FORM 10-Q
(Mark One)
| [X] |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended March 31, 2006 |
OR
| [ ] |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________ |
Commission File Number 000-29829
PACIFIC FINANCIAL
CORPORATION
(Exact name of
registrant as specified in its charter)
| Washington | 91-1815009 | |
|---|---|---|
| (State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification No.) |
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer or non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act):
Large accelerated filer [ ] Accelerated Filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes [ ] No [X]
The number of shares of the issuer’s common stock, par value $1.00 per share, outstanding as of April 28, 2006, was 6,480,362 shares.
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PACIFIC FINANCIAL
CORPORATION
Condensed Consolidated
Balance Sheets
(Dollars in thousands)
| March 31, 2006 (Unaudited) |
December 31, 2005 | ||||
|---|---|---|---|---|---|
| Assets | |||||
| Cash and due from banks | $ 12,829 | $ 11,223 | |||
| Interest bearing balances with banks | 173 | 283 | |||
| Federal funds sold | 15,865 | — | |||
| Investment securities available for sale | 29,363 | 29,748 | |||
| Investment securities held-to-maturity | 6,418 | 6,504 | |||
| Federal Home Loan Bank stock, at cost | 1,858 | 1,858 | |||
| Loans held for sale | 11,069 | 10,111 | |||
| Loans | 392,790 | 398,870 | |||
| Allowance for credit losses | 5,202 | 5,296 | |||
| Loans, net | 387,588 | 393,574 | |||
Premises and equipment | 10,739 |
10,085 |
|||
| Foreclosed real estate | 37 | 37 | |||
| Accrued interest receivable | 2,364 | 2,364 | |||
| Cash surrender value of life insurance | 9,476 | 9,394 | |||
| Goodwill | 11,282 | 11,282 | |||
| Other intangible assets | 709 | 745 | |||
| Other assets | 2,374 | 2,201 | |||
| Total assets | $502,144 | $489,409 | |||
Liabilities and Shareholders' Equity | |||||
| Deposits: | |||||
| Non-interest bearing | $ 81,402 | $ 86,264 | |||
| Interest bearing | 337,076 | 313,462 | |||
| Total deposits | 418,478 | 399,726 | |||
Accrued interest payable | 628 | 547 | |||
| Secured borrowings | 1,951 | 2,150 | |||
| Short-term borrowings | — | 3,985 | |||
| Long-term borrowings | 24,500 | 24,500 | |||
| Junior subordinated debentures | 5,155 | 5,155 | |||
| Other liabilities | 3,072 | 6,746 | |||
| Total liabilities | 453,784 | 442,809 | |||
Shareholders' Equity | |||||
| Common Stock (par value $1); 25,000,000 shares authorized; | |||||
| 6,480,362 shares issued and outstanding at March 31, 2006 | |||||
| and 6,464,536 at December 31, 2005 | 6,480 | 6,464 | |||
| Additional paid-in capital | 25,618 | 25,386 | |||
| Retained earnings | 16,663 | 15,073 | |||
| Accumulated other comprehensive loss | (401 | ) | (323 | ) | |
| Total shareholders' equity | 48,360 | 46,600 | |||
Total liabilities and shareholders' equity | $502,144 |
$489,409 |
|||
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PACIFIC FINANCIAL CORPORATION
Condensed Consolidated Statements of Income
Three months ended March 31, 2006 and 2005
(Dollars in thousands, except per share)
(Unaudited)
| 2006 | 2005 | ||||
|---|---|---|---|---|---|
| Interest and dividend income | |||||
| Loans | $ 7,691 | $ 6,124 | |||
| Investment securities and FHLB dividends | 360 | 450 | |||
| Deposits with banks and federal funds sold | 75 | 72 | |||
| Total interest and dividend income | 8,126 | 6,646 | |||
Interest Expense | |||||
| Deposits | 2,123 | 1,304 | |||
| Other borrowings | 370 | 215 | |||
| Total interest expense | 2,493 | 1,519 | |||
Net Interest Income | 5,633 |
5,127 |
|||
| Provision for credit losses | — | 300 | |||
| Net interest income after provision for | 5,633 | 4,827 | |||
| credit losses | |||||
Non-interest Income | |||||
| Service charges on deposits | 376 | 321 | |||
| Gain on sales of loans | 380 | 279 | |||
| Gain on sale of investments available for sale | — | 9 | |||
| Gain on sale of premises and equipment | 2 | 80 | |||
| Other operating income | 188 | 197 | |||
| Total non-interest income | 946 | 886 | |||
Non-interest Expense | |||||
| Salaries and employee benefits | 2,531 | 2,414 | |||
| Occupancy and equipment | 531 | 467 | |||
| Other | 1,252 | 998 | |||
| Total non-interest expense | 4,314 | 3,879 | |||
Income before income taxes | 2,265 | 1,834 | |||
| Provision for income taxes | 675 | 545 | |||
Net Income | $ 1,590 | $ 1,289 | |||
Comprehensive Income | $ 1,512 | $ 992 | |||
Earnings per common share: | |||||
| Basic | $ 0.25 | $ 0.20 | |||
| Diluted | 0.24 | 0.20 | |||
| Average shares outstanding: | |||||
| Basic | 6,478,188 | 6,421,396 | |||
| Diluted | 6,574,831 | 6,525,848 | |||
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PACIFIC FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 2006 and
2005
(Dollars in thousands)
(Unaudited)
| 2006 | 2005 | |||||||
|---|---|---|---|---|---|---|---|---|
| OPERATING ACTIVITIES | ||||||||
| Net income | $ | 1,590 | $ | 1,289 | ||||
| Adjustments to reconcile net income to net cash provided by | ||||||||
| (used in) operating activities: | ||||||||
| Provision for credit losses | — | 300 | ||||||
| Depreciation and amortization | 293 | 268 | ||||||
| Origination of loans held for sale | (20,830 | ) | (25,426 | ) | ||||
| Proceeds of loans held for sale | 20,252 | 19,634 | ||||||
| Gain on sales of loans | (380 | ) | (279 | ) | ||||
| Gain on sale of investment securities | — | (9 | ) | |||||
| Gain on sale of premises and equipment | (2 | ) | (80 | ) | ||||
| Increase in accrued interest receivable | — | (56 | ) | |||||
| Increase in accrued interest payable | 81 | 6 | ||||||
| Other | 742 | (87 | ) | |||||
| Net cash provided by (used in) operating activities | 1,746 | (4,440 | ) | |||||
INVESTING ACTIVITIES | ||||||||
| Net increase in federal funds | (15,865 | ) | (6,451 | ) | ||||
| (Increase) decrease in interest bearing deposits with banks | 110 | (3,206 | ) | |||||
| Purchase of securities available for sale | (362 | ) | (2,715 | ) | ||||
| Proceeds from maturities of investments held to maturity | 84 | 157 | ||||||
| Proceeds from sales of securities available for sale | — | 1,100 | ||||||
| Proceeds from maturities of securities available for sale | 586 | 2,076 | ||||||
| Net increase in loans | 6,059 | 5,370 | ||||||
| Additions to premises and equipment | (848 | ) | (226 | ) | ||||
| Proceeds from sales of premises and equipment | 4 | 104 | ||||||
| Net cash used in investing activities | (10,232 | ) | (3,791 | ) | ||||
FINANCING ACTIVITIES | ||||||||
| Net increase in deposits | 18,752 | 18,284 | ||||||
| Net decrease in short-term borrowings | (3,985 | ) | — | |||||
| Net decrease in secured borrowings | (199 | ) | (156 | ) | ||||
| Proceeds from issuance of long-term borrowings | 2,000 | — | ||||||
| Repayments of long-term borrowings | (2,000 | ) | (2,000 | ) | ||||
| Issuance of common stock | 243 | — | ||||||
| Payment of cash dividends | (4,719 | ) | (4,624 | ) | ||||
Net cash provided by financing activities | 10,092 | 11,504 | ||||||
Net increase in cash and due from banks | 1,606 | 3,273 | ||||||
CASH AND DUE FROM BANKS | ||||||||
| Beginning of period | 11,223 | 10,213 | ||||||
End of period | $ | 12,829 | $ | 13,486 | ||||
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | ||||||||
| Cash payments for: | ||||||||
| Interest | $ | 2,412 | $ | 1,513 | ||||
| Income Taxes | — | 375 | ||||||
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES | ||||||||
| Change in fair value of securities available for sale, net of tax | (78 | ) | (297 | ) | ||||
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PACIFIC FINANCIAL
CORPORATION
Condensed Consolidated
Statements of Shareholders’ Equity
Three months ended March 31, 2006
and 2005 (Dollars in thousands) (Unaudited)
| COMMON STOCK |
ADDITIONAL PAID-IN CAPITAL |
RETAINED EARNINGS |
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) |
TOTAL | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance December 31, 2004 | $ | 6,421 | $ | 25,003 | $ | 13,746 | $ | 133 | $ | 45,303 | |||||||
| Other comprehensive income: | |||||||||||||||||
| Net income | 1,289 | 1,289 | |||||||||||||||
| Change in fair value of securities | (297 | ) | (297 | ) | |||||||||||||
| available for sale, net | |||||||||||||||||
| Comprehensive income | 992 | ||||||||||||||||
Balance March 31, 2005 | $ | 6,421 | $ | 25,003 | $ | 15,035 | ($ 164 | ) | $ | 46,295 | |||||||
Balance December 31, 2005 | $ | 6,464 | $ | 25,386 | $ | 15,073 | ($ 323 | ) | $ | 46,600 | |||||||
| Other comprehensive income: | |||||||||||||||||
| Net income | 1,590 | 1,590 | |||||||||||||||
| Change in fair value of securities | (78 | ) | (78 | ) | |||||||||||||
| available for sale, net | |||||||||||||||||
| Comprehensive income | 1,512 | ||||||||||||||||
| Issuance of common stock | 16 | 227 | 243 | ||||||||||||||
| Stock compensation expense | 5 | 5 | |||||||||||||||
| Balance March 31, 2006 | $ | 6,480 | $ | 25,618 | $ | 16,663 | ($ 401 | ) | $ | 48,360 | |||||||
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PACIFIC FINANCIAL
CORPORATION
Notes to Condensed
Consolidated Financial Statements
Nine months ended September 30, 2005
and 2004
(unaudited)
The accompanying unaudited consolidated financial statements have been prepared by Pacific Financial Corporation (“Pacific” or the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial information and with instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2006, are not necessarily indicative of the results anticipated for the year ending December 31, 2006. Certain information and footnote disclosures included in the Company’s consolidated financial statements for the year ended December 31, 2005, have been condensed or omitted from this report. Accordingly, these statements should be read with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
All dollar amounts in tables, except earnings per share tables and per share information, are stated in thousands.
The following table illustrates the computation of basic and diluted earnings per share.
| 2006 | 2005 | |||||||
|---|---|---|---|---|---|---|---|---|
| Basic: | ||||||||
| Net income | $ | 1,590,000 | $ | 1,289,000 | ||||
| Weighted average shares outstanding | ||||||||
| 6,478,188 | 6,421,396 | |||||||
| Basic earnings per share | $ | 0.25 | $ | 0.20 | ||||
| Diluted: | ||||||||
| Net income | $ | 1,590,000 | $ | 1,289,000 | ||||
| Weighted average shares outstanding | ||||||||
| 6,478,188 | 6,421,396 | |||||||
| Effect of dilutive stock options | 96,643 | 104,452 | ||||||
| Weighted average shares outstanding | ||||||||
| assuming dilution | 6,574,831 | 6,525,848 | ||||||
| Diluted Earnings Per Share | $ | 0.24 | $ | 0.20 | ||||
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As of March 31, 2006 and 2005, there were 272,600 and 93,600 shares, respectively, subject to outstanding options to acquire common stock with exercises prices in excess of the current market value. These shares are not included in the table above, as exercise of these options may not be considered dilutive to shareholders.
Investment securities consist principally of short and intermediate term debt instruments issued by the U.S. Treasury, other U.S. government agencies, state and local government units, and other corporations.
| Securities Held to Maturity | AMORTIZED COST |
UNREALIZED GAINS |
UNREALIZED LOSSES |
FAIR VALUE | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
March 31, 2006 |
||||||||||||||
| U.S. Government Securities | $ | 1,122 | $ | 1 | $ | 7 | $ | 1,116 | ||||||
| State and Municipal Securities | 5,296 | 29 | 49 | 5,276 | ||||||||||
| Total | $ | 6,418 | $ | 30 | $ | 56 | $ | 6,392 | ||||||
| Securities Available for Sale | AMORTIZED COST |
UNREALIZED GAINS |
UNREALIZED LOSSES |
FAIR VALUE | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
March 31, 2006 |
||||||||||||||
| U.S. Government Securities | $ | 12,277 | $ | 24 | $ | 325 | $ | 11,976 | ||||||
| State and Municipal Securities | 12,586 | 71 | 199 | 12,458 | ||||||||||
| Corporate Securities | 2,066 | 3 | 55 | 2,014 | ||||||||||
| Mutual Funds | 3,041 | — | 126 | 2,915 | ||||||||||
| Total | $ | 29,970 | $ | 98 | $ | 705 | $ | 29,363 | ||||||
For all the above investment securities, the unrealized losses are generally due to changes in interest rates and, as such, are considered to be temporary by management. The Company has evaluated the securities shown above and anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment. The Company regularly reviews its investment portfolio to determine whether any of its securities are other than temporarily impaired. In addition to accounting and regulatory guidance, in determining whether a security is other than temporarily impaired, the Company considers duration and amount of each unrealized loss, the financial condition of the issuer, and the prospects for a change in market or net asset value within a reasonable period of time. We also consider that the contractual cash flow of certain mortgage backed securities are guaranteed by an agency of the United States Government.
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| THREE MONTHS ENDED MARCH 31, |
TWELVE MONTHS ENDED DECEMBER 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2006 | 2005 | 2005 | |||||||||
Balance at beginning of period |
$ | 5,296 | $ | 4,236 | $ | 4,236 | |||||
Provision for credit losses | — | 300 | 1,100 | ||||||||
Charge-offs | (100 | ) | — | (65 | ) | ||||||
| Recoveries | 6 | 8 | 25 | ||||||||
| Net (charge-offs) recoveries | (94 | ) | 8 | (40 | ) | ||||||
Balance at end of period | $ | 5,202 | $ | 4,544 | $ | 5,296 | |||||
Ratio of net charge-offs to | |||||||||||
| average loans outstanding | .02 | % | .00 | % | .01 | % | |||||
Prior to January 1, 2006, the Company accounted for stock option plans under recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost was reflected in net income for previous awards, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
Effective January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment”, which requires measurement of compensation cost for all stock based awards based on the grant date fair value and recognition of compensation cost over the service period of stock based awards. The Company has adopted SFAS No. 123R using the modified prospective method, which provides for no restatement of prior periods and no cumulative adjustment to equity accounts. It also provides for expense recognition for both new and existing unvested stock-based awards. Stock based compensation expense during the three months ended March 31, 2006 was $5,000, ($3,000 net of tax benefit). Future compensation expense for unvested awards outstanding as of March 31, 2006 is estimated to be $32,000 recognized over a weighted average period of 3.5 years. Cash received from the exercise of stock options during the three months ended March 31, 2006 and 2005, respectively, totaled $10,000 and $0.
The fair value of stock options is determined using the Black-Scholes option pricing model, which is consistent with the Company’s methodology previously utilized for options in footnote disclosures. Expected volatilies are based on historical volatility of the Company’s common shares. The expected term of stock options granted will be based on the simplified method, which is the simple average between contractual term and vesting period. The risk-free rate is based on the expected term of stock options and the applicable U.S. Treasury yield in effect at the time of grant. There were no options granted during the quarter ended March 31, 2006. The following assumptions were used for valuing option grants made during the three months ended March 31, 2005: dividend yield – 4.43%, expected life – 10 years, risk-free interest rate – 4.48%, expected volatility – 17.27%. Applying the model, the weighted average grant date fair value of stock options granted during the three months ended March 31, 2005 was $4.52.
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A summary of stock option activity under the stock option plans as of March 31, 2006 and changes during the three months ended March 31, 2006 and 2005, are presented below:
| March 31, 2006 | Shares | Weighted Average Exercise Price |
Weighted Average Remaining Contractual Term ( Years) |
Aggregate Instrinsic Value | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding beginning of period |
687,674 | $ | 13.28 | |||||||||||
| Exercised | (900 | ) | 11.11 | |||||||||||
| Forfeited | — | — | ||||||||||||
| Outstanding end of period | 686,774 | $ | 13.28 | 6.4 | $ | 1,350 | ||||||||
Exercisable end of period | 611,968 | $ | 13.33 | 5.2 | $ | 1,176 | ||||||||
| March 31, 2005 | Shares | Weighted Average Exercise Price |
Weighted Average Remaining Contractual Term ( Years) |
Aggregate Instrinsic Value | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding beginning of period |
619,794 | $ | 12.51 | |||||||||||
| Exercised | 115,500 | 16.25 | ||||||||||||
| Forfeited | (10,000 | ) | 17.13 | |||||||||||
| Outstanding end of period | 725,294 | $ | 13.04 | 7.4 | $ | 2,002 | ||||||||
Exercisable end of period | 329,269 | $ | 10.74 | 7.1 | $ | 1,666 | ||||||||
A summary of the status of the status of the Company's nonvested options as of March 31, 2006 and 2005, and changes during the three months then ended is presented below:
| 2006 Shares |
Weighted Average Fair Value |
2005 Shares |
Weighted Average Fair Value | ||||||
|---|---|---|---|---|---|---|---|---|---|
Non-vested beginning of period |
144,006 | $2.00 | 362,104 | 3.30 | |||||
| Granted | — | — | 115,500 | 4.52 | |||||
| Vested | (69,200 | ) | 1.22 | (71,579 | ) | 1.32 | |||
| Forfeited | — | — | (10,000 | ) | 5.13 | ||||
| Non-vested end of period | 74,806 | $2.72 | 396,025 | $3.96 | |||||
The total intrinsic value of stock options exercised during the three months ended March 31, 2006 was $4,000. There is no instrinsic value for options granted and exercised during the three months ended March 31, 2005 as the shares are anti-dilutive.
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The following table illustrates the effect on net income and earnings per share had the Company applied the fair value recognition provisions of SFAS No. 123R to the prior year’s quarter ended March 31, 2005.
| Net Income, as reported | $ | 1,289,000 | |||
Less total stock-based compensation expense | |||||
| determined under fair value method for all | |||||
| qualifying awards, net of tax | 54,000 | ||||
Pro forma net income | 1,235,000 | ||||
Earnings per share basic - as reported | $ | 0.20 | |||
| Earnings per share basic - pro forma | 0.19 | ||||
| Earnings per share diluted - as reported | 0.20 | ||||
| Earnings per share diluted - pro forma | 0.19 | ||||
The Company has operating segments which have been aggregated into one reporting segment as provided in SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information."
In April 2006, the Company entered into a contract to construct a new branch in the Barkley district of Bellingham, Washington. Construction costs are estimated at $2,000,000.
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This document contains forward-looking statements that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of our management, and on information currently available to them. Forward-looking statements include the information concerning our possible future results of operations set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and statements preceded by, followed by or that include the words “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates” or similar expressions.
Any forward-looking statements in this document are subject to risks relating to, among other things, the following:
1. competitive pressures among depository and other financial institutions may impede our ability to attract and retain borrowers, depositors and other customers, retain key employees, and maintain our interest margins and fee income; |
2. changes in the interest rate environment may reduce margins or decrease the value of our securities; |
3. our growth strategy, particularly if accomplished through acquisitions, may not be successful if we fail to accurately assess market opportunities, asset quality, anticipated cost savings, and transaction costs, or experience significant difficulty integrating acquired businesses or assets; |
4. general economic or business conditions, either nationally or in the regions in which we do business, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; and |
5. a lack of liquidity in the market for our common stock may make it difficult or impossible for you to liquidate your investment in our stock or lead to distortions in the market price of our stock. |
Our management believes the forward-looking statements in this report are reasonable; however, you should not place undue reliance on them. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Many of the factors that will determine our future results and share value are beyond our ability to control or predict. We undertake no obligation to update forward-looking statements.
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Pacific Financial Corporation is a bank holding company headquartered in Aberdeen, Washington. The Company’s wholly-owned subsidiary, The Bank of the Pacific (the “Bank”), is a state chartered bank, also located in Washington. The Company also has one wholly-owned subsidiary trust known as of PFC Statutory Trust I (the “Trust”) that was formed in connection with the issuance of pooled trust preferred securities in December 2005. The Company was incorporated in the State of Washington on February 12, 1997, pursuant to a holding company reorganization of the Bank.
The Company conducts its banking business through the Bank, which operates 17 branches located in communities in Grays Harbor, Pacific, Whatcom, and Wahkiakum counties in the state of Washington and one loan production office in Clatsop County, Oregon. A full service branch located in Anacortes, Washington is expected to open in May 2006. In addition, the Bank has entered into a contract to construct a new branch in the Barkley district of Bellingham, Washington, and the Bank has entered into a deposit transfer and assumption agreement with an Oregon bank that will, subject to regulatory approvals, enable the Bank to establish its first full-service branch in Oregon. The Bank provides loan and deposit services to customers, who are predominantly small and middle-market businesses and middle-income individuals.
Net income. For the three months ended March 31, 2006, Pacific’s net income was $1,590,000 compared to $1,289,000 for the same period in 2005. Increases in net income for the three month period resulted from an increase in net interest income for the period, as described below, and no provision for credit loss in the period, as well as increases in non-interest income arising from greater service charge revenues and gain on sales of loans, as compared to the same period in 2005. These increases were partially offset by increased non-interest expense for the period arising out of greater staffing and benefit expenses, increased professional fees, and increased supplies expense.
Net interest income. Net interest income for the three months ended March 31, 2006 increased $506,000, or 9.87%, compared to the same period in 2005. The increase is primarily related to the increase in interest income as a result of the rise in short-term interest rates and increased balances of interest earning assets. See the table on the following page and discussion thereafter for further information on interest income and expense. The net interest margin (net interest income divided by average earning assets) decreased to 4.99% for March 31, 2006 from 5.05% for the same period last year. The slight decline in net interest margin is due primarily to an increase in cost of funds from 1.89% to 2.78% for the three months ended March 31, 2005 and 2006, respectively. We have, however, been able to maintain a stable net interest margin in part due to our continued focus on variable rate loans and fixed rate loan terms of not longer than three years.
-13-
The following table sets forth information with regard to average balances of the interest earnings assets and interest bearing liabilities and the resultant yields or cost, net interest income, and the net interest margin on a tax equivalent basis. Loans held for sale and non-accrual loans are included in total loans.
Three Months Ended March 31,
| (dollars in thousands) | Average Balance |
2006 Interest Income (Expense) |
Avg Rate |
Average Balance |
2005 Interest Income (Expense) |
Avg Rate |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest Earnings Assets |
|||||||||||||||||||||||
| Loans (1) | $ | 406,300 | $ | 7,708 | * | 7.59 | % | $ | 349,625 | $ | 6,133 | * | 7.02 | % | |||||||||
| Taxable Securities | 20,960 | 202 | 3.85 | 26,407 | 284 | 4.30 | |||||||||||||||||
| Tax-Exempt Securities | 15,862 | 239 | * | 6.04 | 15,779 | 252 | * | 6.38 | |||||||||||||||
| Federal Home Loan Bank Stock | 1,858 | — | — | 1,850 | — | — | |||||||||||||||||
| Interest earnings deposits with banks | 6,570 | 75 | 4.57 | 12,705 | 72 | 2.27 | |||||||||||||||||
Total interest earning assets | $ | 451,550 | $ | 8,224 | 7.29 | % | $ | 406,366 | $ | 6,741 | 6.63 | % | |||||||||||
Cash and due from banks | 11,282 | 8,888 | |||||||||||||||||||||
| Bank premises and equipment (net) | 10,387 | 6,883 | |||||||||||||||||||||
| Other assets | 24,960 | 24,836 | |||||||||||||||||||||
| Allowance for credit losses | (5,296 | ) | (4,369 | ) | |||||||||||||||||||
Total assets | $ | 492,883 | $ | 442,604 | |||||||||||||||||||
Interest Bearing Liabilities | |||||||||||||||||||||||
| Savings and interest bearing demand | $ | 197,769 | $ | (984 | ) | 1.99 | % | $ | 185,829 | $ | (619 | ) | 1.33 | % | |||||||||
| Time deposits | 125,780 | (1,139 | ) | 3.62 | 111,365 | (685 | ) | 2.46 | |||||||||||||||
| Total deposits | 323,549 | (2,123 | ) | 2.62 | 297,194 | (1,304 | ) | 1.76 | |||||||||||||||
Short-term borrowings | 2,898 | (36 | ) | 4.97 | — | — | — | ||||||||||||||||
| Long-term borrowings | 24,500 | (215 | ) | 3.51 | 20,098 | (154 | ) | 3.06 | |||||||||||||||
| Secured borrowings | 2,051 | (39 | ) | 7.61 | 3,655 | (61 | ) | 6.68 | |||||||||||||||
| Junior subordinated debentures | 5,155 | (80 | ) | 6.21 | — | — | — | ||||||||||||||||
| Total borrowings | 34,604 | (370 | ) | 4.28 | 23,753 | (215 | ) | 3.62 | |||||||||||||||
Total interest-bearing liabilities | $ | 358,153 | $ | (2,493 | ) | 2.78 | % | $ | 320,947 | $ | (1,519 | ) | 1.89 | % | |||||||||
| Demand deposits | 82,834 | 73,698 | |||||||||||||||||||||
| Other liabilities | 4,570 | 3,129 | |||||||||||||||||||||
| Shareholders' equity | 47,326 | 44,830 | |||||||||||||||||||||
Total liabilities and shareholders' equity | $ | 492,883 | $ | 442,604 | |||||||||||||||||||
Net interest income | $ | 5,731 | * | $ | 5,222 | * | |||||||||||||||||
Net interest spread | 5.08 | % | 5.14 | % | |||||||||||||||||||
| Net interest margin | 4.99 | % | 5.05 | % | |||||||||||||||||||
(1) Interest income on loans include loan fees of $278,000, and $521,000 in 2006 and 2005, respectively.
Interest and dividend income for the three months ended March 31, 2006, increased $1,480,000, or 22.3%, compared to the same period in 2005. Loans averaged $406.3 million with an average yield of 7.59% for the three months ended March 31, 2006 compared to average loans of $349.6 million with an average yield of 7.02% for the same period in 2005. The Company experienced significant loan growth during the year ended December 31, 2005, with a slight reduction in loans during the current period.
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Interest expense for the three months ended March 31, 2006 increased $974,000, or 64.1%, compared to the same periods in 2005. The increase is primarily attributable to increased deposit balances and rates paid on certain deposits, as well as expense related to Pacific’s junior subordinated debentures and higher interest rates. Average interest-bearing deposit balances for the three months ended March 31, 2006 and March 31, 2005 were $323,549,000 and $297,194,000, respectively, with an average cost of 2.62% and 1.76%, respectively.
Average secured borrowings for the three months ended March 31, 2006 and March 31, 2005 were $2,051,000 and $3,655,000, respectively. The secured borrowings represent borrowings collateralized by participation interests in loans originated by the Company. These borrowings are repaid as payments are made on the underlying loans, bearing interest rates ranging from 6.5% to 8.5%. Average long and short term borrowings for the three months ended March 31, 2006 were $27,398,000 with an average cost of 3.66% compared to $20,098,000 with an average cost of 3.06% for the same period in 2005.
Provision and allowance for credit losses. The allowance for credit losses reflects management’s current estimate of the amount required to absorb losses on existing loans and commitments to extend credit. Loans deemed uncollectible are charged against and reduce the allowance. Periodically, a provision for credit losses is charged to current expense. This provision acts to replenish the allowance for credit losses and to maintain the allowance at a level that management deems adequate.
There is no precise method of predicting specific credit losses or amounts that ultimately may be charged off on segments of the loan portfolio. The determination that a loan may become uncollectible, in whole or in part, is a matter of judgment. Similarly, the adequacy of the allowance for credit losses can be determined only on a judgmental basis, after full review, including (a) consideration of economic conditions and the effect on particular industries and specific borrowers; (b) a review of borrowers’ financial data, together with industry data, the competitive situation, the borrowers’ management capabilities and other factors; (c) a continuing evaluation of the loan portfolio, including monitoring by lending officers and staff credit personnel of all loans which are identified as being of less than acceptable quality; (d) an in-depth appraisal, on a monthly basis, of all loans judged to present a possibility of loss (if, as a result of such monthly appraisals, the loan is judged to be not fully collectible, the carrying value of the loan is reduced to that portion considered collectible); and (e) an evaluation of the underlying collateral for secured lending, including the use of independent appraisals of real estate properties securing loans. A formal analysis of the adequacy of the allowance is conducted quarterly and is reviewed by the Board of Directors. Based on this analysis, management considers the allowance for credit losses to be adequate at March 31, 2006.
Periodic provisions for credit losses are made to maintain the allowance for credit losses at an appropriate level. The provisions are based on an analysis of various factors including historical loss experience based on volumes and types of loans, volumes and trends in delinquencies and non-accrual loans, trends in portfolio volume, results of internal and independent external credit reviews, and anticipated economic conditions. For additional information, please see the discussion under the heading “Critical Accounting Policy” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2005.
During the three months ended March 31, 2006, no loan loss provision was provided for possible credit losses, compared to $300,000 for the same period in 2005. For the three months ended March 31, 2006, net charge-offs were $94,000 compared to $8,000 of net recoveries for the same period in 2005.
At March 31, 2006, the allowance for credit losses stood at $5,202,000 compared to $5,296,000 at December 31, 2005, and $4,544,000 at March 31, 2005. The increase over March 31, 2005 was attributable to the additions in loan loss provision that was allocated to the allowance for credit losses as a result of continued growth in the loan portfolio during 2005. The slight decrease in 2006 is related
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primarily to one charge-off amount totaling $100,000. The ratio of the allowance to total loans outstanding including loans held for sale was 1.29%, 1.29% and 1.30%, respectively, at March 31, 2006, December 31, 2005, and March 31, 2005.
Non-performing assets and foreclosed real estate owned. Non-performing assets totaled $6,406,000 at March 31, 2006. This represents 1.59% of total loans including loans held for sale, compared to $6,769,000 or 1.66% at December 31, 2005, and $7,746,000 or 2.22% at March 31, 2005. Non-accrual loans at March 31, 2006 totaled $6,324,000. This relates primarily to one borrower involved in the forest products industry. Although the borrower is continuing operations and making principle and interest payments as agreed, the deteriorating financial condition of the borrower creates the potential the Company may not be able to collect all principal and interest according to the terms of the loan. Of the non-accrual loans outstanding, $3,484,000 are guaranteed by the United States Department of Agriculture representing 55.09% of non-accrual loans outstanding. Based on current analysis, management has made provisions in the loan loss reserves for potential losses associated with non-accrual loans. Foreclosed real estate consists of two properties secured by real estate with no individual material balances.
ANALYSIS OF NON-PERFORMING ASSETS
| (in thousands) | MARCH 31, 2006 |
DECEMBER 31, 2005 |
MARCH 31, 2005 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Accruing loans past due 90 days or more |
$ | 45 | $ | 82 | $ | 6 | |||||
Non-accrual loans | 6,324 | 6,650 | 7,706 | ||||||||
Foreclosed real estate | 37 | 37 | 40 | ||||||||
TOTAL | $ | 6,406 | $ | 6,769 | $ | 7,752 | |||||
Non-interest income and expense. Non-interest income for the three months ended March 31, 2006 increased $60,000 compared to the same period in 2005. The primary reason for the increase was gain on sale of loans. Gain on sale of loans totaled $380,000 and $279,000, respectively, for the three months ended March 31, 2006 and 2005. This increase is attributable to increased pricing of loans sold in the secondary market over the prior year. Commitment to sell and sale price is established at the time of origination of loans to limit any potential price risk. Management expects flat growth in mortgage banking activity for the remainder of the year. Additionally, during the three months ended March 31, 2005, the Company recognized a one-time gain on sale of fixed assets totaling $80,000.
Non-interest expense for the three months ended March 31, 2006 increased $435,000 compared to the same period in 2005. Increased staffing, benefits and professional fees were the major contributing factors to increased non-interest expense, as well as other operating expenses incurred in the opening of the Raymond, Washington branch in January 2006. Full time equivalent employees at March 31, 2006 were 185 compared to 163 at March 31, 2005.
Income taxes. The federal income tax provision for the three months ended March 31, 2006 was $675,000, an increase of $130,000 compared to the same period in 2005. The effective tax rate for the three months ended March 31, 2006 was 29.8%.
Financial Condition
Assets. Total assets were $502,144,000 at March 31, 2006, an increase of $12,735,000, or 2.6%, over year-end 2005. Loans, including loans held for sale, were $403,859,000 at March 31, 2006, a decrease of
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$5,122,000, or 1.25%, over year-end 2005. The decrease in the portfolio was primarily a result of two significant payoffs in commercial real estate loans. Total deposits were $418,478,000 at March 31, 2006, an increase of $18,752,000, or 4.7%, compared to December 31, 2005. The $18,752,000 increase is comprised of a $4,862,000 decrease in non-interest bearing accounts, $3,420,000 increase in NOW accounts, $8,893,000 increase in money market accounts, $79,000 increase in savings accounts and a $11,222,000 increase in certificates of deposits.
Loans. Loan detail by category, including loans held for sale, as of March 31, 2006 and December 31, 2005 follows:
| March 31, 2006 |
December 31, 2005 | |||||||
|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 113,034 | $ | 101,327 | ||||
| Agricultural | 24,497 | 25,359 | ||||||
| Real estate mortgage | 175,736 | 183,353 | ||||||
| Real estate construction | 78,240 | 87,621 | ||||||
| Installment | 9,283 | 8,487 | ||||||
| Credit cards and other | 3,069 | 2,834 | ||||||
| Total Loans | 403,859 | 408,981 | ||||||
| Allowance for credit losses | (5,202 | ) | (5,296 | ) | ||||
| Net Loans | $ | 398,657 | $ | 403,685 | ||||
Liquidity. Adequate liquidity is available to accommodate fluctuations in deposit levels, fund operations, and provide for customer credit needs and meet obligations and commitments on a timely basis. The Bank’s primary sources of funds are customer deposits, maturities of investment securities, sales of securities available for sale, loan sales, loan repayments, net income and other borrowings. When necessary, liquidity can be increased by taking advances available from the Federal Home Loan Bank of Seattle. The Bank maintains credit facilities with correspondent banks totaling $37,000,000, none of which were used at March 31, 2006. In addition, the Bank has a credit line with the Federal Home Loan Bank of Seattle for up to 20% of assets, $24,500,000 of which was used at March 31, 2006. For its funds, the Company relies on dividends from the Bank, proceeds from the exercise of stock options, and proceeds from the issuance of trust preferred securities, all of which are used for various corporate purposes.
Capital. Total shareholders’ equity was $48,360,000 at March 31, 2006, an increase of $1,760,000, or 3.8%, compared to December 31, 2005. Tangible book value per share was $5.61 at March 31, 2006 compared to $5.35 at December 31, 2005. Tangible book value is calculated by dividing total equity capital minus goodwill and other intangibles, by total shares outstanding.
The Federal Reserve and the Federal Deposit Insurance Commission have established minimum guidelines that mandate risk-based capital requirements for bank holding companies and member banks. Under the guidelines, risk percentages are assigned to various categories of assets and off-balance sheet items to calculate a risk-adjusted capital ratio. Regulatory minimum risk-based capital guidelines require Tier 1 capital to risk-weighted assets of 4% and total capital to risk-weighted assets of 8%. The Company’s Tier 1 and Total Risk Based Capital ratios were 10.03% and 11.28%, respectively, at March 31, 2006 compared with 9.44% and 10.69%, respectively at December 31, 2005.
Additionally, to qualify as “well-capitalized”, the Bank must have a Tier 1 risk based capital ratio of at least 6%, total risk based capital of at least 10%, and a leverage ratio of a least 5%. The Bank qualified as “well-capitalized” at March 31, 2006.
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Interest rate, credit, and operations risks are the most significant market risks which affect the Company’s performance. The Company relies on loan review, prudent loan underwriting standards and an adequate allowance for possible credit losses to mitigate credit risk.
An asset/liability management simulation model is used to measure interest rate risk. The model produces regulatory oriented measurements of interest rate risk exposure. The model quantifies interest rate risk by simulating forecasted net interest income over a 12-month time period under various interest rate scenarios, as well as monitoring the change in the present value of equity under the same rate scenarios. The present value of equity is defined as the difference between the market value of assets less current liabilities. By measuring the change in the present value of equity under various rate scenarios, management is able to identify interest rate risk that may not be evident from changes in forecasted net interest income.
The Company is currently asset sensitive, meaning that interest earning assets mature or re-price more quickly than interest-bearing liabilities in a given period. Therefore, a significant increase in market rates of interest could improve net interest income. Conversely, a decreasing rate environment may adversely affect net interest income.
It should be noted that the simulation model does not take into account future management actions that could be undertaken should actual market rates change during the year. Also, the model simulation results are not exact measures of the Company’s actual interest rate risk. They are rather only indicators of rate risk exposure, based on assumptions produced in a simplified modeling environment designed to heighten sensitivity to changes in interest rates. The rate risk exposure results of the simulation model typically are greater than the Company’s actual rate risk. That is due to the conservative modeling environment, which generally depicts a worst-case situation. Management has assessed the results of the simulation reports as of March 31, 2006, and believes that there has been no material change since December 31, 2005.
The Company’s disclosure controls and procedures are designed to ensure that information the Company must disclose in its reports filed or submitted under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized, and reported on a timely basis. Our management has evaluated, with the participation and under the supervision of our chief executive officer (CEO) and chief financial officer (CFO), the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our CEO and CFO have concluded that, as of such date, the Company’s disclosure controls and procedures are effective in ensuring that information relating to the Company, including its consolidated subsidiaries, required to be disclosed in reports that it files under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosures.
No change in the Company’s internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Pacific held its Annual Meeting of Shareholders on April 19, 2006, at which the shareholders of the Company voted on the election of five Class A directors (Edwin Ketel, Dennis A. Long, Joseph A. Malik, Randy Rust, Robert J. Worrell) for a three year term.
The voting with respect to the election of directors was as follows:
| NAME | FOR | WITHHELD | ||||||
|---|---|---|---|---|---|---|---|---|
Edwin Ketel |
3,628,430 | 24,410 | ||||||
| Dennis A. Long | 3,647,750 | 5,090 | ||||||
| Joseph A. Malik | 3,509,860 | 142,980 | ||||||
| Randy Rust | 3,628,430 | 24,410 | ||||||
| Robert J. Worrell | 3,440,800 | 212,040 | ||||||
See Exhibit Index immediately following signatures below.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PACIFIC FINANCIAL CORPORATION | |
DATED: May 9, 2006 |
By: /s/ Dennis A. Long Dennis A. Long Chief Executive Officer |
By: /s/ Denise Portmann Denise Portmann Chief Financial Officer | |
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EXHIBIT INDEX
| EXHIBIT NO. | EXHIBIT |
10.1 |
Employment Agreement dated December 20, 2005, between the registrant and Philippe S. Swaab.* |
| 31.1 | Certification of CEO under Rule 13a - 14(a) of the Exchange Act. |
| 31.2 | Certification of CFO under Rule 13a - 14(a) of the Exchange Act. |
| 32 | Certification of CEO and CFO under 18 U.S.C. Section 1350. |
*Mr. Swaab was named an Executive Vice President of the registrant at the annual meeting of directors of the Company on April 19, 2006.
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