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Pacific Financial Corp 3Q16 Earnings Increased 24% Year-over-Year and Grew 20% Year-to-Date; Boosted by Strong Loan Growth, Stable Net Interest Margin and Higher Noninterest Income

ABERDEEN, Wash., Oct. 25, 2016 (GLOBE NEWSWIRE) -- Pacific Financial Corporation (OTCQB:PFLC), the holding company for Bank of the Pacific today reported net income increased 13% to $2.0 million, or $0.19 per share, for the third quarter of 2016, compared to $1.8 million, or $0.17 per share, for the second quarter of 2016, and grew 24% from $1.6 million, or $0.15 per share, from the third quarter of 2015. For the first nine months ended September 30, 2016, net income was $5.1 million, or $0.49 per share, compared to $4.3 million, or $0.41 per share, for the first nine months ended September 30, 2015. Driving profitability in 2016 was continued loan growth, stable net interest margin and increased noninterest income. All results are unaudited.

“We reported strong third quarter results, delivering steady loan growth and solid revenue with an above average net interest margin. This growth demonstrates the continued impact 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 robust, up 27% this quarter versus the third quarter in 2015,” said Denise Portmann, President & Chief Executive Officer. “With the recent upswing in low longer-term interest rates, consumers are increasingly interested in locking in these long-term fixed rates. Our residential mortgage lending team is well situated to generate additional revenue from the anticipated increase in refinance activity.”

“Our credit quality remained solid with a continued decline in adversely classified loans during the third quarter,” added Portmann. “Despite our loan growth over the recent quarters, we continue to foster a strong risk management culture by managing our concentration of commercial real estate well within regulatory guidelines. In addition, our recent initiatives to grow our commercial deposit balances via expansion of our treasury management offerings have begun to bear fruit. We will continue our focus on loan and revenue growth opportunities available to us in our drive to achieve high-performance.”

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

  • Net interest margin (NIM), on a tax equivalent basis was 4.02%, as compared to 4.16% in the preceding quarter and 4.06% for third quarter 2015. Net interest margin declined during the current quarter due to retention of seasonal deposit inflows in lower-yielding cash equivalents in anticipation of funding continued loan growth as indicated by a strong pipeline.

  • Total assets increased 6% to $896.6 million during the quarter from $844.3 million at June 30, 2016, and grew 10% from $814.9 million at September 30, 2015.

  • Gross loans increased 2% to $650.7 million, as compared to $640.6 million as of June 30, 2016. Gross loans grew 7% from a year ago.

  • Total deposits increased 7% to $783.9 million, compared to $734.2 million at June 30, 2016, and increased 11% from a year earlier. Non-interest bearing demand deposits grew 19% on a linked quarter basis and 30% over the third quarter of 2015.

  • Nonperforming assets were $3.8 million, or 0.42% of total assets, compared to 0.41% on a linked quarter basis and 0.72% a year ago.

  • Net charge offs totaled $16,000, or 0.01% of average gross loans in the current quarter. This compares to $128,000, or 0.08% of average gross loans in second quarter 2016. Loans 30 – 89 days delinquent, not in nonaccrual status, stood at 0.03% of total loans outstanding.

  • Classified loans were $9.8 million, or 1.51% of gross loans, compared to 2.72% and 2.37% at June 30, 2016 and September 30, 2015, respectively.

Operating Results

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

Balance Sheet Overview
(Unaudited)
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$
Change
%
Change
Assets: (Dollars in thousands, except per share data)
Cash and cash equivalents$ 76,310 $ 29,731 $ 46,579 157%$ 48,904 $ 27,406 56%
Other interest earning deposits 2,727 2,727 - 0% 2,727 - 0%
Investment securities 100,358 103,460 (3,102) -3% 89,702 10,656 12%
Loans held-for-sale 14,069 15,081 (1,012) -7% 9,799 4,270 44%
Loans, net of deferred fees 649,108 639,065 10,043 2% 609,475 39,633 7%
Allowance for loan losses (8,960) (8,700) (260) 3% (8,756) (204) 2%
Net loans 640,148 630,365 9,783 2% 600,719 39,429 7%
Federal Home Loan Bank and Pacific Coast
Bankers' Bank stock, at cost
2,336 2,338 (2) 0% 2,348 (12) -1%
Other assets 60,623 60,551 72 0% 60,657 (34) 0%
Total assets$ 896,571 $ 844,253 $ 52,318 6%$ 814,856 $ 81,715 10%
Liabilities and Shareholders' Equity:
Total deposits$ 783,888 $ 734,245 $ 49,643 7%$ 705,100 $ 78,788 11%
Borrowings 22,094 22,131 (37) 0% 24,885 (2,791) -11%
Accrued interest payable and other liabilities 7,878 7,122 756 11% 7,386 492 7%
Shareholders' equity 82,711 80,755 1,956 2% 77,485 5,226 7%
Total liabilities and shareholders' equity$ 896,571 $ 844,253 $ 52,318 6%$ 814,856 $ 81,715 10%
Common Stock Shares Outstanding 10,422,871 10,419,957 2,914 0% 10,384,997 37,874 0%
Book value per common share (1) $ 7.94 $ 7.75 $ 0.19 2%$ 7.46 $ 0.48 6%
Tangible book value per common share (2) $ 6.64 $ 6.45 $ 0.19 3%$ 6.15 $ 0.49 8%
Gross loans to deposits ratio 82.8% 87.0% 86.4%
(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 increased from the linked quarter due primarily to an increase in the volume of loans and cash equivalents, as previously noted. For the nine months ending September 30, 2016, net interest income was enhanced by a net $107,000 one-time additional interest assessment due to the loan agreement breach. Net interest income grew versus the third quarter a year ago and was up compared to the corresponding nine-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 declined as compared to the linked quarter with the reduction in Libor-based rates paid on borrowings during the period. Interest expense grew year-to-date versus the corresponding period in 2015, commensurate with growth in core deposits and an 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.

Income Statement Overview
(Unaudited)
For the Three Months Ended,
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$ Change %
Change
(Dollars in thousands, except per share data)
Interest and dividend income $8,518$8,394$ 124 1%$7,946$572 7%
Interest expense 616 628 (12) -2% 561 55 10%
Net interest income 7,902 7,766 136 2% 7,385 517 7%
Loan loss provision 276 276 - 0% 165 111 67%
Noninterest income 3,194 3,025 169 6% 2,686 508 19%
Noninterest expense 8,178 7,981 197 2% 7,709 469 6%
Income before income taxes 2,642 2,534 108 4% 2,197 445 20%
Income tax expense 649 772 (123) -16% 596 53 9%
Net Income$1,993$1,762$ 231 13%$1,601$392 24%
Average common shares outstanding - basic 10,421,921 10,418,560 3,361 0% 10,384,997 36,924 0%
Average common shares outstanding - diluted 10,582,695 10,578,267 4,428 0% 10,520,581 62,114 1%
Income per common share
Basic$0.19$0.17$ 0.02 12%$0.15$0.04 27%
Diluted$0.19$0.17$ 0.02 12%$0.15$0.04 27%
For the Nine Months Ended,
Sept 30,
2016
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands, except per share data)
Interest and dividend income $25,441$23,196$ 2,245 10%
Interest expense 1,851 1,598 253 16%
Net interest income 23,590 21,598 1,992 9%
Loan loss provision 814 382 432 113%
Noninterest income 8,751 7,482 1,269 17%
Noninterest expense 24,430 22,925 1,505 7%
Income before income taxes 7,097 5,773 1,324 23%
Income tax expense 1,966 1,493 473 32%
Net Income$5,131$4,280$ 851 20%
Average common shares outstanding - basic 10,413,903 10,379,742 34,161 0%
Average common shares outstanding - diluted 10,569,483 10,523,625 45,858 0%
Income per common share
Basic$0.49$0.41$ 0.08 20%
Diluted$0.49$0.41$ 0.08 20%


Noninterest Income

Noninterest income was up versus the linked quarter, primarily as a result of growth in revenue from residential mortgage loans and miscellaneous loan fees. This was mainly due to increases in residential sales activity typical for the summer 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. Noninterest income for the linked quarter included $104,000 from gain on sale of SBA guaranteed loans and a one-time gain on death benefit from bank-owned life insurance of $100,000. Noninterest income increased versus the third quarter a year ago, primarily due to the previously mentioned growth in revenue from residential mortgage loans and miscellaneous loan fees. Noninterest income was also up as compared to the prior year-to-date period. 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,
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Service charges on deposits $477$485$ (8) -2%$451$ 26 6%
Gain on sale of other real estate owned, net - 5 (5) -100% 57 (57) -100%
Gain on sale of loans, net 1,864 1,635 229 14% 1,464 400 27%
Gain on sale of securities available for sale, net - - - 0% - - -
Earnings on bank owned life insurance 116 116 - 0% 120 (4) -3%
Other noninterest income
Fee income 694 520 174 33% 553 141 25%
Income from other real estate owned - - - 0% - - -
Other 43 264 (221) -84% 41 2 5%
Total noninterest income $3,194$3,025$ 169 6%$2,686$ 508 19%
For the Nine Months Ended,
Sept 30,
2016
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Service charges on deposits $1,411$1,314$ 97 7%
Gain on sale of other real estate owned, net 425 140 285 204%
Gain on sale of loans, net 4,530 3,844 686 18%
Gain on sale of securities available for sale, net 6 53 (47) -89%
Earnings on bank owned life insurance 353 368 (15) -4%
Other noninterest income
Fee income 1,656 1,541 115 7%
Income from other real estate owned - 67 (67) -100%
Other 370 155 215 139%
Total noninterest income $8,751$7,482$ 1,269 17%


Noninterest Expense

Noninterest expense increased from the immediate prior quarter, primarily due to higher commission expenses associated with increased residential real estate loan production and a write-down of OREO. Noninterest expense was up compared to the year-over-year quarter, primarily related to salary and benefit costs, including 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 salary and benefit costs, as mentioned above, and $348,000 in OREO operating expense incurred earlier in the year to prepare a $1.2 million OREO property for its eventual sale.

Noninterest Expense
(Unaudited)
For the Three Months Ended,
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Salaries and employee benefits $5,321$5,165$ 156 3%$4,868$ 453 9%
Occupancy 512 520 (8) -2% 480 32 7%
Equipment 254 274 (20) -7% 271 (17) -6%
Data processing 535 489 46 9% 451 84 19%
Professional services 98 122 (24) -20% 194 (96) -49%
Other real estate owned write-downs 71 - 71 0% - 71 0%
Other real estate owned operating costs 8 14 (6) -43% 80 (72) -90%
State and local taxes 129 121 8 7% 125 4 3%
FDIC and State assessments 130 143 (13) -9% 131 (1) -1%
Other noninterest expense:
Director fees 66 81 (15) -19% 71 (5) -7%
Communication 63 66 (3) -5% 63 - 0%
Advertising 68 75 (7) -9% 88 (20) -23%
Professional liability insurance 48 47 1 2% 25 23 92%
Amortization 60 56 4 7% 85 (25) -29%
Other 815 808 7 1% 777 38 5%
Total noninterest expense $8,178$7,981$ 197 2%$7,709$ 469 6%
For the Nine Months Ended,
Sept 30,
2016
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Salaries and employee benefits $15,542$14,283$ 1,259 9%
Occupancy 1,527 1,487 40 3%
Equipment 786 788 (2) 0%
Data processing 1,515 1,400 115 8%
Professional services 346 511 (165) -32%
Other real estate owned write-downs 71 104 (33) -32%
Other real estate owned operating costs 439 87 352 405%
State and local taxes 372 347 25 7%
FDIC and State assessments 407 397 10 3%
Other noninterest expense:
Director fees 219 225 (6) -3%
Communication 193 185 8 4%
Advertising 213 265 (52) -20%
Professional liability insurance 144 62 82 132%
Amortization 174 256 (82) -32%
Other 2,482 2,528 (46) -2%
Total noninterest expense $24,430$22,925$ 1,505 7%

Financial Performance Overview
(Unaudited)
For the Three Months Ended
Sept 30,
2016
June 30,
2016
Change Sept 30,
2015
Change
Performance Ratios
Return on average assets, annualized 0.91% 0.85% 0.06 0.79% 0.12
Return on average equity, annualized 9.63% 8.87% 0.76 8.30% 1.33
Efficiency ratio (1) 73.70% 73.96% (0.26) 76.55% (2.85)
For the Nine Months Ended,
Sept 30,
2016
Sept 30,
2015
Change
Performance Ratios
Return on average assets, annualized 0.82% 0.74% 0.08
Return on average equity, annualized 8.58% 7.62% 0.96
Efficiency ratio (1) 75.54% 78.83% (3.29)
(1) Non-interest expense divided by net interest income plus noninterest income.


LIQUIDITY

Cash and Cash Equivalents and Investment Securities
(Unaudited)
Sept 30,
2016
% of
Total
June 30,
2016
% of
Total
$
Change
%
Change
Sept 30,
2015
Total $
Change
%
Change
(Dollars in thousands)
Cash on hand and in banks $15,395 8%$16,803 12%$ (1,408) -8%$12,613 9%$ 2,782 22%
Interest bearing deposits 60,915 34% 12,928 9% 47,987 371% 36,291 25% 24,624 68%
Certificates of deposit 2,727 2% 2,727 2% - 0% 2,727 2% - 0%
Total cash equivalents and certificate of deposits 79,037 43% 32,458 23% 46,579 144% 51,631 36% 27,406 53%
Investment securities:
Collateralized mortgage obligations: agency issued 34,100 20% 36,156 27% (2,056) -6% 36,377 25% (2,277) -6%
Collateralized mortgage obligations: non-agency 483 0% 483 0% - 0% 483 0% - 0%
Mortgage-backed securities: agency issued 10,384 6% 10,711 8% (327) -3% 9,349 7% 1,035 11%
U.S. Government and agency securities 9,876 5% 9,930 7% (54) -1% 10,026 7% (150) -1%
State and municipal securities 45,515 25% 46,180 33% (665) -1% 33,467 23% 12,048 36%
FHLB Stock, at cost 1,336 1% 1,338 1% (2) 0% 1,348 1% (12) -1%
Pacific Coast Bankers' Bank stock, at cost 1,000 1% 1,000 1% - 0% 1,000 1% - 0%
Total investment securities 102,694 57% 105,798 77% (3,104) -3% 92,050 64% 10,644 12%
Total cash equivalents and investment securities $181,731 100%$138,256 100%$ 43,475 31%$143,681 100%$ 38,050 26%
Total cash equivalents and investment securities
as a percent of total assets 20% 16% 14%

Liquidity remains strong based on current levels of combined cash equivalents, investment securities and unused borrowing capacity. “During the third quarter, we retained a portion of our deposit growth in cash equivalents in anticipation of funding continued loan growth and seasonal deposit outflows,” 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 3.3 years at September 30, 2016, 3.4 years at June 30, 2016 and 3.6 years at September 30, 2015.

The Bank had $8.7 million in outstanding borrowings against its $187.8 million in established borrowing capacity with the Federal Home Loan Bank of Des Moines (FHLB) at September 30, 2016. The Bank had $8.7 million and $11.3 million in outstanding borrowings with the FHLB at June 30, 2016 and September 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 $60.6 million, subject to collateral requirements, and $16.0 million from correspondent banks, with no balance outstanding on any of these facilities.

LOANS

Loans by Category
(unaudited)
Sept 30,
2016
% of
Gross
Loans
June 30,
2016
% of
Gross
Loans
$
Change
%
Change
Sept 30,
2015
% of
Gross Loans
$
Change
%
Change
(Dollars in thousands)
Commercial and agricultural $ 133,341 20%$ 133,285 21%$ 56 0%$ 120,818 20%$ 12,523 10%
Real estate:
Construction and development 36,022 6% 29,639 5% 6,383 22% 35,071 6% 951 3%
Residential 1-4 family 90,900 14% 93,194 15% (2,294) -2% 96,182 16% (5,282) -5%
Multi-family 30,871 5% 29,786 5% 1,085 4% 24,797 4% 6,074 24%
Commercial real estate -- owner occupied 134,565 20% 134,421 20% 144 0% 134,092 22% 473 0%
Commercial real estate -- non owner occupied 139,246 21% 137,156 21% 2,090 2% 130,977 21% 8,269 6%
Farmland 23,668 4% 23,363 4% 305 1% 19,951 3% 3,717 19%
Consumer 62,042 10% 59,746 9% 2,296 4% 48,998 8% 13,044 27%
Gross loans 650,655 100% 640,590 100% 10,065 2% 610,886 100% 39,769 7%
Less: allowance for loan losses (8,960) (8,700) (260) (8,756) (204)
Less: deferred fees (1,547) (1,525) (22) (1,411) (136)
Loans, net$ 640,148 $ 630,365 $ 9,783 $ 600,719 $ 39,429
Loan Concentration
(unaudited)
Sept 30,
2016
% of Risk
Based
Capital
June 30,
2016
% of Risk
Based
Capital
Change Sept 30,
2015
% of Risk
Based
Capital
Change
(Dollars in thousands)
Commercial and agricultural $ 133,341 149%$ 133,285 152% -3%$ 120,818 142% 7%
Real estate:
Construction and development 36,022 40% 29,639 34% 6% 35,071 41% -1%
Residential 1-4 family 90,900 101% 93,194 106% -5% 96,182 113% -12%
Multi-family 30,871 34% 29,786 34% 0% 24,797 29% 5%
Commercial real estate -- owner occupied 134,565 150% 134,421 153% -3% 134,092 158% -8%
Commercial real estate -- non owner occupied 139,246 155% 137,156 156% -1% 130,977 154% 1%
Farmland 23,668 26% 23,363 27% -1% 19,951 23% 3%
Consumer 62,042 69% 59,746 68% 1% 48,998 58% 11%
Gross loans$ 650,655 $ 640,590 $ 610,886
Regulatory Commercial Real Estate$ 200,010 223%$ 191,572 218% 5%$ 182,732 215% 8%
Total Risk Based Capital*$ 89,678 $ 87,690 $ 84,990
*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. Increases in loans were generated in most categories during the current period. The portfolio includes $39.4 million in lower-yielding LIBOR-based floating rate commercial real estate loans. The portfolio also includes $23.6 million in purchased government-guaranteed commercial and commercial real estate loans. In addition, the portfolio contains $51.6 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 a 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)
Sept 30,
2016
% of
Total
June 30,
2016
% of
Total
$
Change
%
Change
Sept 30,
2015
% of
Total
$
Change
%
Change
(Dollars in thousands)
Interest-bearing demand and money market$334,564 43%$319,609 44%$ 14,955 5%$298,993 42%$ 35,571 12%
Savings 84,952 11% 83,475 11% 1,477 2% 88,561 13% (3,609) -4%
Time deposits (CDs) 131,747 17% 135,040 18% (3,293) -2% 138,200 20% (6,453) -5%
Total interest-bearing deposits 551,263 70% 538,124 73% 13,139 2% 525,754 75% 25,509 5%
Non-interest bearing demand 232,625 30% 196,121 27% 36,504 19% 179,346 25% 53,279 30%
Total deposits$783,888 100%$734,245 100%$ 49,643 7%$705,100 100%$ 78,788 11%

Total deposits grew during the current quarter, primarily due to seasonal deposit inflows and recent successes in acquiring business deposit relationships in conjunction with the growth in lending achieved over the past year. Time deposits continue to decline as a component of funding due to the increasing propensity of retail depositors to not lock in relatively low interest rates for an extended period. The proportion of noninterest bearing deposits to total deposits continued to increase due to the deposit seasonality and success of business deposit acquisition activities noted above.

Total brokered deposits were $52.1 million, which included $1.1 million via reciprocal deposit arrangements, down from $53.7 million at June 30, 2016 and $44.7 million at September 30, 2015. The brokered deposits were acquired during the latter part of 2015 with 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 leverage ratios have declined as compared to the linked and the third quarter a year ago, primarily due to the successful execution of the Company’s growth strategy. Risk-weighted ratios remained relatively unchanged as compared to the linked quarter due to a shift to lower-weighted assets in the current period. These same ratios declined versus the third quarter a year ago due to the 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)
Sept 30,
2016
June 30,
2016
Change Sept 30,
2015
Change To be Well
Capitalized
Under
Prompt
Correction
Action
Regulations*
Pacific Financial Corporation
Total risk-based capital ratio 12.67% 12.64% 0.03 13.35% (0.68) N/A
Tier 1 risk-based capital ratio 11.42% 11.39% 0.03 12.10% (0.68) N/A
Common equity tier 1 ratio 9.60% 9.52% 0.08 10.06% (0.46) N/A
Leverage ratio 9.35% 9.72% (0.37) 9.83% (0.48) N/A
Tangible common equity ratio 7.89% 8.16% (0.27) 7.98% (0.09) N/A
Bank of the Pacific
Total risk-based capital ratio 12.58% 12.55% 0.03 13.31% (0.73) 10.5%
Tier 1 risk-based capital ratio 11.33% 11.30% 0.03 12.05% (0.72) 8.5%
Common equity tier 1 ratio 11.33% 11.30% 0.03 12.05% (0.72) 7.0%
Leverage ratio 9.27% 9.65% (0.38) 9.79% (0.52) 7.5%
*Includes Basel III 2019 Capital Conservation Buffer

Net Interest Margin

Net interest margin declined compared to second quarter 2016, predominantly due to maintaining a portion of our current period deposit growth in lower-yielding cash equivalents in anticipation of funding continued loan growth and seasonal deposit outflows. Year-to date, a one-time interest of $107,000 was assessed due to a loan agreement breach, enhancing net interest margin by 2 basis points.

Yield on loans remained stable across all timeframes, despite the growth experienced over the prior four quarters, due to disciplined pricing. Yield on investment securities decreased as compared to the linked quarterly period, but remained unchanged versus the year-over-year quarter. This was primarily due to maintaining a portion of our current period deposit growth in lower-yielding cash equivalents in anticipation of funding continued loan growth and seasonal deposit outflows, as previously mentioned.

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,
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$
Change
%
Change
Average Balances (Dollars in thousands)
Gross loans $ 647,412 $ 642,560 $ 4,852 1%$ 605,552 $ 41,860 7%
Loans held for sale$ 14,538 $ 9,425 $ 5,113 54%$ 11,787 $ 2,751 23%
Investment securities$ 136,459 $ 114,673 $ 21,786 19%$ 118,102 $ 18,357 16%
Total interest-earning assets$ 798,409 $ 766,658 $ 31,751 4%$ 735,441 $ 62,968 9%
Non-interest bearing demand deposits$ 212,447 $ 189,744 $ 22,703 12%$ 181,091 $ 31,356 17%
Interest bearing deposits$ 539,627 $ 526,445 $ 13,182 3%$ 506,257 $ 33,370 7%
Borrowings $ 22,880 $ 27,742 $ (4,862) -18%$ 28,794 $ (5,914) -21%
Total interest-bearing liabilities$ 562,507 $ 554,187 $ 8,320 2%$ 535,051 $ 27,456 5%
Total Equity $ 82,088 $ 79,719 $ 2,369 3%$ 76,540 $ 5,548 7%
For the Three Months Ended,
Sept 30,
2016
June 30,
2016
Change Sept 30,
2015
Change
Yield on average gross loans (1) 4.81% 4.85% (0.04) 4.83% (0.02)
Yield on average investment securities (1) 1.95% 2.39% (0.44) 1.95% -
Cost of average interest bearing deposits 0.36% 0.37% (0.01) 0.34% 0.02
Cost of average borrowings 2.25% 2.01% 0.24 1.67% 0.58
Cost of average total deposits and borrowings 0.32% 0.34% (0.02) 0.31% 0.01
Yield on average interest-earning assets 4.32% 4.48% (0.16) 4.37% (0.05)
Cost of average interest-bearing liabilities 0.43% 0.45% (0.02) 0.42% 0.01
Net interest spread 3.89% 4.03% (0.14) 4.06% (0.17)
Net interest margin (1) 4.02% 4.16% (0.14) 4.06% (0.04)
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a 34% rate.
For the Nine Months Ended,
Sept 30,
2016
Sept 30,
2015
$
Change
%
Change
Average Balances (Dollars in thousands)
Gross loans $ 642,405 $ 589,499 $ 52,906 9%
Loans held for sale$ 11,318 $ 11,097 $ 221 2%
Investment securities$ 122,394 $ 113,745 $ 8,649 8%
Interest-earning assets$ 776,117 $ 714,341 $ 61,776 9%
Non-interest bearing demand deposits$ 194,721 $ 172,534 $ 22,187 13%
Interest bearing deposits$ 529,504 $ 492,989 $ 36,515 7%
Borrowings $ 29,263 $ 29,498 $ (235) -1%
Interest-bearing liabilities$ 558,767 $ 522,487 $ 36,280 7%
Total Equity $ 79,895 $ 75,067 $ 4,828 6%
For the Nine Months Ended,
Sept 30,
2016
Sept 30,
2015
Change
Net Interest Margin
Yield on average gross loans (1) 4.90% 4.86% 0.04
Yield on average investment securities (1) 2.19% 2.10% 0.09
Cost of average interest bearing deposits 0.36% 0.34% 0.02
Cost of average borrowings 2.37% 1.63% 0.74
Cost of average total deposits and borrowings 0.33% 0.31% 0.02
Yield on average interest-earning assets 4.47% 4.42% 0.05
Cost of average interest-bearing liabilities 0.44% 0.41% 0.03
Net interest spread 4.03% 4.01% 0.02
Net interest margin (1) 4.15% 4.12% 0.03
(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 $1.6 million adversely classified 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 payoff of the above referenced loan, 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)
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Rated substandard or worse, but not impaired$ 8,307 $ 9,963 $ (1,656) -17%$ 9,803 $ (1,496) -15%
Impaired 1,505 1,145 360 31% 4,681 (3,176) -68%
Total adversely classified loans¹$ 9,812 $ 11,108 $ (1,296) -12%$ 14,484 $ (4,672) -32%
Total adversely classified investment securities²$ - $ - $ - 0%$ 179 $ (179) -100%
Gross loans (excluding deferred loan fees)$ 650,655 $ 644,856 $ 5,799 1%$ 610,886 $ 39,769 7%
Adversely classified loans to gross loans 1.51% 2.72% 2.37%
Allowance for loan losses$ 8,960 $ 8,552 $ 408 5%$ 8,756 $ 204 2%
Allowance for loan losses as a percentage of adversely classified loans 91.32% 48.84% 60.45%
Allowance for loan losses to total impaired loans 595.35% 446.58% 187.05%
Adversely classified loans and securities to total assets 1.09% 2.13% 1.80%
Delinquent loans to gross loans, not in nonaccrual status 0.04% 0.31% 0.08%
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 September 30, 2016.


Nonperforming assets increased on a linked quarter basis, primarily due to the placement of a $355,000 home equity line of credit on nonaccrual. However, nonperforming assets remained unchanged as a percentage of total assets as compared to the linked quarter.

Nonperforming Assets
(Unaudited)
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Loans on nonaccrual status$ 1,505 $ 1,145 $ 360 31%$ 2,142 $ (637) -30%
Loans past due greater than 90 days but
not on nonaccrual status - - - - - - -
Total non-performing loans 1,505 1,145 360 31% 2,142 (637) -30%
Other real estate owned and
foreclosed assets 2,268 2,339 (71) -3% 3,761 (1,493) -40%
Total nonperforming assets$ 3,773 $ 3,484 $ 289 8%$ 5,903 $ (2,130) -36%
Percentage of nonperforming assets to total assets 0.42% 0.41% 0.72%
Nonperforming loans to total loans 0.23% 0.18% 0.35%

The Company took a $71,000 write-down on one OREO commercial real estate property in the current period. After recognizing this decline, the book value of this property stands at $405,000. The remaining property, with a current book value of $1.9 million, is in escrow. It is projected to close before year-end with net proceeds anticipated to approximate current book value.

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 decreased from the linked quarter, which included a partial charge-off of $97,000 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 year-over-year quarter contained a net recovery of $244,000 resulting from the payoff of a $1.1 million nonaccrual loan during the current period. 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,
Sept 30,
2016
June 30,
2016
$
Change
%
Change
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Gross loans outstanding at end of period$ 650,655 $ 640,590 $ 10,065 2%$ 610,886 $ 39,769 7%
Average loans outstanding, gross$ 647,412 $ 642,560 $ 4,852 1%$ 605,552 $ 41,860 7%
Allowance for loan losses, beginning of period$ 8,700 $ 8,552 $ 148 2%$ 8,347 $ 353 4%
Commercial - (8) 8 100% - - 0%
Commercial Real Estate - (97) 97 100% - - -
Residential Real Estate - (19) 19 -100% - - 100%
Consumer (36) (17) (19) 112% (30) (6) 20%
Total charge-offs (36) (141) 105 -74% (30) (6) 20%
Commercial - 1 (1) -100% 2 (2) -100%
Commercial Real Estate 2 2 - 0% 257 (255) -99%
Residential Real Estate 18 2 16 800% 7 11 157%
Consumer - 8 (8) -100% 8 (8) -100%
Total recoveries 20 13 7 54% 274 (254) -93%
Net (charge-offs)/recoveries (16) (128) 112 -88% 244 (260) -107%
Provision charged to income 276 276 - 0% 165 111 67%
Allowance for loan losses, end of period$ 8,960 $ 8,700 $ 260 3%$ 8,756 $ 204 2%
Ratio of net loans charged-off to average
gross loans outstanding, annualized 0.01% 0.08% -0.07% -88% -0.16% 0.17% -106%
Ratio of allowance for loan losses to
gross loans outstanding 1.38% 1.36% 0.02% 1% 1.43% -0.05% -3%
For the Nine Months Ended,
Sept 30,
2016
Sept 30,
2015
$
Change
%
Change
(Dollars in thousands)
Gross loans outstanding at end of period$ 650,655 $ 610,886 $ 39,769 7%
Average loans outstanding, gross$ 642,405 $ 589,499 $ 52,906 9%
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 (79) (123) 44 -36%
Total charge-offs (219) (331) 112 -34%
Commercial 2 45 (43) -96%
Commercial Real Estate 6 261 (255) -98%
Residential Real Estate 31 20 11 55%
Consumer 9 26 (17) -65%
Total recoveries 48 352 (304) -86%
Net (charge-offs)/recoveries (171) 21 (192) -914%
Provision charged to income 814 382 432 113%
Allowance for loan losses, end of period$ 8,960 $ 8,756 $ 204 2%
Ratio of net loans charged-off to average
gross loans outstanding, annualized 0.03% -0.10% 0.13% -130%
Ratio of allowance for loan losses to
gross loans outstanding 1.38% 1.43% -0.05% -3%

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 September 30, 2016, the Company had total assets of $897 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