactions, many of which are highly complex, across numerous and diverse markets. These transactions, as well as the information technology services we provide to clients, often must adhere to client-specific guidelines, as well as legal and regulatory standards. Due to the breadth of our client base and our geographical reach, developing and maintaining our operational systems and infrastructure is challenging, particularly as a result of rapidly evolving legal and regulatory requirements and technological shifts. Our financial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, such as electrical, internet or telecommunications outages, a spike in transaction volume, a cyber-security attack, a natural disaster, or other unforeseen catastrophic events, which may adversely affect our ability to process these transactions or provide services.

In addition, our operations rely on the secure processing, storage, transmission and reporting of personal, confidential and other sensitive information or data on our computer systems, networks and business applications. Although we take numerous protective measures to maintain the confidentiality, integrity and availability of our and our clients’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks may be vulnerable to breaches, unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-security attacks and other events that could have an adverse security impact and significant negative consequences to us. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third-parties, such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or the threats may originate from within our organization. These events could result in litigation or financial losses that are either not insured against or not fully covered by insurance, regulatory consequences or reputational harm, any of which could harm our competitive position, operating results and financial condition. These types of incidents can remain undetected for extended periods of time, thereby increasing the associated risks. We may also be required to expend significant resources to modify our protective measures or to investigate and remediate vulnerabilities or exposures arising from cyber-security risks.

We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third-parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.

Other financial institutions have been the target of various denial-of-service or other cyber-attacks as part of what appears to be a coordinated effort to disrupt the operations of financial institutions and potentially test their cybersecurity in advance of future and more advanced cyber-attacks. These denial-of-service attacks require substantial resources to defend, and may affect customer satisfaction and behavior. In addition, there have been increasing efforts on the part of third parties to breach data security at financial institutions as well as the other types of companies, such as large retailers, or with respect to financial transactions, including through the use of social engineering schemes such as “phishing”. The ability of our customers to bank

 

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remotely, including online and through mobile devices, requires secure transmissions of confidential information and increase the risk of data security breaches which would expose us to financial claims by customers or others and which could adversely affect our reputation. Even if cyber-attacks and similar tactics are not directed specifically at Pacific Continental Bank, such attacks on other large financial institutions could disrupt the overall functioning of the financial systems and undermine consumer confidence in banks generally, to the detriment of other financial institutions, including the Bank.

In March of 2015, the Federal bank regulators issued two related statements regarding cyber security. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes that enable recovery of data and business operations and that address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. While we do not believe that these statements contain any new regulatory expectations, we are continuing to evaluate them, and they do indicate that the regulators regard cyber-security to be a matter of great importance for U.S. financial institutions. A financial institution which fails to observe the regulatory guidance could be subject to various regulatory sanctions, including financial sanctions.

To date we have not experienced any material losses relating to a cyber-security incident or other information security breaches, but there can be no assurance that we will not suffer such losses or information security breaches in the future. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, as well as our clients’ or other third-parties’, operations which could result in damage to our reputation, substantial costs, regulatory penalties and/or client dissatisfaction or loss. Potential costs of a cyber-security incident may include, but would not be limited to, remediation costs, increased protection costs, lost revenue from the unauthorized use of proprietary information or the loss of current and/or future customers, and litigation.

We maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems. However, we cannot assure that this policy would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should we experience any one or more of our or a third-party’s systems failing or experiencing attack.

 

ITEM 2

Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

 

ITEM 3

Defaults upon Senior Securities

None

 

ITEM 4

Mine Safety Disclosures

Not applicable

 

ITEM 5

Other Information

None

 

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ITEM 6

Exhibits

 

31.1		Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer of the Registrant
31.2		Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of the Registrant
32*		Furnished statements of the Chief Executive Officer and Chief Financial Officer under 18 U.S.C Section 1350
101		The following financial information from Pacific Continental Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2015, is formatted in XBRL: (i) the Unaudited Consolidated Balance Sheets, (ii) the Unaudited Consolidated Statements of Income, (iii) the Unaudited Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income, (iv) the Unaudited Consolidated Statements of Cash Flows, and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text.

 

*

In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibit 32 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

						PACIFIC CONTINENTAL CORPORATION
						(Registrant)
Dated		May 8, 2015				/s/ Roger Busse
						Roger Busse
						Chief Executive Officer
						(Duly Authorized Officer; Principal Executive Officer)
Dated		May 8, 2015				/s/ Michael A. Reynolds
						Michael A. Reynolds
						Executive Vice President and Chief Financial Officer (Duly Authorized Officer; Principal Financial Officer)

 

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