Pacific Financial Corp Achieves Record Profits for 3Q17 and YTD; Earnings Grow 16% to $2.2 Million from 2Q17

ABERDEEN, Wash., Oct. 24, 2017 (GLOBE NEWSWIRE) -- Pacific Financial Corporation (OTCQB:PFLC), the holding company for Bank of the Pacific today reported record net income of $2.2 million, or $0.20 per diluted share, up 16% for the third quarter of 2017, compared to $1.9 million, or $0.18 per share for the second quarter of 2017, and grew 8% from $2.0 million, or $0.19 per share, for the third quarter of 2016. For the nine months ended September 30, 2017, net income was $5.6 million, or $0.53 per diluted share, up 9% from $5.1 million, or $0.49 per share, for the nine months ended September 30, 2016. All results are unaudited.

“We delivered record earnings for the third quarter and year-to-date, driven by steady loan growth, an expanded net interest margin and our dedication to improving operating efficiencies,” said Denise Portmann, President & Chief Executive Officer. “During the second quarter, we collaborated with a seasoned industry consultant to assist us in identifying enhancements to efficiency. We are streamlining our operations by expanding use of technology, reviewing processes to improve workflows, and finding other revenue enhancement and expense management opportunities. Some initiatives are already being implemented and beginning to show positive results.”

“Residential mortgage lending continues to enhance our revenues, contributing $1.4 million to noninterest income during the quarter,” commented Portmann. “Residential housing demand is healthy, but low supply in several of our markets is limiting sales volume in the markets we serve.” Total loans grew by $10.2 million from the second quarter to $680.5 million, and increased by $31.2 million compared to the third quarter a year ago. The loan portfolio is well-diversified by category and concentration with 40% of the loan portfolio in commercial real estate, predominantly in the Washington and Oregon markets.

Third Quarter 2017 Highlights (as of, or for the period ended September 30, 2017, except as noted):

  • Diluted earnings per share totaled $0.20 for the third quarter of 2017, compared to $0.18 for the second quarter of 2017, and $0.19 for the third quarter of 2016. Diluted earnings per share totaled $0.53 for the first nine months of 2017, compared to $0.49 per diluted share for the first nine months of 2016.
  • Net interest income increased 3% to $8.7 million for the third quarter of 2017, compared to $8.4 million for the second quarter of 2017, and increased 10% from $7.9 million for the third quarter of 2016. For the nine months of 2017, net interest income increased 7% to $25.1 million, compared to $23.6 million for the first nine months of 2016.
  • Net interest margin (“NIMTE”), on a tax equivalent basis, was 4.29%, compared to 4.33% in the preceding quarter and 4.02% for the third quarter of 2016. The contraction in NIMTE from the preceding quarter was primarily due to higher average balances in short-term interest-bearing cash equivalents reflecting seasonal increases in deposits.
  • Total deposits grew 4% to $798.0 million, compared to $764.5 million at June 30, 2017, and increased 2% from $783.9 million at September 30, 2016. Seasonal inflows of deposits normally begin in the summer and extend into fall due to the increase in tourism activity in our core markets in Washington and Oregon. Noninterest-bearing demand deposits increased 10% on a linked quarter basis and grew 12% over the third quarter of 2016.
  • Gross loans grew by $10.2 million, or 2%, to $681.7 million versus $671.5 million on a linked quarter basis, and increased by $31.0 million, or 5%, from $650.7 million over the third quarter of 2016.
  • Asset quality remains solid.
    • Loans 30 – 89 days’ delinquent, not in nonaccrual status, were minimal at 0.08% of total loans outstanding.
    • Net charge-offs totaled $28,000, or 0.02% of average gross loans in the third quarter of 2017, compared to $127,000, or 0.08% of average gross loans in second quarter of 2017, and net charge-offs of $16,000, or 0.01% of average gross loans, in third quarter of 2016.
    • Primarily due to the downgrade of one $4.7 million commercial loan relationship in the third quarter, adversely classified loans increased to $11.4 million, or 1.67% of gross loans at September 30, 2017, compared to $6.5 million, or 0.97% of gross loans at June 30, 2017, and $9.8 million, or 1.51% of gross loans at September 30, 2016. On October 13, 2017, $3.5 million of the $4.7 million relationship referenced above paid off. Adjusted for the payoff, adversely classified loans to gross loans and to total assets would be 1.16% and 0.86%, respectively, as of September 30, 2017.
    • Nonperforming assets were $2.6 million, or 0.28% of total assets, primarily due to the placement of one commercial relationship totaling $1.6 million on nonaccrual status. This compared to $1.0 million, or 0.12% of total assets on a linked quarter basis, and $3.8 million, or 0.42% of total assets, at September 30, 2016.
    • There was a $150,000 provision for loan losses for the third quarter of 2017, compared to no provision for the preceding quarter and a provision of $276,000 for the third quarter of 2016. For the first nine months of 2017, the provision for loan losses was $272,000, compared to a provision of $814,000 for the first nine months of 2016. Reduction in provision expenses reflect the Company’s solid asset quality and recent growth experience.
    • The allowance for loan losses to gross loans stood at 1.35% at September 30, 2017, compared to 1.35% at June 30, 2017 and 1.38% at September 30, 2016.
  • Capital ratios of Bank of the Pacific remain strong with a total risk-based capital ratio at 12.71%, Tier 1 risk-based capital ratio at 11.47% and the leverage ratio at 9.75%, at September 30, 2017.

Operating Results

Total assets were up from the linked quarter, due to seasonal deposit inflows primarily from customers serving the summer tourist markets in coastal Washington and Oregon. Loans and cash equivalents grew during the period, as did investment securities and loans held for sale. Total assets were higher year-over-year primarily due to the increase 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. Total assets increased to $921.4 million, at September 30, 2017, compared to $878.5 million, at June 30, 2017, and $896.6 million, at September 30, 2016.

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,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$ Change %
Change
Assets: (Dollars in thousands, except per share data)
Cash and cash equivalents$66,545 $37,346 $29,199 78%$76,310 $(9,765) -13%
Other interest earning deposits 1,490 2,231 (741) -33% 2,727 (1,237) -45%
Investment securities 111,159 107,697 3,462 3% 100,358 10,801 11%
Loans held-for-sale 9,505 7,940 1,565 20% 14,069 (4,564) -32%
Loans, net of deferred fees 680,514 670,326 10,188 2% 649,108 31,406 5%
Allowance for loan losses (9,212) (9,090) (122) 1% (8,960) (252) 3%
Net loans 671,302 661,236 10,066 2% 640,148 31,154 5%
Federal Home Loan Bank and Pacific Coast
Bankers' Bank stock, at cost
2,410 2,412 (2) 0% 2,336 74 3%
Other assets 58,991 59,636 (645) -1% 60,623 (1,632) -3%
Total assets$921,402 $878,498 $42,904 5%$896,571 $24,831 3%
Liabilities and Shareholders' Equity:
Total deposits$798,044 $764,459 $33,585 4%$783,888 $14,156 2%
Borrowings 21,944 21,981 (37) 0% 22,094 (150) -1%
Accrued interest payable and other liabilities 14,790 7,688 7,102 92% 7,878 6,912 88%
Shareholders' equity 86,624 84,370 2,254 3% 82,711 3,913 5%
Total liabilities and shareholders' equity$921,402 $878,498 $42,904 5%$896,571 $24,831 3%
Common Stock Shares Outstanding 10,479,475 10,437,462 42,013 0% 10,422,871 56,604 1%
Book value per common share (1)$8.27 $8.08 $0.19 2%$7.94 $0.33 4%
Tangible book value per common share (2)$6.98 $6.79 $0.19 3%$6.64 $0.34 5%
Gross loans to deposits ratio 85.3% 87.7% 82.8%
(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 grew on a linked quarter basis, due to both growth in earning assets and an increase in yields associated with the recent rise in short-term interest rates. Net interest income grew versus the comparable quarter a year ago, reflecting the growth in earning assets and an increase in yields associated with the recent rise in short-term interest rates over the period. Loan balances increased year-over-year due to loan production generated predominately in Western Washington and Oregon. For the first nine months of 2017, net interest income increased 7% over the like period in 2016.

Interest expense remained virtually unchanged from the second quarter of 2017 and from the third quarter a year ago, primarily due to the non-renewal of higher-cost brokered and public certificates of deposit during the current period. Year-to-date interest expense also declined as compared to the corresponding period in 2016 for reasons previously cited, despite rate increases in LIBOR-based junior subordinated debentures during the period. The continued growth of noninterest-bearing deposits mitigated the impact of the above.

Pre-tax, pre-credit operating income (non-GAAP) for third quarter 2017, increased significantly from the linked quarter, primarily due to increased net interest income, partially offset by modest loan loss provision expense. Pre-tax, pre-credit operating income was down slightly from the like quarter in 2016, due to a decline in gain on sale of residential real estate loans, partially offset by no loan loss provision expense. Year-to-date pre-tax, pre-credit operating income (non-GAAP) increased as compared to the first nine months of 2016, primarily due to growth in net interest income and a lower loan loss provision expense, offset by a decline in gain on sale of residential real estate loans and other real estate owned.

Income Statement Overview
(Unaudited)
For the Three Months Ended,
Sept 30,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$ Change %
Change
(Dollars in thousands, except per share data)
Interest and dividend income$9,283$8,989$294 3%$8,518$765 9%
Interest expense 594 588 6 1% 616 (22) -4%
Net interest income 8,689 8,401 288 3% 7,902 787 10%
Loan loss provision 150 - 150 100% 276 (126) -46%
Noninterest income 2,662 2,861 (199) -7% 3,194 (532) -17%
Noninterest expense 8,164 8,555 (391) -5% 8,178 (14) 0%
Income before income taxes 3,037 2,707 330 12% 2,642 395 15%
Income tax expense 884 844 40 5% 649 235 36%
Net Income$2,153$1,863$290 16%$1,993$160 8%
Average common shares outstanding - basic 10,456,923 10,436,591 20,332 0% 10,421,921 35,002 0%
Average common shares outstanding - diluted 10,630,969 10,639,588 (8,619) 0% 10,582,695 48,274 0%
Income per common share
Basic$0.21$0.18$0.03 17%$0.19$0.02 11%
Diluted$0.20$0.18$0.02 11%$0.19$0.01 5%
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
$
Change
%
Change
(Dollars in thousands, except per share data)
Interest and dividend income$26,950$25,441$1,509 6%
Interest expense 1,802 1,851 (49) -3%
Net interest income 25,148 23,590 1,558 7%
Loan loss provision 272 814 (542) -67%
Noninterest income 7,804 8,751 (947) -11%
Noninterest expense 24,870 24,430 440 2%
Income before income taxes 7,810 7,097 713 10%
Income tax expense 2,205 1,966 239 12%
Net Income$5,605$5,131$474 9%
Average common shares outstanding - basic 10,441,726 10,413,903 27,823 0%
Average common shares outstanding - diluted 10,641,876 10,569,483 72,393 1%
Income per common share
Basic$0.54$0.49$0.05 10%
Diluted$0.53$0.49$0.04 8%

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

Reconciliation of Non-GAAP Measure
(Unaudited)
For the Three Months Ended,
Sept 30,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$ Change %
Change
Non-GAAP Operating Income (Dollars in thousands)
Net Income$2,153$1,863 $290 16%$1,993$160 8%
Loan loss provision 150 - 150 100% 276 (126) -46%
Loss on sale of other real estate owned, net - (5) 5 -100% - - 0%
Loss on real estate owned, net - 34 (34) -100% - - 100%
Income tax expense 884 844 40 5% 649 235 36%
Pre-tax, pre-credit operating income$3,187$2,736 $451 16%$2,918$269 9%
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
$
Change
%
Change
Non-GAAP Operating Income (Dollars in thousands)
Net Income$5,605$5,131 $474 9%
Loan loss provision 272 814 (542) -67%
Gain on sale of other real estate owned, net 47 (425) 472 -111%
Loss on real estate owned, net 34 - 34 100%
Income tax expense 2,205 1,966 239 12%
Pre-tax, pre-credit operating income$8,163$7,486 $677 9%

Noninterest Income

Noninterest income was down versus the linked quarter. Revenue generated in the second quarter 2017 from sale of non-owner occupied commercial real estate loans ($160,000) and monetized fee income associated with the pricing of loans over the swap curve ($182,000) were not replicated in the current period. Noninterest income was down as compared to the third quarter in 2016, primarily due to a decline in revenue from the sale of residential mortgage loans for the reasons cited above. Recent increases in mortgage rates have moderated demand for refinancing. However, demand for purchase financing remains strong, with robust demand for new homes chasing a limited supply of housing in several of our Western Washington and Oregon markets. Supply constraints, and resulting increases in housing prices, have, in part, stemmed from increased governmental regulations governing real estate development over the past several years.

For the first nine months of 2017, noninterest income was down versus the first nine months of 2016. This was primarily a result of a decline in revenue from the sale of residential mortgage loans for reasons noted above, and a $351,000 gain on the sale of a $1.2 million OREO property that occurred in the first quarter of 2016. In addition, fee income from ATM/debit card activity increased in the current period versus the comparable period a year ago, due to the impacts of recent promotional activities and growth in debit card usage.

Noninterest Income
(Unaudited)
For the Three Months Ended,
Sept 30,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$ Change %
Change
(Dollars in thousands)
Service charges on deposits$456 $467$(11) -2%$477$(21) -4%
Net loss on sale of other real estate owned, net - 5 (5) -100% - - 0%
Gain on sale of loans, net 1,398 1,319 79 6% 1,864 (466) -25%
Gain on sale of securities available for sale, net - - - 0% - - 0%
Earnings on bank owned life insurance 110 111 (1) -1% 116 (6) -5%
Other noninterest income
Fee income 672 633 39 6% 694 (22) -3%
Other 26 326 (300) -92% 43 (17) -40%
Total noninterest income$2,662 $2,861$(199) -7%$3,194$(532) -17%
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
$
Change
%
Change
(Dollars in thousands)
Service charges on deposits$1,382 $1,411$(29) -2%
Gain on sale of other real estate owned, net (47) 425 (472) -111%
Gain on sale of loans, net 3,737 4,530 (793) -18%
Gain on sale of securities available for sale, net 79 6 73 1217%
Earnings on bank owned life insurance 331 353 (22) -6%
Other noninterest income
Fee income 1,913 1,656 257 16%
Income from other real estate owned - - - 0%
Other 409 370 39 11%
Total noninterest income$7,804 $8,751$(947) -11%

Noninterest Expense

Noninterest expense decreased from the linked quarter, primarily due to $385,000 in consulting fees associated with a process improvement and revenue enhancement engagement undertaken in the prior quarter. In addition, a loss of $34,000 was taken on the sale of a former branch property in the prior quarter.

Noninterest expense was also up year-to-date as compared to the first half of 2016, primarily for the reasons cited previously. This was despite $348,000 in OREO operating expense that was incurred in the first quarter of 2016 to prepare a $1.2 million OREO property for its eventual sale. Data processing and software expense also increased versus the prior periods with the recent introduction of several technology solutions to augment cyber-security and enhance productivity. This was offset partially by a decline in deposit premium and low-income housing tax amortization expense.

Noninterest Expense
(Unaudited)
For the Three Months Ended,
Sept 30,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$ Change %
Change
(Dollars in thousands)
Salaries and employee benefits$5,090 $5,147$(57) -1%$5,321$(231) -4%
Occupancy 489 530 (41) -8% 512 (23) -4%
Equipment 282 273 9 3% 254 28 11%
Data processing 581 602 (21) -3% 535 46 9%
Professional services 330 587 (257) -44% 98 232 237%
Other real estate owned write-downs - - - 0% 71 (71) 0%
Other real estate owned operating costs (1) 6 (7) -117% 8 (9) -113%
State and local taxes 195 140 55 39% 129 66 51%
FDIC and State assessments 115 122 (7) -6% 130 (15) -12%
Other noninterest expense:
Director fees 64 83 (19) -23% 66 (2) -3%
Communication 69 41 28 68% 63 6 10%
Advertising 78 82 (4) -5% 68 10 15%
Professional liability insurance 48 47 1 2% 48 - 0%
Amortization 72 67 5 7% 60 12 20%
Loss on real estate owned, net - 34 (34) -100% - - 100%
Other 752 794 (42) -5% 815 (63) -8%
Total noninterest expense$8,164 $8,555$(391) -5%$8,178$(14) 0%
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
$
Change
%
Change
(Dollars in thousands)
Salaries and employee benefits$15,384 $15,542$(158) -1%
Occupancy 1,521 1,527 (6) 0%
Equipment 837 786 51 6%
Data processing 1,722 1,515 207 14%
Professional services 1,133 346 787 227%
Other real estate owned write-downs - 71 (71) -100%
Other real estate owned operating costs 16 439 (423) -96%
State and local taxes 465 372 93 25%
FDIC and State assessments 343 407 (64) -16%
Other noninterest expense:
Director fees 198 219 (21) -10%
Communication 199 193 6 3%
Advertising 242 213 29 14%
Professional liability insurance 142 144 (2) -1%
Amortization 72 174 (102) -59%
Loss on real estate owned, net 34 - 34 100%
Other 2,562 2,482 80 3%
Total noninterest expense$24,870 $24,430$440 2%


Financial Performance Overview
(Unaudited)
For the Three Months Ended
Sept 30,
2017
June 30,
2017
Change Sept 30,
2016
Change
Performance Ratios
Return on average assets, annualized0.96% 0.87% 0.09 0.91% 0.05
Return on average equity, annualized9.90% 8.93% 0.97 9.63% 0.27
Efficiency ratio (1)71.92% 75.96% (4.04) 73.70% (1.78)
(1) Non-interest expense divided by net interest income plus noninterest income.
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
Change
Performance Ratios
Return on average assets, annualized0.86% 0.82% 0.04
Return on average equity, annualized8.97% 8.58% 0.39
Efficiency ratio (1)75.47% 75.54% (0.07)
(1) Non-interest expense divided by net interest income plus noninterest income.

LIQUIDITY

Cash and Cash Equivalents and Investment Securities
(Unaudited)
Sept 30,
2017
% of
Total
June 30,
2017
% of
Total
$
Change
%
Change
Sept 30,
2016
Total $
Change
%
Change
(Dollars in thousands)
Cash on hand and in banks$18,460 9%$19,957 13%$(1,497) -8%$15,395 9%$3,065 20%
Interest bearing deposits 48,085 27% 17,389 12% 30,696 177% 60,915 34% (12,830) -21%
Other interest earning deposits 1,490 1% 2,231 2% (741) -33% 2,727 2% (1,237) -45%
Total cash equivalents and interest earning deposits 68,035 38% 39,577 27% 28,458 72% 79,037 44% (11,002) -14%
Investment securities:
Collateralized mortgage obligations: agency issued 39,320 21% 38,083 25% 1,237 3% 34,100 20% 5,220 15%
Collateralized mortgage obligations: non-agency 305 0% 305 0% - 0% 483 0% (178) -37%
Mortgage-backed securities: agency issued 13,469 8% 14,129 10% (660) -5% 10,384 6% 3,085 30%
U.S. Government and agency securities 2,578 1% 2,644 2% (66) -2% 9,876 6% (7,298) -74%
State and municipal securities 55,488 31% 52,536 36% 2,952 6% 45,515 25% 9,973 22%
Total investment securities 111,160 62% 107,697 73% 3,463 3% 100,358 56% 10,802 11%
Total cash equivalents and investment securities$179,195 100%$147,274 100%$31,921 22%$179,395 100%$(200) 0%
Total cash equivalents and investment securities
as a percent of total assets 19% 17% 20%

Liquidity remains strong based on existing levels of combined cash equivalents, investment securities and unused borrowing capacity. “During the current quarter, we experienced seasonal deposit inflows typical for this time of year which funded a mix of earning assets during the period,” 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 September 30, 2017, 3.9 years at June 30, 2017 and 3.3 years at September 30, 2016.

The Bank had $8.5 million in outstanding borrowings against its $184.8 million in established borrowing capacity with the Federal Home Loan Bank of Des Moines (FHLB) at September 30, 2017. The Bank had $8.6 million and $8.7 million in outstanding borrowings with the FHLB at June 30, 2017 and September 30, 2016, 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 $52.5 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,
2017
% of
Gross
Loans
June 30, 2017 % of
Gross
Loans
$ Change %
Change
Sept 30,
2016
% of
Gross Loans
$ Change % Change
(Dollars in thousands)
Commercial and agricultural$137,520 19%$137,730 20%$(210) 0%$133,341 20%$4,179 3%
Real estate:
Construction and development 67,967 10% 55,901 8% 12,066 22% 36,022 6% 31,945 89%
Residential 1-4 family 88,897 13% 91,578 14% (2,681) -3% 90,900 14% (2,003) -2%
Multi-family 19,425 3% 19,407 3% 18 0% 30,871 5% (11,446) -37%
Commercial real estate -- owner occupied 134,970 20% 133,363 20% 1,607 1% 134,565 20% 405 0%
Commercial real estate -- non owner occupied 135,925 20% 137,682 21% (1,757) -1% 139,246 21% (3,321) -2%
Farmland 34,583 5% 34,393 5% 190 1% 23,668 4% 10,915 46%
Consumer 62,408 9% 61,469 9% 939 2% 62,042 10% 366 1%
Loans net of deferred fees 681,695 100% 671,523 100% 10,172 2% 650,655 100% 31,040 5%
Less: allowance for loan losses (9,212) (9,090) (122) (8,960) (252)
Less: deferred fees (1,181) (1,197) 16 (1,547) 366
Net loans$671,302 $661,236 $10,066 $640,148 $31,154
Loan Concentration
(Unaudited)
Sept 30,
2017
% of Risk
Based Capital
June 30, 2017 % of Risk
Based Capital
Change Sept 30, 2016 % of Risk
Based
Capital
Change
(Dollars in thousands)
Commercial and agricultural$137,520 146%$133,533 148% -2%$133,341 149% -3%
Real estate:
Construction and development 67,967 72% 46,049 51% 21% 36,022 40% 32%
Residential 1-4 family 88,897 94% 91,924 102% -8% 90,900 101% -7%
Multi-family 19,425 21% 28,619 32% -11% 30,871 34% -13%
Commercial real estate -- owner occupied 134,970 143% 131,507 145% -2% 134,565 150% -7%
Commercial real estate -- non owner occupied 135,925 144% 143,578 159% -15% 139,246 155% -11%
Farmland 34,583 37% 27,850 31% 6% 23,668 26% 11%
Consumer 62,408 66% 65,306 72% -6% 62,042 69% -3%
Loans net of deferred fees$681,695 $668,366 $650,655
Regulatory Commercial Real Estate$210,142 222%$208,604 231% -9%$200,010 223% -1%
Total Risk Based Capital*$94,494 $90,420 $89,678
*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 quarter. The portfolio includes $33.2 million in LIBOR-based and $119.8 million in Wall Street Journal Prime-based floating rate commercial and commercial real estate loans. The portfolio also includes $19.1 million in purchased government-guaranteed commercial and commercial real estate loans. In addition, the portfolio contains $55.1 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)
Sept 30,
2017
% of
Total
June 30,
2017
% of
Total
$
Change
%
Change
Sept 30,
2016
% of
Total
$
Change
%
Change
(Dollars in thousands)
Interest-bearing demand and money market $337,474 42%$325,779 43%$11,695 4%$334,564 43%$2,910 1%
Savings 88,306 11% 85,366 11% 2,940 3% 84,952 11% 3,354 4%
Time deposits (CDs) 111,064 14% 116,259 15% (5,195) -4% 131,747 17% (20,683) -16%
Total interest-bearing deposits 536,844 67% 527,404 69% 9,440 2% 551,263 70% (14,419) -3%
Non-interest bearing demand 261,200 33% 237,055 31% 24,145 10% 232,625 30% 28,575 12%
Total deposits$798,044 100%$764,459 100%$33,585 4%$783,888 100%$14,156 2%

Total deposits increased during the quarter primarily due to recovery of seasonal deposits typical for this time of year as tourism activity in certain core markets has begun to pick up. 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. In addition, $2.0 million in higher-cost public certificates of deposit were not renewed. The proportion of noninterest bearing deposits to total deposits continued to increase due to the seasonality referenced above.

Brokered certificates of deposit totaled $47.9 million, which included $0.8 million via reciprocal deposit arrangements, down from $48.9 million at June 30, 2017 and $52.1 million at September 30, 2016. 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. Leverage ratios decreased due to asset growth during the current period. However, risk-weighted ratios have increased compared to the linked and prior year quarters, due to the retention of earnings, coupled with the modest level of growth during the period. As such, the balance sheet has exhibited only a modest increase in risk-weighting as compared to the year-over-year quarter.

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)
Sept 30,
2017
June 30,
2017
Change Sept 30,
2016
Change To be Well
Capitalized
Under
Prompt
Correction
Action
Regulations*
Pacific Financial Corporation
Total risk-based capital ratio12.82% 12.76% 0.06 12.67% 0.15 N/A
Tier 1 risk-based capital ratio11.58% 11.51% 0.07 11.42% 0.16 N/A
Common equity tier 1 ratio9.84% 9.73% 0.11 9.60% 0.24 N/A
Leverage ratio9.85% 9.90% (0.05) 9.58% 0.27 N/A
Tangible common equity ratio8.08% 8.22% (0.14) 7.89% 0.19 N/A
Bank of the Pacific
Total risk-based capital ratio12.71% 12.66% 0.05 12.58% 0.13 10.5%
Tier 1 risk-based capital ratio11.47% 11.41% 0.06 11.33% 0.14 8.5%
Common equity tier 1 ratio11.47% 11.41% 0.06 11.33% 0.14 7.0%
Leverage ratio9.75% 9.81% (0.06) 9.49% 0.26 7.5%
*Includes Basel III 2019 Capital Conservation Buffer

Net Interest Margin

Net interest margin contracted compared to the linked quarter, primarily due to the investment of seasonal deposit inflows in short-term interest-bearing bank balances. Increases in interest rates recently initiated by the Federal Reserve had a positive impact on loan yields during the period. These increases, along with growth in higher-yielding loans, contributed to an increase in net interest margin versus the prior year quarter. Net interest margin for the first nine months of 2017 improved as compared to the same period prior year for similar reasons despite additional one-time interest income assessed for a breach in loan agreement during first quarter 2016. This one-time interest income enhanced net interest margin by 3 basis points for the prior year period.

Cost of deposits and borrowings remained relatively unchanged as compared to the linked and year-over-year periods. The increase in the proportion of deposits coming from noninterest-bearing deposits favorably impacted funding costs during these respective periods. Improvement in loan and investment security yields offset increases in the cost of LIBOR-based junior subordinated debentures in the current quarter as compared to the linked and year-over-year periods.

The following tables set forth information regarding 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,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$
Change
%
Change
Average Balances (Dollars in thousands)
Gross loans$676,059 $667,711 $8,348 1%$647,412 $28,647 4%
Loans held for sale$8,457 $7,760 $697 9%$14,538 $(6,081) -42%
Investment securities$140,167 $122,539 $17,628 14%$136,459 $3,708 3%
Total interest-earning assets$824,683 $798,010 $26,673 3%$798,409 $26,274 3%
Non-interest bearing demand deposits$251,003 $227,132 $23,871 11%$212,447 $38,556 18%
Interest bearing deposits$521,545 $521,643 $(98) 0%$539,627 $(18,082) -3%
Borrowings$21,956 $22,373 $(417) -2%$22,880 $(924) -4%
Total interest-bearing liabilities$543,501 $544,016 $(515) 0%$562,507 $(19,006) -3%
Total Equity$86,262 $83,647 $2,615 3%$82,088 $4,174 5%
For the Three Months Ended,
Sept 30,
2017
June 30,
2017
Change Sept 30,
2016
Change
Yield on average gross loans (1) 5.04% 5.00% 0.04 4.81% 0.23
Yield on average investment securities (1) 2.32% 2.57% (0.25) 1.95% 0.37
Cost of average interest bearing deposits 0.34% 0.34% - 0.36% (0.02)
Cost of average borrowings 2.69% 2.58% 0.11 2.25% 0.44
Cost of average total deposits and borrowings 0.30% 0.31% (0.01) 0.32% (0.02)
Yield on average interest-earning assets 4.58% 4.63% (0.05) 4.32% 0.26
Cost of average interest-bearing liabilities 0.43% 0.43% - 0.43% -
Net interest spread 4.15% 4.20% (0.05) 3.89% 0.26
Net interest margin (1) 4.29% 4.33% (0.04) 4.02% 0.27
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a 34% rate.
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
$
Change
%
Change
Average Balances (Dollars in thousands)
Gross loans$669,723 $642,405 $27,318 4%
Loans held for sale$7,104 $11,318 $(4,214) -37%
Investment securities$131,135 $122,394 $8,741 7%
Interest-earning assets$807,962 $776,117 $31,845 4%
Non-interest bearing demand deposits$234,637 $194,721 $39,916 20%
Interest bearing deposits$524,156 $529,504 $(5,348) -1%
Borrowings$22,135 $29,263 $(7,128) -24%
Interest-bearing liabilities$546,291 $558,767 $(12,476) -2%
Total Equity$83,800 $79,895 $3,905 5%
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
Change
Net Interest Margin
Yield on average gross loans (1) 5.00% 4.90% 0.10
Yield on average investment securities (1) 2.41% 2.19% 0.22
Cost of average interest bearing deposits 0.35% 0.36% (0.01)
Cost of average borrowings 2.62% 2.37% 0.25
Cost of average total deposits and borrowings 0.31% 0.33% (0.02)
Yield on average interest-earning assets 4.58% 4.47% 0.11
Cost of average interest-bearing liabilities 0.44% 0.44% -
Net interest spread 4.14% 4.03% 0.11
Net interest margin (1) 4.28% 4.15% 0.13
(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 downgrade of a commercial loan relationship totaling $4.7 million. The downgrade was as a result of a decline in management performance, but the loans were not placed on nonaccrual status. On October 13, 2017, a $3.5 million commercial real estate loan associated with this relationship was paid off. Adjusted for the payoff, adversely classified loans to gross loans and to total assets would have been 1.16% and 0.86%, respectively. Total 30-89 day delinquencies remained below 0.50%, a positive leading indicator of future credit quality.

Adversely Classified Loans and Securities
(Unaudited)
Sept 30,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$
Change
%
Change
(Dollars in thousands)
Rated substandard or worse, but not impaired$8,490 $5,126 $3,364 66%$8,307 $183 2%
Impaired 2,916 1,355 1,561 115% 1,505 1,411 94%
Total adversely classified loans¹$11,406 $6,481 $4,925 76%$9,812 $1,594 16%
Gross loans (excluding deferred loan fees)$681,695 $671,523 $10,172 2%$650,655 $31,040 5%
Adversely classified loans to gross loans 1.67% 0.97% 1.51%
Allowance for loan losses$9,212 $9,090 $122 1%$8,960 $252 3%
Allowance for loan losses as a percentage of adversely classified loans 80.76% 140.26% 91.32%
Allowance for loan losses to total impaired loans 315.91% 670.85% 595.35%
Adversely classified loans to total assets 1.24% 0.74% 1.09%
Delinquent loans to gross loans, not in nonaccrual status 0.08% 0.03% 0.04%
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.

Nonperforming assets increased on a linked quarter basis, primarily due to the placement of two loans to one commercial relationship on nonaccrual status totaling $1.6 million in the current period. While remaining at modest levels, this resulted in a slight increase in the percentage of nonperforming assets to total assets versus the linked quarter. Nonperforming assets declined compared to the year-over-year quarter due to the sale of a $1.9 million commercial real estate OREO asset in fourth quarter 2016.

Nonperforming Assets
(Unaudited)
Sept 30,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$
Change
%
Change
(Dollars in thousands)
Loans on nonaccrual status$2,545 $977 $1,568 160%$1,505 $1,040 69%
Total nonaccrual loans 2,545 977 1,568 160% 1,505 1,040 69%
Other real estate owned and foreclosed assets 8 105 (97) -92% 2,268 (2,260) -100%
Total nonperforming assets$2,553 $1,082 $1,471 136%$3,773 $(1,220) -32%
Restructured performing loans$371 $378 $(7) -2%$389 $(18) 100%
Accruing loans past due 90 days or more$- $- $- 0%$- $- 0%
Percentage of nonperforming assets to total assets 0.28% 0.12% 0.42%
Nonperforming loans to total loans 0.37% 0.15% 0.23%

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses has been managed 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.

Net charge-offs totaled $28,000 for the third quarter, primarily consumer in nature, compared to $127,000 in the preceding quarter, which were primarily related to several small commercial loans. Net charge-offs in the third quarter a year ago were $16,000. Net charge-offs for the nine months ending September 30, 2017 were up compared to the same period a year ago. Current year-to-date net charge-offs include a $121,000 charge-off related to the payoff of a $2.0 million adversely classified loan participation that occurred earlier in the year. “The low level of charge-offs and ratio of net loan charge-offs to average gross loans demonstrate the solid credit quality of the portfolio,” said Biddle. The overall risk profile of the loan portfolio continues to be modest, demonstrating the solid credit risk management framework in place. 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,
Sept 30,
2017
June 30,
2017
$
Change
%
Change
Sept 30,
2016
$
Change
%
Change
(Dollars in thousands)
Gross loans outstanding at end of period$681,695 $671,523 $10,172 2% $650,655 $31,040 5%
Average loans outstanding, gross$676,059 $667,711 $8,348 1% $647,412 $28,647 4%
Allowance for loan losses, beginning of period $9,090 $9,217 $(127) -1% $8,700 $390 4%
Commercial - (105) 105 -100% - - 0%
Commercial Real Estate - - - 0% - - 0%
Residential Real Estate - (3) 3 -100% - - 0%
Consumer (33) (25) (8) 32% (36) 3 -8%
Total charge-offs (33) (133) 100 -75% (36) 3 -8%
Commercial 2 2 - 0% - 2 100%
Commercial Real Estate - - - 0% 2 (2) -100%
Residential Real Estate 1 2 (1) -50% 18 (17) -94%
Consumer 2 2 - 0% - 2 100%
Total recoveries 5 6 (1) -17% 20 (15) -75%
Net recoveries/(charge-offs) (28) (127) 99 -78% (16) (12) 75%
Provision charged to income 150 - 150 100% 276 (126) -46%
Allowance for loan losses, end of period$9,212 $9,090 $122 1%$8,960 $252 3%
Ratio of net loans charged-off to average
gross loans outstanding, annualized 0.02% 0.08% -0.06% -75% 0.01% 0.01% 100%
Ratio of allowance for loan losses to
gross loans outstanding 1.35% 1.35% 0.00% 0% 1.38% -0.03% -2%
For the Nine Months Ended,
Sept 30,
2017
Sept 30,
2016
$
Change
%
Change
(Dollars in thousands)
Gross loans outstanding at end of period$681,695 $650,655 $31,040 5%
Average loans outstanding, gross$669,723 $642,405 $27,318 4%
Allowance for loan losses, beginning of period$9,192 $8,317 $875 11%
Commercial (236) (8) (228) NM
Commercial Real Estate - (97) 97 -100%
Residential Real Estate (3) (35) 32 -91%
Consumer (74) (79) 5 -6%
Total charge-offs (313) (219) (94) 43%
Commercial 44 2 42 NM
Commercial Real Estate 0 6 (6) -100%
Residential Real Estate 11 31 (20) -65%
Consumer 6 9 (3) -33%
Total recoveries 61 48 13 27%
Net (charge-offs) (252) (171) (81) 47%
Provision charged to income 272 814 (542) -67%
Allowance for loan losses, end of period$9,212 $8,960 $252 3%
Ratio of net loans charged-off to average
gross loans outstanding, annualized 0.04% 0.03% 0.01% 33%
Ratio of allowance for loan losses to
gross loans outstanding 1.35% 1.38% -0.03% -2%

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 September 30, 2017, the Company had total assets of $921 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