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Pacific Financial Corp 4Q16 Earnings Increased 20% from 4Q15; Full Year 2016 Net Income Grew 18%

ABERDEEN, Wash., Jan. 24, 2017 (GLOBE NEWSWIRE) -- Pacific Financial Corporation (OTCQB:PFLC), the holding company for Bank of the Pacific today reported net income increased 18% to $6.6 million, or $0.63 per share, in 2016, compared to $5.6 million, or $0.54 per share, for 2015. For the fourth quarter of 2016, net income was $1.5 million, or $0.14 per share, down from $2.0 million, or $0.19 per share, for the third quarter of 2016, and up 20% compared to $1.2 million, or $0.12 per share, for the fourth quarter of 2015. Profitability in 2016 was sustained by continued loan growth, stable net interest margin and increased noninterest income. Fourth quarter and full year results were negatively impacted by charges related to a loss on the sale of other real estate owned (OREO), totaling $328,000, and a write-down taken to reduce the carrying value of a former branch property of $324,000. All results are unaudited.

"We achieved solid fourth quarter and full year financial results, including charges resulting from a sale of OREO and a valuation adjustment of a former branch property. The continued strength of our core earnings was due to steady loan growth, robust noninterest revenue and stable net interest margin. The commercial lending teams located in our newer markets contributed significantly to loan growth. Revenue from our residential real estate mortgage operation continued to be strong, up 43% for the quarter versus the fourth quarter in 2015," said Denise Portmann, President & Chief Executive Officer. "With the recent increase in long-term interest rates, consumers are increasingly interested in locking in long-term fixed rates, which are still low by historical standards. As the economy continues to strengthen, our residential mortgage lending team is well situated to generate additional revenue from the anticipated increase in purchase activity."

"Our credit quality continues to be solid, as delinquent and non-performing loans remain at low levels, despite the additions to adversely classified loans during the fourth quarter," added Portmann. "Our loan growth over the recent quarters is robust, and we continue to foster a strong risk management culture by administering our commercial real estate portfolio well within regulatory concentration guidelines. In addition, our expansion into treasury management services is producing strong growth of noninterest bearing commercial deposits."

Fourth Quarter 2016 Highlights (as of, or for the period ended December 31, 2016, except as noted):

  • Pre-tax, pre-credit operating income (non-GAAP) grew 22% from $2.3 million for the fourth quarter of 2015. Pre-tax, pre-credit operating income declined 4% to $2.8 million for the fourth quarter of 2016, compared to $2.9 million for the third quarter of 2016. This was primarily due to a decrease of $268,000 in gains on sale of residential real estate loans as a result of typical seasonal slowdown in mortgage activity during this time of the year.
  • An annual cash dividend of $0.23 per share was declared in December 2016, an increase of 5% relative to the dividend paid last year. The current dividend was 36% of 2016 net income as compared to 41% in 2015.
  • Net interest margin (NIM), on a tax equivalent basis, was 4.00%, as compared to 4.02% in the preceding quarter and 4.02% for fourth quarter 2015. Net interest margin declined during the current quarter primarily due to an increase in the cost of borrowings as a result of slight increases in interest rates experienced in the latter portion of the fourth quarter. NIM for the year remained above average at 4.11% compared to the average of 3.58% posted by the 357 banks in the SNL U.S. Microcap Index for the third quarter of 2016.
  • Total assets declined slightly to $891.2 million, at December 31, 2016, compared to $896.6 million, at September 30, 2016, and grew 8% from $824.6 million at December 31, 2015.
  • Gross loans grew by $8.6 million, or 1%, to $659.3 million, on a linked quarter basis and increased by $32.5 million, or 5%, over the fourth quarter of 2015. This growth is net of the sale/participation of $5.1 million in non-owner occupied commercial real estate loans during the fourth quarter of 2016.
  • Total deposits decreased 1% to $779.7 million, compared to $783.9 million at September 30, 2016, and increased 9% from a year earlier. Seasonal outflows of deposits normally begin in the winter and extend into spring due to the slowdown of tourism activity in certain core markets. Non-interest bearing demand deposits were virtually unchanged on a linked quarter basis, but grew 26% over the fourth quarter of 2015.
  • Nonperforming assets were $1.8 million, or 0.20% of total assets, compared to 0.43% on a linked quarter basis and 0.62% a year ago.
  • Net recoveries totaled $48,000, or 0.03% of average gross loans in the fourth quarter, compared to net charge-offs of $16,000, or 0.01% of average gross loans, in third quarter 2016. Loans 30 – 89 days' delinquent, not in nonaccrual status, stood at 0.03% of total loans outstanding.
  • Classified loans were $17.5 million, or 2.65% of gross loans, compared to 1.51% and 2.56% at September 30, 2016 and December 31, 2015, respectively. The recent increase was primarily due to the adverse classification of one commercial relationships totaling $6.9 million during the fourth quarter of 2016.

Operating Results

Total assets were virtually unchanged from the linked quarter, with growth in investments and loans offset by declines in cash equivalents and loans held for sale. Total assets were higher year-over-year primarily in loans, investment securities and cash equivalents, funded by increases in core deposits resulting from growth in commercial deposit relationships from both new and existing clients. 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)
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
Assets: (Dollars in thousands, except per share data)
Cash and cash equivalents$59,298 $76,310 $(17,012) -22%$27,526 $31,772 115%
Other interest earning deposits 2,231 2,727 (496) -18% 2,727 (496) -18%
Investment securities 112,155 100,358 11,797 12% 101,721 10,434 10%
Loans held-for-sale 6,572 14,069 (7,497) -53% 12,333 (5,761) -47%
Loans, net of deferred fees 657,803 649,108 8,695 1% 625,336 32,467 5%
Allowance for loan losses (9,192) (8,960) (232) 3% (8,317) (875) 11%
Net loans 648,611 640,148 8,463 1% 617,019 31,592 5%
Federal Home Loan Bank and Pacific Coast Bankers' Bank stock, at cost 2,335 2,336 (1) 0% 2,346 (11) 0%
Other assets 60,010 60,623 (613) -1% 60,941 (931) -2%
Total assets$891,212 $896,571 $(5,359) -1%$824,613 $66,599 8%
Liabilities and Shareholders' Equity:
Total deposits$779,731 $783,888 $(4,157) -1%$714,499 $65,232 9%
Borrowings 22,056 22,094 (38) 0% 24,706 (2,650) -11%
Accrued interest payable and other liabilities 9,371 7,878 1,493 19% 9,123 248 3%
Shareholders' equity 80,054 82,711 (2,657) -3% 76,285 3,769 5%
Total liabilities and shareholders' equity$891,212 $896,571 $(5,359) -1%$824,613 $66,599 8%
Common Stock Shares Outstanding 10,424,541 10,422,871 1,670 0% 10,394,828 29,713 0%
Book value per common share (1)$7.68 $7.94 $(0.26) -3%$7.34 $0.34 5%
Tangible book value per common share (2)$6.38 $6.64 $(0.26) -4%$6.03 $0.35 6%
Gross loans to deposits ratio 84.4% 82.8% 87.5%
(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 investment securities, as previously noted. Net interest income grew versus the fourth quarter a year ago and was up for the full year compared to 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 remained virtually unchanged as compared to the linked quarter.

For the full year in 2016, interest expense grew compared to the corresponding period in 2015, reflecting growth in core deposits and the addition of higher-cost longer-term fixed-rate brokered deposits throughout the prior year to lengthen liability maturities for interest rate risk management purposes. The continued growth of noninterest bearing deposits mitigated the impact of the addition of longer-term deposits on funding costs.

Pre-tax, pre-credit operating income (non-GAAP) grew 22% to $2.8 million for the fourth quarter of 2016 from $2.3 million for the fourth quarter of 2015, and declined 4%, compared to $2.9 million for the third quarter of 2016. This decline was primarily due to a decrease of $268,000 in gains on sale of residential real estate loans as a result of typical seasonal slowdown in mortgage activity during the reporting quarter.

Income Statement Overview
(Unaudited)
For the Three Months Ended,
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
(Dollars in thousands, except per share data)
Interest and dividend income$8,694$8,518$176 2%$8,145$549 7%
Interest expense 621 616 5 1% 603 18 3%
Net interest income 8,073 7,902 171 2% 7,542 531 7%
Loan loss provision 184 276 (92) -33% 200 (16) -8%
Noninterest income 2,571 3,194 (623) -20% 2,317 254 11%
Noninterest expense 8,507 8,178 329 4% 7,934 573 7%
Income before income taxes 1,953 2,642 (689) -26% 1,725 228 13%
Income tax expense 493 649 (156) -24% 428 65 15%
Net Income$1,460$1,993$(533) -27%$1,297$163 13%
Average common shares outstanding - basic 10,422,889 10,421,921 968 0% 10,391,290 31,599 0%
Average common shares outstanding - diluted 10,625,295 10,582,695 42,600 0% 10,526,857 98,438 1%
Income per common share
Basic$0.14$0.19$(0.05) -26%$0.12$0.02 17%
Diluted$0.14$0.19$(0.05) -26%$0.12$0.02 17%
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 $ Change % Change
(Dollars in thousands, except per share data)
Interest and dividend income$34,135$31,340$2,795 9%
Interest expense 2,472 2,201 271 12%
Net interest income 31,663 29,139 2,524 9%
Loan loss provision 998 582 416 71%
Noninterest income 11,322 9,799 1,523 16%
Noninterest expense 32,937 30,859 2,078 7%
Income before income taxes 9,050 7,497 1,553 21%
Income tax expense 2,460 1,921 539 28%
Net Income$6,590$5,576$1,014 18%
Average common shares outstanding - basic 10,416,162 10,382,499 33,663 0%
Average common shares outstanding - diluted 10,588,724 10,524,303 64,421 1%
Income per common share
Basic$0.63$0.54$0.09 17%
Diluted$0.62$0.53$0.09 17%

The following tables provide the reconciliation of net income to pre-tax, pre-credit operating income (non-GAAP):

Reconcilation of Non-GAAP Measure
(Unaudited)
For the Three Months Ended,
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
Non-GAAP Operating Income (Dollars in thousands)
Net Income$1,460 $1,993 $(533) -27%$1,297$163 13%
Loan loss provision 184 276 (92) -33% 200 (16) -8%
Loss on sale of other real estate owned, net 328 - 328 100% 11 317 N/M
Loss on real estate owned, net 324 - 324 100% 350 (26) -7%
Income tax expense 493 649 (156) -24% 428 65 15%
Pre-tax, pre-credit operating income$2,789 $2,918 $(129) -4%$2,286$503 22%
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 $ Change % Change
Non-GAAP Operating Income (Dollars in thousands)
Net Income$6,590 $5,576 $1,014 18%
Loan loss provision 998 582 416 71%
Gain on sale of other real estate owned, net (97) (128) 31 -24%
Loss on real estate owned, net 324 350 (26) -7%
Income tax expense 2,460 1,921 539 28%
Pre-tax, pre-credit operating income$10,275 $8,301 $1,974 24%

Noninterest Income

Noninterest income was down versus the linked quarter, primarily as a result of a $328,000 net loss on sale of OREO during the fourth quarter. In addition, revenue from residential mortgage loans declined mainly due to seasonal decreases in residential sales activity typical for the fourth quarter. Noninterest income increased over the fourth quarter a year ago, primarily due to the previously mentioned growth in revenue from increased residential mortgage loan sales generated from growth in residential real estate purchase and refinance activity within local markets. For 2016, noninterest income was also up as compared to 2015, primarily due to the aforementioned increase in gains on sale of residential mortgage loans, $104,000 gain on sale of SBA guaranteed loans, $100,000 gain on death benefit from bank-owned life insurance and changes in service charges initiated earlier in the current year.

Noninterest Income
(Unaudited)
For the Three Months Ended,
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Service charges on deposits$465 $477$(12) -3%$451 $14 3%
Net loss on sale of other real estate owned, net (328) - (328) 100% (11) (317) N/M
Gain on sale of loans, net 1,596 1,864 (268) -14% 1,117 479 43%
Gain on sale of securities available for sale, net - - - 0% - - 0%
Earnings on bank owned life insurance 114 116 (2) -2% 122 (8) -7%
Other noninterest income
Fee income 616 694 (78) -11% 615 1 0%
Income from other real estate owned - - - 0% - - 0%
Other 108 43 65 151% 23 85 370%
Total noninterest income$2,571 $3,194$(623) -20%$2,317 $254 11%
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Service charges on deposits$1,876 $1,764$112 6%
Gain on sale of other real estate owned, net 97 128 (31) -24%
Gain on sale of loans, net 6,126 4,961 1,165 23%
Gain on sale of securities available for sale, net 6 53 (47) -89%
Earnings on bank owned life insurance 467 490 (23) -5%
Other noninterest income
Fee income 2,271 2,156 115 5%
Income from other real estate owned - 67 (67) -100%
Other 479 180 299 166%
Total noninterest income$11,322 $9,799$1,523 16%

Noninterest Expense

Noninterest expense increased from the immediate prior quarter, primarily due to a write-down of $324,000 taken to reduce the carrying value of a former branch property, now held for sale, to reflect its current fair value. In addition, expenses in the fourth quarter associated with strategic consulting services increased professional services costs as compared to the linked quarter. 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 and professional services costs, as previously explained. Further, salary and employee benefit expense was incurred as a result of the personnel additions earlier in the year to implement strategic initiatives to expand treasury management and small business lines of business. Noninterest expenses grew in 2016 compared to 2015, primarily due to increases related to salary and benefit costs, as mentioned above, and $348,000 in OREO operating expense incurred earlier in 2016 to prepare a $1.2 million OREO property for its eventual sale.

Noninterest Expense
(Unaudited)
For the Three Months Ended,
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Salaries and employee benefits$5,341$5,321$20 0%$4,788$553 12%
Occupancy 537 512 25 5% 478 59 12%
Equipment 266 254 12 5% 273 (7) -3%
Data processing 532 535 (3) -1% 472 60 13%
Professional services 170 98 72 73% 103 67 65%
Other real estate owned write-downs - 71 (71) 0% - - 0%
Other real estate owned operating costs 26 8 18 225% 98 (72) -73%
State and local taxes 87 129 (42) -33% 119 (32) -27%
FDIC and State assessments 78 130 (52) -40% 138 (60) -43%
Other noninterest expense:
Director fees 71 66 5 8% 70 1 1%
Communication 77 63 14 22% 66 11 17%
Advertising 85 68 17 25% 81 4 5%
Professional liability insurance 47 48 (1) -2% 40 7 18%
Amortization 62 60 2 3% 85 (23) -27%
Loss on real estate owned, net 324 - 324 100% 350 (26) -7%
Other 804 815 (11) -1% 773 31 4%
Total noninterest expense$8,507$8,178$329 4%$7,934$573 7%
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Salaries and employee benefits$20,884$19,070$1,814 10%
Occupancy 2,064 1,965 99 5%
Equipment 1,052 1,061 (9) -1%
Data processing 2,047 1,872 175 9%
Professional services 516 599 (83) -14%
Other real estate owned write-downs 71 104 (33) -32%
Other real estate owned operating costs 464 184 280 152%
State and local taxes 459 465 (6) -1%
FDIC and State assessments 485 535 (50) -9%
Other noninterest expense:
Director fees 289 295 (6) -2%
Communication 270 251 19 8%
Advertising 298 346 (48) -14%
Professional liability insurance 190 102 88 86%
Amortization 324 341 (17) -5%
Loss on real estate owned, net 324 350 (26) -7%
Other 3,200 3,319 (119) -4%
Total noninterest expense$32,937$30,859$2,078 7%


Financial Performance Overview
(Unaudited)
For the Three Months Ended
Dec 31, 2016 Sept 30, 2016 Change Dec 31, 2015 Change
Performance Ratios
Return on average assets, annualized0.65% 0.91% (0.26) 0.59% 0.06
Return on average equity, annualized6.94% 9.63% (2.69) 6.16% 0.78
Efficiency ratio (1)79.92% 73.70% 6.22 80.48% (0.56)
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 Change
Performance Ratios
Return on average assets, annualized0.77% 0.71% 0.06
Return on average equity, annualized8.16% 7.35% 0.81
Efficiency ratio (1)76.62% 79.25% (2.63)
(1) Non-interest expense divided by net interest income plus noninterest income.

LIQUIDITY

Cash and Cash Equivalents and Investment Securities
(Unaudited)
Dec 31, 2016 % of Total Sept 30, 2016 % of Total $ Change % Change Dec 31, 2015 Total $ Change % Change
(Dollars in thousands)
Cash on hand and in banks$15,707 9%$15,395 12%$312 2%$17,680 13%$(1,973) -11%
Interest bearing deposits 43,591 25% 60,915 9% (17,324) -28% 9,846 7% 33,745 343%
Certificates of deposit 2,231 1% 2,727 2% (496) -18% 2,727 2% (496) -18%
Total cash equivalents and certificate of deposits 61,529 35% 79,037 23% (17,508) -22% 30,253 23% 31,276 103%
Investment securities:
Collateralized mortgage obligations: agency issued 35,514 20% 34,213 27% 1,301 4% 39,045 29% (3,531) -9%
Collateralized mortgage obligations: non-agency 331 0% 370 0% (39) -11% 422 0% (91) -22%
Mortgage-backed securities: agency issued 14,166 8% 10,384 8% 3,782 36% 11,022 8% 3,144 29%
U.S. Government and agency securities 8,716 5% 9,876 7% (1,160) -12% 9,867 7% (1,151) -12%
State and municipal securities 53,428 30% 45,515 33% 7,913 17% 41,365 31% 12,063 29%
FHLB Stock, at cost 1,335 1% 1,336 1% (1) 0% 1,346 1% (11) -1%
Pacific Coast Bankers' Bank stock, at cost 1,000 1% 1,000 1% - 0% 1,000 1% - 0%
Total investment securities 114,490 65% 102,694 77% 11,796 11% 104,067 77% 10,423 10%
Total cash equivalents and investment securities$176,019 100%$181,731 100%$(5,712) -3%$134,320 100%$41,699 31%
Total cash equivalents and investment securities
as a percent of total assets 20% 20% 16%

Liquidity remains strong based on 2016 year-end levels of combined cash equivalents, investment securities and unused borrowing capacity. "During the fourth quarter, we redeployed some of our cash equivalents into higher-yielding investment securities, but retained a portion 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 3.9 years at December 31, 2016, 3.3 years at September 30, 2016 and 3.5 years at December 31, 2015.

The Bank had $8.7 million in outstanding borrowings against its $170.3 million in established borrowing capacity with the Federal Home Loan Bank of Des Moines (FHLB) at December 31, 2016. The Bank had $8.7 million and $11.3 million in outstanding borrowings with the FHLB at September 30, 2016 and December 31, 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 $58.8 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)
Dec 31, 2016 % of Gross Loans Sept 30, 2016 % of Gross Loans $ Change % Change Dec 31, 2015 % of Gross Loans $ Change % Change
(Dollars in thousands)
Commercial and agricultural$134,318 20%$133,341 20%$977 1%$131,734 21%$2,584 2%
Real estate:
Construction and development 41,983 6% 36,022 6% 5,961 17% 33,170 5% 8,813 27%
Residential 1-4 family 91,686 14% 90,900 14% 786 1% 94,217 15% (2,531) -3%
Multi-family 29,747 5% 30,871 5% (1,124) -4% 26,828 4% 2,919 11%
Commercial real estate -- owner occupied 132,449 20% 134,565 20% (2,116) -2% 134,366 21% (1,917) -1%
Commercial real estate -- non owner occupied 138,078 21% 139,246 21% (1,168) -1% 134,612 21% 3,466 3%
Farmland 25,588 4% 23,668 4% 1,920 8% 20,492 3% 5,096 25%
Consumer 65,442 10% 62,042 10% 3,400 5% 51,352 8% 14,090 27%
Gross loans 659,291 100% 650,655 100% 8,636 1% 626,771 100% 32,520 5%
Less: allowance for loan losses (9,192) (8,960) (232) (8,317) (875)
Less: deferred fees (1,488) (1,547) 59 (1,435) (53)
Loans, net$648,611 $640,148 $8,463 $617,019 $31,592


Loan Concentration
(unaudited)
Dec 31, 2016 % of Risk Based Capital Sept 30, 2016 % of Risk Based Capital Change Dec 31, 2015 % of Risk Based Capital Change
(Dollars in thousands)
Commercial and agricultural$134,318 149%$133,341 149% 0%$131,734 157% -8%
Real estate:
Construction and development 41,983 47% 36,022 40% 7% 33,170 39% 8%
Residential 1-4 family 91,686 102% 90,900 101% 1% 94,217 112% -10%
Multi-family 29,747 33% 30,871 34% -1% 26,828 32% 1%
Commercial real estate -- owner occupied 132,449 147% 134,565 150% -3% 134,366 160% -13%
Commercial real estate -- non owner occupied 138,078 153% 139,246 155% -2% 134,612 160% -7%
Farmland 25,588 28% 23,668 26% 2% 20,492 24% 4%
Consumer 65,442 73% 62,042 69% 4% 51,352 61% 12%
Gross loans$659,291 $650,655 $626,771
Regulatory Commercial Real Estate$200,010 222%$200,010 223% -1%$189,948 226% -4%
Total Risk Based Capital*$89,999 $89,678 $84,073
*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 fourth quarter 2016, net of $5.1 million in non-owner occupied commercial real estate sold or participated in the quarter as part of a regulatory commercial real estate concentration management strategy. The portfolio includes $35.4 million in lower-yielding LIBOR-based floating rate commercial real estate loans. The portfolio also includes $20.6 million in purchased government-guaranteed commercial and commercial real estate loans. In addition, the portfolio contains $54.1 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)
Dec 31, 2016 % of Total Sept 30, 2016 % of Total $ Change % Change Dec 31, 2015 % of Total $ Change % Change
(Dollars in thousands)
Interest-bearing demand and money market$332,779 42%$334,564 43%$(1,785) -1%$299,343 42%$33,436 11%
Savings 84,146 11% 84,952 11% (806) -1% 90,380 13% (6,234) -7%
Time deposits (CDs) 129,175 17% 131,747 17% (2,572) -2% 139,775 20% (10,600) -8%
Total interest-bearing deposits 546,100 70% 551,263 70% (5,163) -1% 529,498 74% 16,602 3%
Non-interest bearing demand 233,631 30% 232,625 30% 1,006 0% 185,001 26% 48,630 26%
Total deposits$779,731 100%$783,888 100%$(4,157) -1%$714,499 100%$65,232 9%

Total deposits declined during the fourth quarter of 2016, primarily due to seasonal outflows that normally begin in the winter and extend into spring due to the slowdown of tourism activity in certain core markets. 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 success of treasury management activities in attracting business deposits, as previously noted.

Total brokered deposits were $50.3 million, which included $1.1 million via reciprocal deposit arrangements, down from $52.1 million at September 30, 2016 and $52.1 million at December 31, 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 regulatory standards for total risk-based capital, Tier 1 risk-based capital, Common equity Tier 1 and Tier 1 leverage capital. The 2016 fourth quarter leverage and risk-weighted ratios have declined as compared to the linked quarter, due to the declaration of a $2.4 million cash dividend. Ratios as compared to the like quarter a year ago were impacted primarily due to the successful execution of the Company's growth strategy. However, a shift in balance sheet mix to lower risk-weighted investment securities as compared to the fourth quarter a year ago partially mitigated the decline in risk-weighted capital ratios.

The Federal Deposit Insurance Corporation ("FDIC") has established minimum requirements for capital adequacy for 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)
Dec 31, 2016 Sept 30, 2016 Change Dec 31, 2015 Change To be Well Capitalized
Under Prompt Correction
Action Regulations*
Pacific Financial Corporation
Total risk-based capital ratio12.40% 12.67% (0.27) 12.78% (0.38) N/A
Tier 1 risk-based capital ratio11.15% 11.42% (0.27) 11.53% (0.38) N/A
Common equity tier 1 ratio9.35% 9.60% (0.25) 9.57% (0.22) N/A
Leverage ratio9.25% 9.58% (0.33) 9.44% (0.19) N/A
Tangible common equity ratio7.64% 7.89% (0.25) 7.73% (0.09) N/A
Bank of the Pacific
Total risk-based capital ratio12.32% 12.58% (0.26) 12.69% (0.37) 10.5%
Tier 1 risk-based capital ratio11.07% 11.33% (0.26) 11.44% (0.37) 8.5%
Common equity tier 1 ratio11.07% 11.33% (0.26) 11.44% (0.37) 7.0%
Leverage ratio9.18% 9.49% (0.31) 9.35% (0.17) 7.5%
*Includes Basel III 2019 Capital Conservation Buffer

Net Interest Margin

Net interest margin contracted slightly compared to third quarter 2016 and fourth quarter 2015, predominantly due to an increase in the cost of LIBOR-based junior subordinated debentures experienced in the current quarter. Improvement in loan and investment securities yields offset increases in the cost of borrowings during the twelve months ended December 31, 2016, compared to 2015.

The 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 remained unchanged as compared to the linked and year-over-year quarters.

Cost of deposits remained relatively unchanged in the fourth quarter, compared to the linked and year-over-year quarter, and for the full year of 2016. 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.

For the Three Months Ended,
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
Average Balances (Dollars in thousands)
Gross loans$651,985 $647,412 $4,573 1%$612,429 $39,556 6%
Loans held for sale$10,690 $14,538 $(3,848) -26%$10,126 $564 6%
Investment securities$158,255 $136,459 $21,796 16%$137,160 $21,095 15%
Total interest-earning assets$820,930 $798,409 $22,521 3%$759,715 $61,215 8%
Non-interest bearing demand deposits$231,457 $212,447 $19,010 9%$183,876 $47,581 26%
Interest bearing deposits$540,687 $539,627 $1,060 0%$529,188 $11,499 2%
Borrowings$22,070 $22,880 $(810) -4%$24,719 $(2,649) -11%
Total interest-bearing liabilities$562,757 $562,507 $250 0%$553,907 $8,850 2%
Total Equity$83,429 $82,088 $1,341 2%$78,257 $5,172 7%
For the Three Months Ended,
Dec 31, 2016 Sept 30, 2016 Change Dec 31, 2015 Change
Yield on average gross loans (1) 4.86% 4.81% 0.05 4.86% -
Yield on average investment securities (1) 1.94% 1.95% (0.01) 1.92% 0.02
Cost of average interest bearing deposits 0.36% 0.36% - 0.36% -
Cost of average borrowings 2.43% 2.25% 0.18 2.01% 0.42
Cost of average total deposits and borrowings 0.31% 0.32% (0.01) 0.32% (0.01)
Yield on average interest-earning assets 4.30% 4.32% (0.02) 4.33% (0.03)
Cost of average interest-bearing liabilities 0.44% 0.43% 0.01 0.43% 0.01
Net interest spread 3.86% 3.89% (0.03) 3.90% (0.04)
Net interest margin (1) 4.00% 4.02% (0.02) 4.02% (0.02)
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a 34% rate.
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 $ Change % Change
Average Balances (Dollars in thousands)
Gross loans$644,813 $595,278 $49,535 8%
Loans held for sale$11,160 $10,852 $308 3%
Investment securities$131,407 $119,647 $11,760 10%
Interest-earning assets$787,380 $725,777 $61,603 8%
Non-interest bearing demand deposits$203,955 $175,393 $28,562 16%
Interest bearing deposits$532,315 $502,113 $30,202 6%
Borrowings$27,455 $28,294 $(839) -3%
Interest-bearing liabilities$559,770 $530,407 $29,363 6%
Total Equity$80,783 $75,870 $4,913 6%
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 Change
Net Interest Margin
Yield on average gross loans (1) 4.89% 4.86% 0.03
Yield on average investment securities (1) 2.12% 2.05% 0.07
Cost of average interest bearing deposits 0.36% 0.34% 0.02
Cost of average borrowings 2.39% 1.72% 0.67
Cost of average total deposits and borrowings 0.32% 0.31% 0.01
Yield on average interest-earning assets 4.43% 4.40% 0.03
Cost of average interest-bearing liabilities 0.44% 0.41% 0.03
Net interest spread 3.99% 3.99% -
Net interest margin (1) 4.11% 4.10% 0.01
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a 34% rate.

ASSET QUALITY

Adversely classified loans increased compared to the preceding quarter, primarily due to the adverse classification of one commercial relationship totaling $6.9 million during the period due to a reduction in earnings related to a venture outside the company's core competency. Recent evaluation of the company's performance indicate a renewed focus on its core business is having a positive impact on its financial condition. Total 30-89 day delinquencies remained below 0.50%, a positive leading indicator of future credit quality.

Adversely Classified Loans and Securities
(Unaudited)
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Rated substandard or worse, but not impaired$16,086 $8,169 $7,917 97%$14,090 $1,996 14%
Impaired 1,615 1,894 (279) -15% 1,982 (367) -19%
Total adversely classified loans¹$17,701 $10,063 $7,638 76%$16,072 $1,629 10%
Total adversely classified investment securities²$- $- $- - $169 $(169) -100%
Gross loans (excluding deferred loan fees)$659,291 $650,655 $8,636 1%$626,771 $32,520 5%
Adversely classified loans to gross loans 2.68% 1.55% 2.56%
Allowance for loan losses$9,192 $8,960 $232 3%$8,317 $875 11%
Allowance for loan losses as a percentage of adversely classified loans 51.93% 89.04% 51.75%
Allowance for loan losses to total impaired loans 569.16% 473.07% 419.63%
Adversely classified loans and securities to total assets 1.99% 1.12% 1.97%
Delinquent loans to gross loans, not in nonaccrual status 0.03% 0.04% 0.20%
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 December 31, 2016.

Nonperforming assets decreased on a linked quarter basis, primarily due to the sale of a $1.9 million commercial real estate OREO asset during the period. In addition, several nonaccrual loans totaling $208,000 were paid off during the 2016 fourth quarter. As a result, nonperforming assets declined as a percentage of total assets as compared to the linked quarter.

Nonperforming Assets
(Unaudited)
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Loans on nonaccrual status$1,229 $1,505 $(276) -18%$1,518 $(289) -19%
Loans past due greater than 90 days but
not on nonaccrual status - - - - - - -
Total non-performing loans 1,229 1,505 (276) -18% 1,518 (289) -19%
Other real estate owned and
foreclosed assets 549 2,389 (1,840) -77% 3,610 (3,061) -85%
Total nonperforming assets$1,778 $3,894 $(2,116) -54%$5,128 $(3,350) -65%
Percentage of nonperforming assets to total assets 0.20% 0.43% 0.62%
Nonperforming loans to total loans 0.19% 0.23% 0.24%

One of the remaining assets is a commercial real estate property with a book value of $405,000. The remaining assets consist of a commercial sea vessel and a repossessed automobile with book values of $105,000 and $39,000, respectively.

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 fourth quarter 2016, there was a net recovery due to the collection of a $88,000 judgement on a previously charged off loan. This compares to negligible charge-offs taken in the linked quarter. The year-over-year quarter contained a $684,000 write-down of a commercial real estate loan as part of its transfer to OREO. Consequently, charge offs in the twelve-month period ended December 31, 2016, were lower than those taken in 2015, which also included a net recovery of $244,000 resulting from the payoff of a $1.1 million nonaccrual 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 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 provisions 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,
Dec 31, 2016 Sept 30, 2016 $ Change % Change Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Gross loans outstanding at end of period$659,291 $650,655 $8,636 1%$626,771 $32,520 5%
Average loans outstanding, gross$651,985 $647,412 $4,573 1%$612,429 $39,556 6%
Allowance for loan losses, beginning of period$8,960 $8,700 $260 3%$8,756 $204 2%
Commercial - - - 0% - - 0%
Commercial Real Estate - - - 0% (684) 684 -100%
Residential Real Estate (15) - (15) 100% - (15) 100%
Consumer (41) (36) (5) 14% (20) (21) 105%
Total charge-offs (56) (36) (20) 56% (704) 648 -92%
Commercial 5 - 5 100% 7 (2) -29%
Commercial Real Estate 2 2 - 0% - 2 100%
Residential Real Estate 96 18 78 N/M 49 47 96%
Consumer 1 - 1 100% 9 (8) -89%
Total recoveries 104 20 84 N/M 65 39 60%
Net recoveries/(charge-offs) 48 (16) 64 N/M (639) 687 -108%
Provision charged to income 184 276 (92) -33% 200 (16) -8%
Allowance for loan losses, end of period$9,192 $8,960 $232 3%$8,317 $875 11%
Ratio of net loans charged-off to average
gross loans outstanding, annualized -0.03% 0.01% -0.04% N/M 0.41% -0.44% -107%
Ratio of allowance for loan losses to
gross loans outstanding 1.39% 1.38% 0.01% 1% 1.33% 0.06% 5%
For the Year Ended,
Dec 31, 2016 Dec 31, 2015 $ Change % Change
(Dollars in thousands)
Gross loans outstanding at end of period$659,291 $626,771 $32,520 5%
Average loans outstanding, gross$644,813 $595,278 $49,535 8%
Allowance for loan losses, beginning of period$8,317 $8,353 $(36) 0%
Commercial (8) - (8) 100%
Commercial Real Estate (97) (806) 709 -88%
Residential Real Estate (50) (86) 36 -42%
Consumer (120) (143) 23 -16%
Total charge-offs (275) (1,035) 760 -73%
Commercial 7 52 (45) -87%
Commercial Real Estate 8 261 (253) -97%
Residential Real Estate 127 69 58 84%
Consumer 10 35 (25) -71%
Total recoveries 152 417 (265) -64%
Net (charge-offs) (123) (618) 495 -80%
Provision charged to income 998 582 416 71%
Allowance for loan losses, end of period$9,192 $8,317 $875 11%
Ratio of net loans charged-off to average
gross loans outstanding, annualized 0.02% 0.10% -0.08% -80%
Ratio of allowance for loan losses to
gross loans outstanding 1.39% 1.33% 0.06% 5%

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. At December 31, 2016, the Company had total assets of $891 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