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Pacific Financial Corp. Earnings Grow 17% Year-to-Date; 2Q16 Earnings Increase 11% Year-over-Year; Fueled by Loan Growth, Stable Net Interest Margin and Increases in Noninterest Income

ABERDEEN, Wash., July 26, 2016 (GLOBE NEWSWIRE) -- Pacific Financial Corporation (OTCQB:PFLC), the holding company for Bank of the Pacific today reported net income increased 28% to $1.8 million, or $0.17 per share, for the second quarter of 2016, compared to $1.4 million, or $0.13 per share for the first quarter of 2016, and grew 11% from $1.6 million, or $0.15 per share, for the second quarter of 2015. For the first six months ended June 30, 2016, net income was $3.1 million, or $0.30 per share, compared to $2.7 million, or $0.26 per share, for the first six months ended June 30, 2015. Driving profitability in 2016 was continued loan growth, stable net interest margin and increased noninterest income. All results are unaudited.

“We delivered strong second quarter results supported by our recent loan growth over the past year. This growth demonstrates the increasing effectiveness of the commercial lending teams we placed in additional markets during the past several years. Revenue from residential real estate mortgage activity continued to be strong, up 7% this quarter versus the like quarter in 2015,” said Denise Portmann, President & Chief Executive Officer. “With the recent decline in longer-term interest rates, our residential mortgage lending team is well positioned to generate additional revenue from the expected increase in refinance activity.”

“Our credit quality continues to strengthen, with a solid decline in adversely classified loans during the quarter and further reductions in non-performing assets,” added Portmann. “This improvement was primarily the result of the payoff of a $6.9 million non-owner occupied commercial real estate loan. Despite our loan growth over the recent quarters, we continue to promote a strong risk management culture by maintaining prudent levels of commercial real estate that are well within regulatory guidelines. Looking forward, we will remain focused on loan and revenue growth opportunities in our pursuit of results commensurate with a high-performance community bank.”

Second Quarter 2016 Highlights (as of, or for the period ended June 30, 2016, except as noted):

  • Earnings per share (EPS) were $0.17, as compared to $0.13 in the linked quarter, and $0.15 in second quarter 2015. Year-to-date, EPS increased 15% to $0.30 per share from the first half of 2015.

  • Net interest income declined $156,000, or 2%, to $7.8 million, compared to $7.9 million for the immediate prior quarter, and grew 7% from $7.3 million in the second quarter of 2015. Net interest income was reduced in the current period by an adjustment of $192,000 in settlement of additional one-time interest assessed due to a breach in loan agreement.

  • Net interest margin (NIM), on a tax equivalent basis was 4.16%, as compared to 4.27% in the preceding quarter and 4.16% for second quarter 2015. Net interest margin was reduced by 11 basis points during the current quarter due to the settlement reached as described above.

  • Total assets increased 2% to $844.3 million during the quarter from $829.5 million at March 31, 2016, and grew 7% from $786.5 million at June 30, 2015.

  • Gross loans decreased 1% to $640.6 million, as compared to $644.9 million as of March 31, 2016, primarily due to the payoff of a $6.9 million adversely classified non-owner occupied commercial real estate loan and the sale of $909,000 in loans guaranteed by the SBA. Gross loans grew 6% from a year ago.

  • Total deposits increased 2% to $734.2 million, compared to $722.7 million at March 31, 2016, and increased 10% from a year ago. Non-interest bearing demand deposits grew 1% on a linked quarter basis and 15% over the second quarter of 2015.

  • Nonperforming assets decreased to $3.5 million, or 0.41% of total assets, compared to 0.47% on a linked quarter basis and 0.94% a year ago.

  • Net charge offs totaled $128,000, or 0.08% of average gross loans. This compares to $27,000, or 0.02% of average gross loans in first quarter 2016. Loans 30 – 89 days delinquent, not in nonaccrual status, stood at 0.15% of total loans outstanding.

  • Classified loans were $11.1 million, or 1.73% of gross loans, compared to 2.72% and 2.67% at March 31, 2016 and June 30, 2015, respectively.

Operating Results

Total assets grew from the linked quarter primarily due to growth in investment securities and cash equivalents. Total assets grew from the year-over-year primarily due to growth in loans, investment securities and cash equivalents. During both periods, asset growth was funded primarily by increases in core deposits. Liquidity remains strong, including ample unused borrowing capacity. Capital ratios continue to exceed the thresholds to be considered “Well-Capitalized” under published regulatory standards.

Net interest income declined from the linked quarter due to an adjustment of $192,000 in settlement of additional one-time interest assessed, as previously noted. However, for the six months ending June 30, 2016, net interest income was enhanced by a net $107,000 in one-time additional interest assessed due to the loan agreement breach. Net interest income grew versus the same quarter a year ago and as compared to the corresponding six-month period in 2015. This increase reflects growth in earning assets over the recent quarters. Loan balances increased year-over-year due to loan production generated predominately in Western Washington and Oregon. Interest expense grew commensurate with growth in core deposits and a modest addition of higher-cost longer-term fixed-rate deposits throughout the prior year to lengthen liability maturities for interest rate risk management purposes. The continued growth of noninterest bearing deposits ameliorated the impact of the addition of longer-term deposits on funding costs. The increase in loan yields year-to-date was partially due to the imposition of additional interest due to a breach in loan agreement as noted above.

Balance Sheet Overview
(Unaudited)
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
Assets: (Dollars in thousands, except per share data)
Cash and cash equivalents$ 29,731 $ 22,961 $ 6,770 29%$ 16,965 $ 12,766 75%
Other interest earning deposits 2,727 2,727 - 0% 2,727 - 0%
Investment securities 103,460 96,004 7,456 8% 90,976 12,484 14%
Loans held-for-sale 15,081 9,446 5,635 60% 16,482 (1,401) -9%
Loans, net of deferred fees 639,065 643,377 (4,312) -1% 603,562 35,503 6%
Allowance for loan losses (8,700) (8,552) (148) 2% (8,347) (353) 4%
Net loans 630,365 634,825 (4,460) -1% 595,215 35,150 6%
Federal Home Loan Bank and Pacific Coast
Bankers' Bank stock, at cost
2,338 2,339 (1) 0% 2,949 (611) -21%
Other assets 60,551 61,205 (654) -1% 61,228 (677) -1%
Total assets$ 844,253 $ 829,507 $ 14,746 2%$ 786,542 $ 57,711 7%
Liabilities and Shareholders' Equity:
Total deposits$ 734,245 $ 722,736 $ 11,509 2%$ 664,816 $ 69,429 10%
Borrowings 22,131 22,169 (38) 0% 39,781 (17,650) -44%
Accrued interest payable and other liabilities 7,122 6,147 975 16% 6,693 429 6%
Shareholders' equity 80,755 78,455 2,300 3% 75,252 5,503 7%
Total liabilities and shareholders' equity$ 844,253 $ 829,507 $ 14,746 2%$ 786,542 $ 57,711 7%
Common Stock Shares Outstanding 10,419,957 10,417,868 2,089 0% 10,384,997 34,960 0%
Book value per common share (1)$ 7.75 $ 7.53 $ 0.22 3%$ 7.25 $ 0.50 7%
Tangible book value per common share (2)$ 6.45 $ 6.23 $ 0.22 4%$ 5.94 $ 0.51 9%
Gross loans to deposits ratio 87.0% 89.0% 90.8%
(1) Book value per common share is calculated as the total common shareholders' equity divided by the period ending number of common stock shares
outstanding.
(2) Tangible book value per common share is calculated as the total common shareholders' equity less total intangible assets and liabilities, divided by the period
ending number of common stock shares outstanding.


Net interest income declined from the linked quarter due to an adjustment of $192,000 in settlement of additional one-time interest assessed, as previously noted. However, for the six months ending June 30, 2016, net interest income was enhanced by a net $107,000 in one-time additional interest assessed due to the loan agreement breach. Net interest income grew versus the same quarter a year ago and was up compared to the corresponding six-month period in 2015. This increase reflects growth in earning assets over the recent quarters. Loan balances increased year-over-year due to loan production generated predominately in Western Washington and Oregon. Interest expense grew commensurate with growth in core deposits and a modest addition of higher-cost longer-term fixed-rate deposits throughout the prior year to lengthen liability maturities for interest rate risk management purposes. The continued growth of noninterest bearing deposits ameliorated the impact of the addition of longer-term deposits on funding costs. The increase in loan yields year-to-date was partially due to the imposition of additional interest due to a breach in loan agreement, as noted above.

Income Statement Overview
(Unaudited)
For the Three Months Ended,
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
(Dollars in thousands, except per share data)
Interest and dividend income$8,394 $8,529 $ (135) -2% $7,817 $577 7%
Interest expense 628 607 21 3% 528 100 19%
Net interest income 7,766 7,922 (156) -2% 7,289 477 7%
Loan loss provision 276 262 14 5% 187 89 48%
Noninterest income 3,025 2,531 494 20% 2,823 202 7%
Noninterest expense 7,981 8,270 (289) -3% 7,732 249 3%
Income before income taxes 2,534 1,921 613 32% 2,193 341 16%
Income tax expense 772 545 227 42% 611 161 26%
Net Income$1,762 $1,376 $ 386 28% $1,582 $180 11%
Average common shares outstanding - basic 10,418,560 10,401,140 17,420 0% 10,380,542 38,018 0%
Average common shares outstanding - diluted 10,578,267 10,547,413 30,854 0% 10,504,376 73,891 1%
Income per common share
Basic$0.17 $0.13 $ 0.04 31% $0.15 $0.02 13%
Diluted$0.17 $0.13 $ 0.04 31% $0.15 $0.02 13%
For the Six Months Ended,
June 30,
2016
June 30,
2015
$
Change
%
Change
(Dollars in thousands, except per share data)
Interest and dividend income$16,922 $15,250 $ 1,672 11%
Interest expense 1,233 1,038 195 19%
Net interest income 15,689 14,212 1,477 10%
Loan loss provision 538 217 321 148%
Noninterest income 5,556 4,797 759 16%
Noninterest expense 16,253 15,216 1,037 7%
Income before income taxes 4,454 3,576 878 25%
Income tax expense 1,317 897 420 47%
Net Income$3,137 $2,679 $ 458 17%
Average common shares outstanding - basic 10,409,850 10,377,072 32,778 0%
Average common shares outstanding - diluted 10,562,832 10,505,135 57,697 1%
Income per common share
Basic$0.30 $0.26 $ 0.04 15%
Diluted$0.30 $0.26 $ 0.04 15%

Noninterest Income

Noninterest income was up versus the linked quarter, primarily as a result of growth in revenue from residential mortgage loans. This was mainly due to increases in residential sales activity typical for the spring season and growth in refinance activity resulting from recent declines in longer-term interest rates. Increases in residential real estate sales continue to benefit from improvement in the local economy. This revenue growth more than offset the $351,000 gain on the sale of a $1.2 million other-real-estate-owned (OREO) property taken in the linked quarter. Noninterest income for the current quarter also included $104,000 from gain on sale of SBA guaranteed loans. Deposit service charge income grew due to the increase in selected business deposit account fees introduced throughout the linked quarter. In addition, the current period contained a one-time gain on death benefit from bank-owned life insurance of $100,000. Noninterest income increased versus the same quarter a year ago and as compared to the same year-to-date period in 2015. This was primarily due to the aforementioned gain on sale of OREO, increase in gains on sale of residential mortgage loans, gain on sale of SBA guaranteed loans, gain on death benefit from bank-owned life insurance and changes in service charges, as noted above.

Noninterest Income
(Unaudited)
For the Three Months Ended,
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Service charges on deposits$485 $449 $ 36 8% $436$ 49 11%
Gain on sale of other real estate owned, net 5 420 (415) -99% 89 (84) -94%
Gain on sale of loans, net 1,635 1,032 603 58% 1,426 209 15%
Gain on sale of securities available for sale, net - - - 0% 53 (53) -100%
Earnings on bank owned life insurance 116 121 (5) -4% 126 (10) -8%
Other noninterest income
Fee income 520 443 77 17% 549 (29) -5%
Income from other real estate owned - - - 0% 67 (67) -100%
Other 264 66 198 300% 77 187 243%
Total noninterest income$3,025 $2,531 $ 494 20% $2,823$ 202 7%
For the Six Months Ended,
June 30,
2016
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Service charges on deposits$933 $863 $ 70 8%
Gain on sale of other real estate owned, net 425 83 342 412%
Gain on sale of loans, net 2,667 2,380 287 12%
Gain on sale of securities available for sale, net 6 53 (47) -89%
Earnings on bank owned life insurance 237 247 (10) -4%
Other noninterest income
Fee income 962 988 (26) -3%
Income from other real estate owned - 67 (67) -100%
Other 326 116 210 181%
Total noninterest income$5,556 $4,797 $ 759 16%

Noninterest Expense

Noninterest expense decreased from the immediate prior quarter, primarily due to a one-time OREO operating expense of $348,000 incurred in the linked quarter to prepare a $1.2 million OREO property for sale. Salaries and employee benefit costs increased due to annual merit increases effective in the current period. Noninterest expense was up compared to the year-over-year quarter, primarily related to salary and benefit costs. In addition to higher commission expenses associated with increased residential real estate loan production, further salary and employee benefit expense was incurred as a result of the personnel additions earlier in the current year to implement strategic initiatives to expand treasury management and small business lines of business. Noninterest expenses grew year-to-date versus the same period a year ago, primarily due to increases related to the aforementioned OREO operating expense and salary and benefit costs.

Noninterest Expense
(Unaudited)
For the Three Months Ended,
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Salaries and employee benefits$5,165 $5,057 $ 108 2% $ 4,837 $ 328 7%
Occupancy 520 495 25 5% 485 35 7%
Equipment 274 259 15 6% 250 24 10%
Data processing 489 491 (2) 0% 471 18 4%
Professional services 122 151 (29) -19% 190 (68) -36%
Other real estate owned write-downs - - - 0% 74 (74) 0%
Other real estate owned operating costs 14 417 (403) -97% (10) 24 -240%
State and local taxes 121 121 - 0% 120 1 1%
FDIC and State assessments 143 134 9 7% 133 10 8%
Other noninterest expense:
Director fees 81 72 9 13% 83 (2) -2%
Communication 66 64 2 3% 62 4 6%
Advertising 75 71 4 6% 81 (6) -7%
Professional liability insurance 47 48 (1) -2% 15 32 213%
Amortization 56 57 (1) -2% 88 (32) -36%
Other 808 833 (25) -3% 853 (45) -5%
Total noninterest expense$7,981 $8,270 $ (289) -3% $ 7,732 $ 249 3%
For the Six Months Ended,
June 30,
2016
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Salaries and employee benefits$10,222 $9,415 $ 807 9%
Occupancy 1,015 1,007 8 1%
Equipment 532 517 15 3%
Data processing 980 949 31 3%
Professional services 248 331 (83) -25%
Other real estate owned write-downs - 104 (104) -100%
Other real estate owned operating costs 431 8 423 5288%
State and local taxes 243 221 22 10%
FDIC and State assessments 278 266 12 5%
Other noninterest expense:
Director fees 153 154 (1) -1%
Communication 130 123 7 6%
Advertising 145 176 (31) -18%
Professional liability insurance 95 37 58 157%
Amortization 114 171 (57) -33%
Other 1,667 1,737 (70) -4%
Total noninterest expense$16,253 $15,216 $ 1,037 7%



Financial Performance Overview
(Unaudited)
For the Three Months Ended
June 30,
2016
March 31,
2016
Change June 30,
2015
Change
Performance Ratios
Return on average assets, annualized 0.85% 0.67% 0.18 0.82% 0.03
Return on average equity, annualized 8.87% 7.11% 1.76 8.44% 0.43
Efficiency ratio (1) 73.96% 79.12% (5.16) 76.46% (2.50)
For the Six Months Ended,
June 30,
2016
June 30,
2015
Change
Performance Ratios
Return on average assets, annualized 0.76% 0.71% 0.05
Return on average equity, annualized 8.01% 7.27% 0.74
Efficiency ratio (1) 76.50% 80.05% (3.55)
(1) Non-interest expense divided by net interest income plus noninterest income.

LIQUIDITY

Cash and Cash Equivalents and Investment Securities
(Unaudited)
June 30,
2016
% of
Total
March 31,
2016
% of
Total
$
Change
%
Change
June 30,
2015
Total $
Change
%
Change
(Dollars in thousands)
Cash on hand and in banks$16,803 12%$13,868 11%$ 2,935 21%$16,431 14%$ 372 2%
Interest bearing deposits 12,928 9% 9,093 7% 3,835 42% 534 0% 12,394 2321%
Certificates of deposit 2,727 2% 2,727 2% - 0% 2,727 2% - 0%
Total cash equivalents and certificate of deposits 32,458 23% 25,688 21% 6,770 26% 19,692 17% 12,766 65%
Investment securities:
Collateralized mortgage obligations: agency issued 36,156 27% 35,020 28% 1,136 3% 38,479 34% (2,323) -6%
Collateralized mortgage obligations: non-agency 483 0% 483 0% - 0% 483 0% - 0%
Mortgage-backed securities: agency issued 10,711 8% 10,920 9% (209) -2% 9,468 8% 1,243 13%
U.S. Government and agency securities 9,930 7% 9,929 8% 1 0% 10,004 9% (74) -1%
State and municipal securities 46,180 33% 39,652 32% 6,528 16% 32,542 29% 13,638 42%
FHLB Stock, at cost 1,338 1% 1,339 1% (1) 0% 1,949 2% (611) -31%
Pacific Coast Bankers' Bank stock, at cost 1,000 1% 1,000 1% - 0% 1,000 1% - 0%
Total investment securities 105,798 77% 98,343 79% 7,455 8% 93,925 83% 11,873 13%
Total cash equivalents and investment securities$138,256 100%$124,031 100%$ 14,225 11%$113,617 100%$ 24,639 22%
Total cash equivalents and investment securities
as a percent of total assets 16% 15% 14%

Liquidity remains strong based on current levels of combined cash equivalents, investment securities and unused borrowing capacity. “During the second quarter, we redeployed a portion of our cash equivalents into higher-yielding investments,” said Douglas N. Biddle, EVP and Chief Financial Officer. “Our investment securities include a large component of fully amortized U.S. agency collateralized mortgage and mortgage-backed securities, for which we expect to have limited extension risk.” The securities portfolio also contains municipal securities rated A or better. The expected modified duration (adjusted for calls, consensus pre-payment speeds and rate adjustment dates) of the investment portfolio was 3.4 years at June 30, 2016, 3.3 years at March 31, 2016 and 3.8 years at June 30, 2015.

The Bank had $8.7 million in outstanding borrowings against its $180.5 million in established borrowing capacity with the Federal Home Loan Bank of Des Moines (FHLB) at June 30, 2016. The Bank had $8.8 million and $26.4 million in outstanding borrowings with the FHLB at March 31, 2016 and June 30, 2015, respectively. The Bank’s borrowing facility with the FHLB is subject to collateral and stock ownership requirements. The Bank also has available a discount window primary credit line with the Federal Reserve Bank of San Francisco of approximately $59.9 million, subject to collateral requirements, and $16.0 million from correspondent banks, with no balance outstanding on either of these facilities.

LOANS

Loans by Category
(unaudited)
June 30,
2016
% of
Gross
Loans
March 31,
2016
% of
Gross
Loans
$
Change
%
Change
June 30,
2015
% of
Gross
Loans
$
Change
%
Change
(Dollars in thousands)
Commercial and agricultural$ 133,285 21%$ 134,540 21%$ (1,255) -1%$ 121,435 20%$ 11,850 10%
Real estate:
Construction and development 29,639 5% 34,469 5% (4,830) -14% 32,382 5% (2,743) -8%
Residential 1-4 family 93,194 15% 93,826 15% (632) -1% 94,616 16% (1,422) -2%
Multi-family 29,786 5% 27,505 4% 2,281 8% 24,617 4% 5,169 21%
Commercial real estate -- owner occupied 134,421 20% 135,704 21% (1,283) -1% 134,680 22% (259) 0%
Commercial real estate -- non owner occupied 137,156 21% 141,203 22% (4,047) -3% 127,654 21% 9,502 7%
Farmland 23,363 4% 22,182 3% 1,181 5% 21,958 4% 1,405 6%
Consumer 59,746 9% 55,427 9% 4,319 8% 47,616 8% 12,130 25%
Gross loans 640,590 100% 644,856 100% (4,266) -1% 604,958 100% 35,632 6%
Less: allowance for loan losses (8,700) (8,552) (148) (8,347) (353)
Less: deferred fees (1,525) (1,479) (46) (1,396) (129)
Loans, net$ 630,365 $ 634,825 $ (4,460) $ 595,215 $ 35,150
Loan Concentration
(unaudited)
June 30,
2016
% of Risk
Based
Capital
March 31,
2016
% of Risk
Based
Capital
Change June 30,
2015
% of Risk
Based
Capital
Change
(Dollars in thousands)
Commercial and agricultural$ 133,285 152%$ 134,540 157% -5%$ 121,435 146% 6%
Real estate:
Construction and development 29,639 34% 34,469 40% -6% 32,382 39% -5%
Residential 1-4 family 93,194 106% 93,826 109% -3% 94,616 113% -7%
Multi-family 29,786 34% 27,505 32% 2% 24,617 29% 5%
Commercial real estate -- owner occupied 134,421 153% 135,704 158% -5% 134,680 161% -8%
Commercial real estate -- non owner occupied 137,156 156% 141,203 165% -9% 127,654 153% 3%
Farmland 23,363 27% 22,182 26% 1% 21,958 26% 1%
Consumer 59,746 68% 55,427 65% 3% 47,616 57% 11%
Gross loans$ 640,590 $ 644,856 $ 604,958
Regulatory Commercial Real Estate$ 191,572 218%$ 199,148 232% -14%$ 178,775 214% 4%
Total Risk Based Capital*$ 87,690 $ 85,814 $ 83,453
*Bank of the Pacific

The loan portfolio continues to be well-diversified with balances in most lending categories originating predominately within the Western Washington and Oregon markets. The decline in loan totals for the current period was impacted primarily by scheduled take-outs of construction loans and the payoff of a $6.9 million adversely classified non-owner-occupied commercial real estate loan. The portfolio includes $39.6 million in lower-yielding LIBOR-based floating rate commercial real estate loans. The portfolio also includes $24.1 million in purchased government-guaranteed commercial and commercial real estate loans. In addition, the portfolio contains $48.2 million in indirect consumer loans to finance luxury and classic cars as a part of a strategy to diversify the loan portfolio. These loans have been made to individuals with high credit scores and have exhibited very low loss experience to date. The Company manages new loan origination volume using concentration limits that establish maximum exposure levels by designated industry segment, real estate product types, geography, and single borrower limits. While the Bank’s recent loan growth does include commercial real estate, the amount of such exposure continues to be managed within regulatory guidelines.

DEPOSITS

Deposits by Category
(Unaudited)
June 30,
2016
% of
Total
March 31,
2016
% of
Total
$
Change
%
Change
June 30,
2015
% of
Total
$
Change
%
Change
(Dollars in thousands)
Interest-bearing demand and money market $ 319,609 44% $295,056 40% $ 24,553 8% $ 284,844 43% $34,765 12%
Savings 83,475 11% 94,734 13% (11,259) -12% 81,619 12% 1,856 2%
Time deposits (CDs) 135,040 18% 138,277 19% (3,237) -2% 127,809 19% 7,231 6%
Total interest-bearing deposits 538,124 73% 528,067 73% 10,057 2% 494,272 74% 43,852 9%
Non-interest bearing demand 196,121 27% 194,669 27% 1,452 1% 170,544 26% 25,577 15%
Total deposits $ 734,245 100% $722,736 100% $ 11,509 2% $ 664,816 100% $69,429 10%


Total deposits grew during the current quarter partially due to recent successes in acquiring business deposit relationships in conjunction with the growth in lending achieved over the past year. Savings balances declined due to a sunsetting of savings account and subsequent transfer of these balances to a money market account product. Accordingly, the proportion of noninterest bearing deposits to total deposits has remained steady over the past several quarters.

Total brokered deposits were $53.7 million, which included $1.1 million via reciprocal deposit arrangements, unchanged from $53.7 million at March 31, 2016 and $29.0 million at March 31, 2015. The brokered deposits acquired during the latter part of 2015 had fixed rates with terms ranging from 2 to 5 years. “These deposits were obtained to lock in historically low rates to enhance the Bank’s interest rate risk mitigation strategies,” explained Biddle.

CAPITAL

Pacific Financial Corporation (“Company”), and its subsidiary Bank of the Pacific (“Bank”), met the thresholds to be considered “Well-Capitalized” under published regulatory standards for total risk-based capital, Tier 1 risk-based capital, Common equity Tier 1 and Tier 1 leverage capital. The current period ratios have declined as compared to the linked and same quarter a year ago, primarily due to the successful execution of the Company’s growth strategy and shift in balance sheet mix to higher risk-weighted assets, such as loans.

The Federal Deposit Insurance Corporation (“FDIC”) has established minimum requirements for capital adequacy for state non-member banks under the Basel III capital framework. On April 9, 2015, The Board of Governors of the Federal Reserve System (“Federal Reserve”) issued a final rule to amend the Small Bank Holding Company Policy Statement. With this amendment, small bank holding companies, including Pacific Financial Corporation, are not being subject to Basel III capital rules. For illustrative purposes, Basel III framework capital ratios are displayed below for both the Company and the Bank.

The total risk-based capital ratios of the Company include $13.4 million of junior subordinated debentures, all of which qualified as Tier 1 capital under guidance issued by the Federal Reserve. As provided in the Dodd-Frank Act, the Company expects to continue to rely on these junior subordinated debentures as part of its regulatory capital.

The following table summarizes the capital measures of the Company and the Bank respectively, at the dates listed below.

Capital Measures
(unaudited)
June 30,
2016
March 31,
2016
Change June 30,
2015
Change To be Well
Capitalized
Under
Prompt
Correction
Action
Regulations*
Pacific Financial Corporation
Total risk-based capital ratio 12.64% 12.73% (0.09) 12.87% (0.23) N/A
Tier 1 risk-based capital ratio 11.39% 11.48% (0.09) 11.62% (0.23) N/A
Common equity tier 1 ratio 9.52% 9.57% (0.05) 9.62% (0.10) N/A
Leverage ratio 9.72% 9.58% 0.14 9.90% (0.18) N/A
Tangible common equity ratio 8.09% 7.95% 0.14 7.98% 0.11 N/A
Bank of the Pacific
Total risk-based capital ratio 12.55% 12.66% (0.11) 12.84% (0.29) 10.5%
Tier 1 risk-based capital ratio 11.30% 11.41% (0.11) 11.59% (0.29) 8.5%
Common equity tier 1 ratio 11.30% 11.41% (0.11) 11.59% (0.29) 7.0%
Leverage ratio 9.65% 9.50% 0.15 9.88% (0.23) 7.5%
*Includes Basel III Capital Conservation Buffer

Net Interest Margin

Net interest margin declined compared to first quarter 2016, predominantly due to an adjustment of $192,000 in settlement of additional one-time interest assessed due to a breach in loan agreement. Despite this adjustment, net interest margin remained unchanged as compared to the year-over-year quarter. Year-to date, the net one-time interest earned due to the loan agreement breach was $107,000, enhancing net interest margin by 3 basis points. Without this enhancement, net interest margin still grew as compared to the same period in 2015.

Yield on investment securities increased as compared to the linked and year-over-year quarterly and year-to-date periods. This was primarily due to an increase in the proportion of higher-yielding tax-exempt securities within the portfolio. Correspondingly, the proportion of mortgage-backed securities was reduced to mitigate the impact of potential changes in interest rates on the value of these types of securities.

Cost of deposits and borrowings remained relatively unchanged in the current quarter as compared to the linked and year-over-year quarterly and year-to-date periods. This was despite the modest addition of higher-cost longer-term fixed rate brokered deposit funding during the prior year. The increase in the proportion of deposits coming from non-interest bearing deposits favorably impacted funding costs during these respective periods.

The following tables set forth information with regard to average balances of interest-earning assets and interest-bearing liabilities and the resultant yields or cost, and the net interest margin on a tax equivalent basis. Loans held for sale and non-accrual loans are included in total loans.

Net Interest Margin
(Unaudited)
(Annualized, tax-equivalent basis)
For the Three Months Ended,
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
Average Balances (Dollars in thousands)
Gross loans$ 642,560 $ 637,187 $ 5,373 1%$ 594,741 $ 47,819 8%
Loans held for sale$ 9,425 $ 9,957 $ (532) -5%$ 14,713 $ (5,288) -36%
Investment securities$ 114,673 $ 115,892 $ (1,219) -1%$ 107,074 $ 7,599 7%
Total interest-earning assets$ 766,658 $ 763,036 $ 3,622 0%$ 716,528 $ 50,130 7%
Non-interest bearing demand deposits$ 189,744 $ 181,777 $ 7,967 4%$ 168,967 $ 20,777 12%
Interest bearing deposits$ 526,445 $ 522,327 $ 4,118 1%$ 491,750 $ 34,695 7%
Borrowings$ 27,742 $ 37,238 $ (9,496) -26%$ 34,809 $ (7,067) -20%
Total interest-bearing liabilities$ 554,187 $ 559,565 $ (5,378) -1%$ 526,559 $ 27,628 5%
Total Equity$ 79,719 $ 77,853 $ 1,866 2%$ 75,164 $ 4,555 6%
For the Three Months Ended,
June 30,
2016
March 31,
2016
Change June 30,
2015
Change
Yield on average gross loans (1) 4.85% 5.01% (0.16) 4.84% 0.01
Yield on average investment securities (1) 2.39% 2.26% 0.13 2.26% 0.13
Cost of average interest bearing deposits 0.37% 0.36% 0.01 0.33% 0.04
Cost of average borrowings 2.01% 1.51% 0.50 1.43% 0.58
Cost of average total deposits and borrowings 0.34% 0.33% 0.01 0.30% 0.04
Yield on average interest-earning assets 4.48% 4.59% (0.11) 4.46% 0.02
Cost of average interest-bearing liabilities 0.45% 0.44% 0.01 0.40% 0.05
Net interest spread 4.03% 4.15% (0.12) 4.06% (0.03)
Net interest margin (1) 4.16% 4.27% (0.11) 4.16% -
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a 34% rate.
For the Six Months Ended,
June 30,
2016
June 30,
2015
$
Change
%
Change
Average Balances (Dollars in thousands)
Gross loans$ 639,874 $ 581,339 $ 58,535 10%
Loans held for sale$ 9,691 $ 10,746 $ (1,055) -10%
Investment securities$ 115,283 $ 111,528 $ 3,755 3%
Interest-earning assets$ 764,848 $ 703,613 $ 61,235 9%
Non-interest bearing demand deposits$ 185,760 $ 168,184 $ 17,576 10%
Interest bearing deposits$ 524,386 $ 486,246 $ 38,140 8%
Borrowings$ 32,490 $ 29,856 $ 2,634 9%
Interest-bearing liabilities$ 556,876 $ 516,102 $ 40,774 8%
Total Equity$ 78,786 $ 74,318 $ 4,468 6%
For the Six Months Ended,
June 30,
2016
June 30,
2015
Change
Net Interest Margin
Yield on average gross loans (1) 4.94% 4.88% 0.06
Yield on average investment securities (1) 2.33% 2.19% 0.14
Cost of average interest bearing deposits 0.37% 0.33% 0.04
Cost of average borrowings 1.71% 1.62% 0.09
Cost of average total deposits and borrowings 0.33% 0.31% 0.02
Yield on average interest-earning assets 4.54% 4.45% 0.09
Cost of average interest-bearing liabilities 0.45% 0.41% 0.04
Net interest spread 4.09% 4.04% 0.05
Net interest margin (1) 4.22% 4.16% 0.06
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a 34% rate.

ASSET QUALITY

Adversely classified loans decreased compared to the preceding quarter, primarily due to the payoff of a $6.9 million non-owner occupied commercial real estate loan during the period. Adversely classified loans declined versus the like quarter a year ago primarily due to the refinancing of a $2.0 million troubled debt restructure (“TDR”) to a fully performing commercial loan and the payoff of a $1.5 million commercial loan on non-accrual. Total 30-89 day delinquencies remained below 0.50%, mirroring the continued improvement in overall credit quality.

Adversely Classified Loans and Securities
(Unaudited)
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Rated substandard or worse, but not impaired$ 9,963 $ 15,597 $ (5,634) -36%$ 10,442 $ (479) -5%
Impaired 1,145 1,915 (770) -40% 5,715 (4,570) -80%
Total adversely classified loans¹$ 11,108 $ 17,512 $ (6,404) -37%$ 16,157 $ (5,049) -31%
Total adversely classified investment securities²$ - $ 165 $ (165) -100%$ 189 $ (189) -100%
Gross loans (excluding deferred loan fees)$ 640,591 $ 644,856 $ (4,266) -1%$ 604,958 $ 35,632 6%
Adversely classified loans to gross loans 1.73% 2.72% 2.67%
Allowance for loan losses$ 8,700 $ 8,552 $ 148 2%$ 8,347 $ 353 4%
Allowance for loan losses as a percentage of adversely classified loans 78.32% 48.84% 51.66%
Allowance for loan losses to total impaired loans 759.83% 446.58% 146.05%
Adversely classified loans and securities to total assets 1.32% 2.13% 2.08%
Delinquent loans to gross loans, not in nonaccrual status 0.15% 0.31% 0.01%
¹Adversely classified loans are defined as loans having a well-defined weakness or weaknesses related to the borrower's financial capacity or to pledged collateral that may
jeopardize the repayment of the debt. They are characterized by the possibility that the Bank may sustain some loss if the deficiencies giving rise to the substandard
classification are not corrected. Note that any loans internally rated worse than substandard are included in the impaired loan totals.
²Adversely classified investment securities consist of one private label collateralized mortgage obligation (CMO) as of March 31, 2016 and June 30, 2015.

Nonperforming assets declined as compared to the linked quarter, primarily due to sales of OREO, as noted below. As a result, nonperforming assets declined during the period as a percentage of total assets.

Nonperforming Assets
(Unaudited)
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Loans on nonaccrual status$ 1,145 $ 1,373 $ (228) -17%$ 3,155 $ (2,010) -64%
Loans past due greater than 90 days but
not on nonaccrual status - - - - - - -
Total non-performing loans 1,145 1,373 (228) -17% 3,155 (2,010) -64%
Other real estate owned and
foreclosed assets 2,339 2,557 (218) -9% 4,240 (1,901) -45%
Total nonperforming assets$ 3,484 $ 3,930 $ (446) -11%$ 7,395 $ (3,911) -53%
Percentage of nonperforming assets to total assets 0.41% 0.47% 0.94%
Nonperforming loans to total loans 0.18% 0.21% 0.52%

The Company sold one OREO commercial real estate hospitality property with a book value of $223,000 for a small gain during the current period. The balances in the OREO portfolio at the quarter end were attributable to two commercial properties, both of which are located within our market area.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses has increased in concert with recent loan growth. With changes in the loan portfolio composition over the past several years and overall improvement in credit quality, loss factors used in estimates to establish reserve levels have declined commensurately.

For the current quarter, charge-offs increased from the linked quarter. This was primarily due to a partial charge-off of $97,000 taken in current quarter related to an adjustment of the carrying value of a collateral dependent commercial loan. “The low level of charge-offs and ratio of net loan charge-offs to average gross loans are indicative of the solid credit quality of the portfolio,” said Biddle. The current quarter’s experience also compares favorably with that of the year-over-year quarter. The overall risk profile of the loan portfolio continues to be modest, illustrative of the solid credit risk management framework in place. However, the trend of future provision for loan losses will depend primarily on economic conditions, growth in the loan portfolio, level of adversely-classified assets, and changes in collateral values.

Allowance for Loan Losses
(Unaudited)
For the Three Months Ended,
June 30,
2016
March 31,
2016
$
Change
%
Change
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Gross loans outstanding at end of period $ 640,590 $ 644,856 $ (4,266) -1%$ 604,958 $ 35,632 6%
Average loans outstanding, gross $ 642,560 $ 637,187 $ 5,373 1%$ 597,741 $ 44,819 7%
Allowance for loan losses, beginning of period $ 8,552 $ 8,317 $ 235 3%$ 8,254 $ 298 4%
Commercial (8) - (8) 100% - (8) 0%
Commercial Real Estate (97) - (97) 100% (114) 17 -15%
Residential Real Estate (19) (16) (3) 19% - (19) 100%
Consumer (17) (26) 9 -35% (30) 13 -43%
Total charge-offs (141) (42) (99) 236% (144) 3 -2%
Commercial 1 1 - 0% 36 (35) -97%
Commercial Real Estate 2 2 - 0% 2 (0) 0%
Residential Real Estate 2 11 (9) -82% 11 (9) -82%
Consumer 8 1 7 700% 1 7 700%
Total recoveries 13 15 (2) -13% 50 (37) -74%
Net (charge-offs)/recoveries (128) (27) (101) 374% (94) (34) 36%
Provision charged to income 276 262 14 5% 187 89 48%
Allowance for loan losses, end of period $ 8,700 $ 8,552 $ 148 2%$ 8,347 $ 353 4%
Ratio of net loans charged-off to average
gross loans outstanding, annualized 0.08% 0.02% 0.06% 300% 0.06% 0.02% 33%
Ratio of allowance for loan losses to
gross loans outstanding 1.36% 1.33% 0.03% 2% 1.38% -0.02% -1%
For the Six Months Ended,
June 30,
2016
June 30,
2015
$
Change
%
Change
(Dollars in thousands)
Gross loans outstanding at end of period $ 640,590 $ 604,958 $ 35,632 6%
Average loans outstanding, gross $ 639,874 $ 581,339 $ 58,535 10%
Allowance for loan losses, beginning of period $ 8,317 $ 8,353 $ (36) 0%
Commercial (8) - (8) 100%
Commercial Real Estate (97) (122) 25 -20%
Residential Real Estate (35) (86) 51 -59%
Consumer (43) (94) 51 -54%
Total charge-offs (183) (302) 119 -39%
Commercial 2 42 (40) -95%
Commercial Real Estate 4 5 (1) -20%
Residential Real Estate 13 20 (7) -35%
Consumer 9 12 (3) -25%
Total recoveries 28 79 (51) -65%
Net (charge-offs)/recoveries (155) (223) 68 -30%
Provision charged to income 538 217 321 148%
Allowance for loan losses, end of period $ 8,700 $ 8,347 $ 353 4%
Ratio of net loans charged-off to average
gross loans outstanding, annualized 0.02% 0.15% -0.13% -87%
Ratio of allowance for loan losses to
gross loans outstanding 1.36% 1.38% -0.02% -1%

ABOUT PACIFIC FINANCIAL CORPORATION

Pacific Financial Corporation of Aberdeen, Washington, is the bank holding company for Bank of the Pacific, a state chartered and federally insured commercial bank. Bank of the Pacific offers banking products and services to small-to-medium sized businesses and professionals in western Washington and Oregon. As of June 30, 2016, the Company had total assets of $844 million and operated fifteen branches in the communities of Grays Harbor, Pacific, Whatcom, Skagit, Clark and Wahkiakum counties in the State of Washington, and three branches in Clatsop County, Oregon. The Company also operated loan production offices in the communities of DuPont and Burlington in Washington and Salem, Oregon. Visit the Company’s website at www.bankofthepacific.com. Member FDIC.

Cautions Concerning Forward-Looking Statements

This press release contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other laws, including all statements in this release that are not historical facts or that relate to future plans or events or projected results of Pacific Financial Corporation and its wholly-owned subsidiary, Bank of the Pacific. These forward-looking statements are subject to risks and uncertainties that could cause actual events or results to differ materially from those projected, anticipated or implied. These risks and uncertainties include various risks associated with growing the Bank and expanding the services it provides, successfully completing and integrating the acquisition of new branches and development of new business lines and markets, competition in the marketplace, general economic conditions, changes in interest rates, extensive and evolving regulation of the banking industry, and many other risks. We undertake no obligation to update or revise any forward-looking statement. Readers of this release are cautioned not to put undue reliance on forward-looking statements.

CONTACTS: DENISE PORTMANN, PRESIDENT & CEO DOUGLAS BIDDLE, EVP & CFO 360.533.8873 The Cereghino Group IR CONTACT: 206-388-5785

Source:Pacific Financial Corporation