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Pacific Financial Corp Earns Record $11.3 Million, or $1.06 per Share, for Full Year of 2018; Net Income Grew to $3.2 Million, or $0.30 per Share, for 4Q18

Company Release - 1/24/2019 9:00 AM ET

ABERDEEN, Wash., Jan. 24, 2019 (GLOBE NEWSWIRE) -- Pacific Financial Corporation (OTCQB: PFLC), the holding company for Bank of the Pacific, today reported net income of $11.3 million, or $1.06 per diluted share, for the year ended December 31, 2018, compared to $7.0 million, or $0.65 per diluted share, for the year ended December 31, 2017. Net income was $3.2 million, or $0.30 per diluted share, for the fourth quarter of 2018, compared to $3.2 million, or $0.30 per diluted share for the third quarter of 2018, and $1.4 million, or $0.13 per diluted share, for the fourth quarter of 2017. Earnings for 2017 were impacted by a write-down of its deferred tax asset resulting in an additional tax expense of $1.0 million for the fourth quarter. This was due to the passage of the Tax Cuts and Jobs Act of 2017, which lowered the corporate tax rate to 21% from 34%.

“We generated record profits for the fourth quarter and full year of 2018, highlighted by an expanded net interest margin of 4.58%, improved yields across all asset classes, and year-over-year solid core deposit growth with minimal increases in cost of funds,” said Denise Portmann, President & Chief Executive Officer. “Income before taxes increased 1% from the preceding quarter, 13% from the year ago quarter and 21% from the prior twelve months. Balance sheet mix and deposit pricing strategies contributed to growth in net interest income during the upsurge in interest rates initiated by the Federal Reserve throughout 2018. In addition, we continue to benefit from initiatives introduced over the past year which have enhanced workflow efficiencies and improved revenue and cost management.

“Credit quality remains solid, aided by continued low levels of adversely classified and nonperforming loans. Our risk management protocols guide the growth of our loan portfolio as we carefully monitor loan concentrations to stay within regulatory guidelines, particularly in commercial real estate. As a result, no provision for loan losses was booked throughout the year,” added Portmann. The contribution of residential mortgage lending to noninterest income was down 9%, 8% and 20% from the linked quarter, year-over-year quarter and prior year, respectively. Rising interest rates and housing prices, as well as tight housing supply are dampening home financing activities within our markets. Correspondingly, we continue to manage our staffing levels in this line of business. 

“The recently announced closures of the two branch locations in Naselle, WA and Warrenton, OR, are proceeding according to plan,” said Portmann. “Optimizing our branch network in light of increasing use of technology-based banking services plays a significant role in allocating capital resources. Resources are being redeployed to augment our technology-based product offerings, enhance our network infrastructure and strengthen our marketing data analytics.”

2018 Financial Highlights (as of, or for the period ended December 31, 2018, except as noted):

 • Diluted earnings per share (“EPS”) was $0.30 for the fourth quarter of 2018, compared to $0.30 for the third quarter of 2018, and $0.13 for the fourth quarter of 2017. Diluted EPS was $1.06 for 2018, compared to $0.65 per diluted EPS for 2017.

 • 
Income before tax increased 1% to $4.0 million, compared to $3.9 million for the third quarter of 2018 and increased 13% compared to $3.5 million for the fourth quarter of 2017. Income before tax increased 21% to $13.7 million compared to $11.3 million for the prior twelve months.

 • 
Return on average assets (“ROAA”) increased to 1.39% and return on average equity (“ROAE”) was 13.76%, compared to 1.38% and 13.89%, respectively, for the third quarter of 2018, and 0.60% and 6.09%, respectively, for the fourth quarter of 2017. ROAA was 1.26% and ROAE was 12.63% for 2018, compared to 0.79% and 8.19%, respectively, for the year ended December 31, 2017. Industry peer ROAA was 1.04% and ROAE was 10.38% at September 30, 2018. [Industry peers comprise of 409 banks in the SNL Microcap U.S. Bank Index.]

 • 
Net interest income increased 2% to $9.8 million, compared to $9.7 million for the third quarter of 2018 and increased 10% compared to $8.9 million for the fourth quarter of 2017. Net interest income increased 10% to $37.5 million for the year, from $34.0 million for 2017.

 • 
Net interest margin, on a tax equivalent basis (“NIMTE”), expanded 3 basis points to 4.58%, compared to 4.55% in the preceding quarter and improved 26 basis points from 4.32% for the fourth quarter of 2017. NIMTE expanded 24 basis points to 4.52% for the year ended 2018, compared to 4.28% for 2017, reflecting improving yields on interest earning assets and slower growth in cost of funds. Industry peer NIM was 3.75%. [Industry peers are the 409 banks that comprised the SNL Microcap U.S. Bank Index, at September 2018.]

 • 
Gross loans grew to $704.1 million versus $693.1 million, at September 30, 2018, and $688.4 million at December 31, 2017.

 • 
Total deposits were $783.5 million, compared to $815.2 million at September 30, 2018, and $777.2 million at December 31, 2017. Non-interest-bearing deposits comprise 31% of total deposits.

 • 
Asset quality remains solid: 

  
  • Loans 30 – 89 days delinquent, still on accrual status, were minimal at 0.36% of gross loans outstanding. 
  • Net charge-offs totaled $18,000, or 0.01% of average gross loans in the fourth quarter of 2018, compared to $76,000, or 0.04% of average gross loans, in the third quarter of 2018 and $120,000, or 0.07% of average gross loans, in the fourth quarter of 2017. 
  • Nonperforming assets were $700,000, or 0.08% of total assets, compared to $746,000, or 0.08% of total assets at September 30, 2018, and $2.2 million, or 0.25% of total assets at December 31, 2017. 
  • Adversely classified loans were $7.8 million, or 1.10% of gross loans, versus $7.8 million, or 1.12% of gross loans, at September 30, 2018, and $7.5 million, or 1.10% of gross loans, at December 31, 2017. 
  • No provision for loan losses was incurred in 2018 versus $272,000 in 2017. 
  • The allowance for loan losses to gross loans declined to 1.29% at December 30, 2018 compared to 1.31% at September 30, 2018, and 1.32% at December 31, 2017.
 • 
The Company’s consolidated capital ratios and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under current regulatory requirements.

Operating Results Overview

Total assets declined from the third quarter, mostly due to seasonal deposit outflows, which are typical of tourism markets in coastal Washington and Oregon. Deposits grew slightly year-over-year despite the withdrawal of $12.0 million in deposits in the second quarter associated with a relationship the Bank declined to offer a credit facility. Loans increased modestly year-over-year despite the payoff of several large non-owner occupied commercial real estate loans and the seasonal reduction in commercial lines of credit balances. Total assets were up slightly year-over-year, primarily due to the increase in loans and investment securities funded by redeployment of cash equivalents, growth in deposits and retained earnings. Liquidity remains strong, including 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,  2018 Sept 30,  2018 $  Change %  Change Dec 31,  2017 $ Change
 % Change
Assets:(Dollars in thousands, except per share data)
Cash and cash equivalents$22,188 $80,121 $(57,933) -72%$34,571 $(12,383) -36 
 
Other interest earning deposits3,250  994  2,256  227% 994  2,256  227
Investment securities122,610  104,343  18,267  18% 110,767  11,843  11
Loans held-for-sale6,204  7,745  (1,541) -20% 10,886  (4,682) -43
Loans, net of deferred fees703,103  692,092  11,011  2% 687,319  15,784  2
Allowance for loan losses(9,049) (9,067) 18  0% (9,092) 43  0
Net loans694,054  683,025  11,029  2% 678,227  15,827  2
Federal Home Loan Bank and Pacific Coast Bankers' Bank stock, at cost2,407  2,409  (2) 0% 2,409  (2) 0
Other assets57,216  58,455  (1,239) -2% 57,099  117  0
Total assets$907,929 $937,092 $(29,163) -3%$894,953 $12,976  1
                     
Liabilities and Shareholders' Equity:                    
Total deposits$783,549 $815,153 $(31,604) -4%$777,225 $6,324  1
Borrowings21,756  21,794  (38) 0% 21,906  (150) -1
Accrued interest payable and other liabilities10,141  8,806  1,335  15% 10,791  (650) -6
Shareholders' equity92,483  91,339  1,144  1% 85,031  7,452  9
Total liabilities and shareholders' equity$907,929 $937,092 $(29,163) -3%$894,953 $12,976  1
                     
Common Stock Shares Outstanding10,568,720  10,565,034  3,686  0% 10,491,892  76,828  1
                     
Book value per common share (1)$8.75 $8.65 $0.10  1%$8.10 $0.65  8
Tangible book value per common share (2)$7.47 $7.37 $0.10  1%$6.82 $0.65  10
Gross loans to deposits ratio89.7% 84.9% 4.8%    88.4% 1.3%   
                     
(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 prior three months, largely due to an increase in earning asset (primarily loan) yields, which outpaced growth in funding costs as a result of the recent rise in interest rates. Similarly, net interest income increased from the fourth quarter a year ago and from the prior year period, primarily as a result of the increase in earning assets and the impact of rising interest rates on earning asset yields.

Interest expense increased from the third quarter of 2018 and the like quarter a year ago, due to rate increases in non-maturity deposits, LIBOR-based junior subordinated debentures and public funds during the periods. This was partially offset by non-renewal of higher-cost brokered certificates of deposit. Interest expense increased for the year ended December 31, 2018, compared to 2017 for similar reasons.  

Pre-tax, pre-credit operating income (non-GAAP) for the fourth quarter of 2018 increased from the preceding quarter, primarily due to growth in net interest income, despite a decrease in gain on sale of real estate. Noninterest income for the year ended December 31, 2018 was down versus the full year of 2017. This was primarily due to the decline in gain on sale of real estate loans cited above, and one-time revenue of $340,000 earned from the sale of commercial loans and monetized fees from pricing of loans over the swap curve in the second quarter of 2017. This was partially mitigated by increases in deposit service charges and related fee income in the current period. 

Noninterest expense declined from the preceding quarter chiefly from reductions in compensation costs and state and local tax expense, the latter due to a $150,000 refund of state revenue taxes from a reconciliation of apportionable income in prior years. Gain on sale of real estate loans was down as compared to the prior periods, reflecting rising interest rates and tight housing supply that have impacted mortgage loan production. “December 2018 MLS data revealed inventory in our Western Washington and Oregon markets dipped below two months of supply for the first time since July. A year-over-year comparison of the number of new listings, pending sales, and closed sales show drops overall, while prices rose from the same month a year ago”, commented Portmann.

Income Statement Overview
(Unaudited)
                       
    For the Three Months Ended,  
   Dec 31,  2018
 Sept 30,  2018
 $  Change
 %  Change
 Dec 31,  2017
 $ Change
 % Change
    (Dollars in thousands, except per share data)  
Interest and dividend income$10,519 $10,337 $182  2%$9,495 $1,024  11%
Interest expense 700  686  14  2% 593  107  18%
 Net interest income 9,819  9,651  168  2% 8,902  917  10%
Loan loss provision -  -  -  0% -  -  0%
Noninterest income 2,409  2,648  (239) -9% 2,625  (216) -8%
Noninterest expense 8,264  8,392  (128) -2% 8,013  251  3%
Income before income taxes 3,964  3,907  57  1% 3,514  450  13%
Income tax expense 719  724  (5) -1% 2,156  (1,437) -67%
 Net Income$3,245 $3,183 $62  2%$1,358 $1,887  139%
                       
Average common shares outstanding - basic  10,565,595  10,563,104  2,491  0% 10,482,545  83,050  1%
Average common shares outstanding - diluted 10,673,908  10,685,274  (11,366) 0% 10,661,422  12,486  0%
                       
Income per common share                     
 Basic$0.31 $0.30 $0.01  3%$0.13 $0.18  138%
 Diluted$0.30 $0.30 $-  0%$0.13 $0.17  131%
                       
Effective tax rate 18.1% 18.5% -0.4%    61.4% -43.3%   



    For the Year Ended,
   Dec 31,  2018  Dec 31,  2017  $  Change  %  Change 
    (Dollars in thousands, except per share data)   
Interest and dividend income$40,060 $36,445 $3,615  10%
Interest expense 2,590  2,396  194  8%
 Net interest income 37,470  34,049  3,421  10%
Loan loss provision -  272  (272) -100%
Noninterest income 10,031  10,523  (492) -5%
Noninterest expense 33,793  32,976  817  2%
Income before income taxes 13,708  11,324  2,384  21%
Income tax expense 2,378  4,361  (1,983) -45%
 Net Income$11,330 $6,963 $4,367  63%
              
Average common shares outstanding - basic  10,551,174  10,452,014  99,160  1%
Average common shares outstanding - diluted 10,673,393  10,647,279  26,114  0%
              
Income per common share            
 Basic$1.07 $0.67 $0.40  60%
 Diluted$1.06 $0.65 $0.41  63%
              
Effective tax rate 17.3% 38.5% -21.2%   


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, 
   Dec 31,  2018 Sept 30,  2018 $  Change %  Change Dec 31,  2017 $ Change % Change
Non-GAAP Operating Income  (Dollars in thousands) 
Net Income$3,245$3,183$62 2%$1,358$1,887 139%
 Loan loss provision - - - 0% - - 0%
 Loss on real estate owned, net - - - 0% - - 0%
 Income tax expense 719 724 (5) -1% 2,156 (1,437) -67%
Pre-tax, pre-credit operating income$3,964$3,907$57 1%$3,514$450 13%
                
                
                
    For the Year Ended,       
   Dec 31,  2018 Dec 31,  2017 $  Change %  Change      
Non-GAAP Operating Income  (Dollars in thousands)       
Net Income$11,330$6,963$4,367 63%      
 Loan loss provision - 272 (272) -100%      
 Loss on real estate owned, net - 34 (34) -100%      
 Income tax expense 2,378 4,361 (1,983) -45%      
Pre-tax, pre-credit operating income$13,708$11,630$2,078 18%      


Noninterest Income

Noninterest income in the fourth quarter of 2018 declined compared to the linked quarter and the year-over-year quarter, primarily due a decrease in revenue from sale of residential mortgage loans versus the prior period. Similarly, for 2018, noninterest income declined versus 2017, primarily due to factors related to the decline in demand for residential mortgages for the reasons commented below. Deposit service charges and other related fees were increased earlier in the current year consistent with product pricing in the market, resulting in increases in revenue from these sources year-over-year. “Recent increases in mortgage rates have moderated demand for refinancing. Demand for purchase financing has slowed as the increase in mortgage rates are beginning to price some prospective purchasers out of the market. Supply constraints from increased governmental regulations governing real estate development over the past several years, and resulting increases in housing prices, have also contributed to the recent dampened mortgage financing activity,” Portmann noted.

Noninterest Income
(Unaudited)
   Dec 31,  2018 Sept 30,  2018 $  Change %  Change Dec 31,  2017 $ Change % Change
   (Dollars in thousands)
Service charges on deposits$507$504$3 1%$474$33 7%
Gain on sale of loans, net 941 1,155 (214) -19% 1,406 (465) -33%
Gain on sale of securities available for sale, net - - - 0% (70) 70 -100%
Earnings on bank owned life insurance 111 108 3 3% 109 2 2%
Other noninterest income              
 Fee income 811 871 (60) -7% 661 150 23%
 Other 39 10 29 290% 45 (6) -13%
Total noninterest income$2,409$2,648$(239) -9%$2,625$(216) -8%
                
                
   For the Year Ended,       
   Dec 31,  2018 Dec 31,  2017 $  Change %  Change      
   (Dollars in thousands)      
Service charges on deposits$2,034$1,856$178 10%      
Gain on sale of loans, net 4,103 5,303 (1,200) -23%      
Gain on sale of securities available for sale, net - 9 (9) -100%      
Earnings on bank owned life insurance 432 440 (8) -2%      
Other noninterest income              
 Fee income 3,331 2,575 756 29%      
 Other 131 340 (209) -61%      
Total noninterest income$10,031$10,523$(492) -5%      


Noninterest Expense

Noninterest expenses declined from the preceding quarter chiefly from reductions in compensation costs and state and local tax expense, the latter due to a $150,000 refund of state revenue taxes from a reconciliation of apportionable income for in prior years. This was partially offset by a one-time increase of $62,000 in occupancy expense due to a write-down in book value of a building to be donated to a rural hospital district in our marketplace. Noninterest expenses grew compared to the year-over-year quarter, mainly due to data processing and software expense incurred as a result of continued introduction of technology solutions to augment cyber-security and enhance productivity. 

Noninterest expenses for 2018 increased compared to 2017, primarily due to the addition of commercial banking production personnel in higher growth markets and an increase in bonus accrual expense. In addition, technology and software amortization expense increased to support the technology initiatives mentioned above. These increases were offset by a decline in $547,000 in professional fees paid to a firm providing process improvement consulting in the prior year.

Noninterest Expense
(Unaudited)
                     
   For the Three Months Ended,     
   Dec 31,
2018
 Sept 30,  2018 $  Change %  Change Dec 31,  2017 $ Change % Change
   (Dollars in thousands)     
Salaries and employee benefits$5,186 $5,328$(142) -3%$5,181$5  0%
Occupancy 606  524 82  16% 498 108  22%
Equipment 246  255 (9) -4% 262 (16) -6%
Data processing 740  726 14  2% 575 165  29%
Professional services 193  173 20  12% 137 56  41%
State and local taxes (15) 131 (146) -111% 123 (138) -112%
FDIC and State assessments 73  84 (11) -13% 120 (47) -39%
Other noninterest expense:                   
 Director fees 67  65 2  3% 71 (4) -6%
 Communication 74  73 1  1% 70 4  6%
 Advertising 95  82 13  16% 80 15  19%
 Professional liability insurance 51  49 2  4% 43 8  19%
 Amortization 88  92 (4) -4% 86 2  2%
 Other 860  810 50  6% 767 93  12%
Total noninterest expense$8,264 $8,392$(128) -2%$8,013$251  3%

 

   For the Year Ended, 
   Dec 31,  2018 Dec 31,  2017 $
Change
  %
Change
 
   (Dollars in thousands)  
Salaries and employee benefits$21,265$20,565$700  3%
Occupancy 2,207 2,019 188  9%
Equipment 1,087 1,100 (13) -1%
Data processing 2,862 2,297 565  25%
Professional services 756 1,270 (514) -40%
Other real estate owned write-downs - 47 (47) -100%
Other real estate owned operating costs 6 62 (56) -90%
State and local taxes 360 588 (228) -39%
FDIC and State assessments 393 462 (69) -15%
Other noninterest expense:          
 Director fees 264 269 (5) -2%
 Communication 303 269 34  13%
 Advertising 341 323 18  6%
 Professional liability insurance 193 185 8  4%
 Amortization 374 86 288  335%
 Loss on real estate owned, net - 34 (34) -100%
 Other 3,382 3,400 (18) -1%
Total noninterest expense$33,793$32,976$817  2%

Income Tax Provision

For the fourth quarter of 2018, Pacific Financial recorded $719,000 in income tax expense with an effective tax rate of 18.1%. The amount included a $78,000 refund due to a refreshed cost segregation analysis performed on premises constructed during a prior period. For the third quarter of 2018, tax expense was $724,000 with an effective tax rate of 18.5%, reflecting the new lower federal corporate rate. For the fourth quarter of 2017, tax expense was $2.2 million, which included a $1.0 million write-down of its deferred tax asset. Similarly, tax expense for the year ended December 31, 2018, was $2.4 million versus $4.4 million for 2017. In addition to the lower federal tax rates for the current period, resulting from the Tax Cuts and Jobs Act enacted on December 22, 2017, Pacific Financial also pays Oregon corporate income tax on profits and Washington Business and Occupation tax on revenues.

Financial Performance Overview
(Unaudited)
               
 For the Three Months Ended
 Dec 31,  2018 Sept 30,  2018 Change Dec 31,  2017 Change
Performance Ratios              
Return on average assets, annualized1.39% 1.38%   0.01  0.60%   0.79 
Return on average equity, annualized13.76% 13.89%   (0.13) 6.09%   7.67 
Efficiency ratio (1)67.58% 68.23%   (0.65) 69.52%   (1.94)
               
(1) Non-interest expense divided by net interest income plus noninterest income.          
               
               
 For the Year Ended,      
 Dec 31,  2018 Dec 31,  2017 Change      
Performance Ratios              
Return on average assets, annualized1.26% 0.79%   0.47       
Return on average equity, annualized12.63% 8.19%   4.44       
Efficiency ratio (1)71.14% 73.98%   (2.84)      
               
(1) Non-interest expense divided by net interest income plus noninterest income.          

 


LIQUIDITY

Cash and Cash Equivalents and Investment Securities
(Unaudited)
    Dec 31,  2018  % of Total  Sept 30,  2018  % of Total  $  Change  %  Change  Dec 31,  2017  Total  $  Change  %  Change 
    (Dollars in thousands)       
Cash on hand and in banks$15,899 11%$14,767 8%$1,132  8%$14,667 9%$1,232  8%
Interest bearing deposits 6,289 4% 65,354 35% (59,065) -90% 19,904 14% (13,615) -68%
Other interest earning deposits 3,250 2% 994 1% 2,256  227% 994 1% 2,256  227%
 Total cash equivalents and interest earning deposits 25,438 17% 81,115 44% (55,677) -69% 35,565 24% (10,127) -28%
                              
Investment securities:                           
 Collateralized mortgage obligations: agency issued 40,247 27% 35,789 19% 4,458  12% 39,719 27% 528  1%
 Collateralized mortgage obligations: non-agency  176 0% 191 0% (15) -8% 257 0% (81) -32%
 Mortgage-backed securities: agency issued 22,393 15% 14,190 8% 8,203  58% 15,775 11% 6,618  42%
 U.S. Government and agency securities 4,185 3% 4,193 2% (8) 0% 2,483 2% 1,702  69%
 Corporate bonds 959 1% - 0% 959  100% - 0% 959  100%
 State and municipal securities 54,650 37% 49,980 27% 4,670  9% 52,533 36% 2,117  4%
  Total investment securities 122,610 83% 104,343 56% 18,267  18% 110,767 76% 11,843  11%
Total cash equivalents and investment securities$148,048 100%$185,458 100%$(37,410) -20%$146,332 100%$1,716  1%
                              
Total cash equivalents and investment securities                           
 as a percent of total assets   16%   20%         19%      


“Liquidity remains strong based on existing levels of combined cash equivalents, investment securities and unused borrowing capacity. Seasonal outflows typical for this time of year impacted total deposits during the quarter,” 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 3.8 years at December 31, 2018; 4.0 years at September 30, 2018, and 4.0 years at December 31, 2017.

The Bank had $8.4 million in outstanding borrowings against its $195.0 million in established borrowing capacity with the Federal Home Loan Bank of Des Moines (FHLB) at December 31, 2018. The Bank had $8.4 million and $8.5 million in outstanding borrowings with the FHLB at September 30, 2018, and December 31, 2017, 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)
                                 
    Dec 31,  2018 % of Gross Loans Sept 30,  2018 % of Gross Loans $  Change  %  Change  Dec 31,  2017 % of Gross Loans $  Change  %  Change 
    (Dollars in thousands)          
 Commercial and agricultural$140,167  20%$135,204  20%$4,963  4%$138,629  21%$1,538  1%
 Real estate:                              
 Construction and development 47,291  7% 49,697  7% (2,406) -5% 62,980  9% (15,689) -25%
 Residential 1-4 family 89,091  13% 90,394  13% (1,303) -1% 88,055  13% 1,036  1%
 Multi-family 30,948  4% 31,134  4% (186) -1% 22,333  3% 8,615  39%
 Commercial real estate -- owner occupied 142,761  20% 144,349  21% (1,588) -1% 139,163  20% 3,598  3%
 Commercial real estate -- non owner occupied 152,017  22% 138,255  20% 13,762  10% 139,169  20% 12,848  9%
 Farmland 28,876  4% 29,075  4% (199) -1% 30,196  4% (1,320) -4%
 Consumer 72,946  10% 74,998  11% (2,052) -3% 67,890  10% 5,056  7%
  Gross Loans 704,097  100% 693,106  100% 10,991  2% 688,415  100% 15,682  2%
    Less:  allowance for loan losses (9,049)    (9,067)    18     (9,092)    43    
    Less:  deferred fees (994)    (1,014)    20     (1,096)    102    
  Net loans$694,054    $683,025    $11,029    $678,227    $15,827    

 

Loan Concentration
(Unaudited)
   Dec 31,
2018
 % of Risk Based Capital  Sept 30,  2018 % of Risk Based Capital   Change   Dec 31,  2017 % of Risk Based Capital   Change  
   (Dollars in thousands)
Commercial and agricultural$140,167 138%$135,204 134% 4%$138,629 148% -10%
Real estate:                     
Construction and development 47,291 47% 49,697 49% -2% 62,980 67% -20%
Residential 1-4 family 89,091 88% 90,394 89% -1% 88,055 94% -6%
Multi-family 30,948 30% 31,134 31% -1% 22,333 24% 6%
Commercial real estate -- owner occupied 142,761 141% 144,349 143% -2% 139,163 149% -8%
Commercial real estate -- non owner occupied 152,017 150% 138,255 137% 13% 139,169 149% 1%
Farmland 28,876 28% 29,075 29% -1% 30,196 32% -4%
Consumer 72,946 72% 74,998 74% -2% 67,890 72% 0%
 Gross Loans$704,097   $693,106      $688,415      
                      
Regulatory Commercial Real Estate$225,806 222%$213,891 212% 10%$215,087 230% -8%
                      
Total Risk Based Capital*$101,487   $101,031      $93,660      
                       
*Bank of the Pacific                     

The loan portfolio continues to be well-diversified and is originated predominately within our Western Washington and Oregon markets. Decreases during the current quarter occurred in commercial real estate, mainly due to the expected payoff from long-term financing sources. Commercial loan balances increased during the current quarter to finance operations in the normal course of business. The portfolio includes $31.6 million in LIBOR-based and $133.3 million in Wall Street Journal Prime-based floating rate commercial, commercial real estate and home equity loans. The portfolio also includes $14.2 million in purchased government-guaranteed commercial and commercial real estate loans and $61.6 million in indirect consumer loans to finance luxury and classic cars as a part of a strategy to diversify the loan portfolio. The indirect consumer loans have been made to individuals with high credit scores and have exhibited very low losses 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. The Bank’s recent portfolio growth includes commercial real estate loans, which are carefully managed to meet regulatory guidelines. 

DEPOSITS

                            
Deposits by Category
(Unaudited)
                            
  Dec 31,  2018 % of Total Sept 30,  2018 % of Total $ Change %  Change Dec 31,  2017 % of Total $  Change %  Change
  (Dollars in thousands)
Interest-bearing demand$191,530 24% $201,058 24% $(9,528) -5% $190,216 25% $1,314  1%
Money market 162,238 21% 161,012 20% 1,226  1% 142,491 19% 19,747  14%
Savings 101,408 13% 102,680 13% (1,272) -1% 89,303 11% 12,105  14%
Time deposits (CDs) 86,188 11% 87,874 11% (1,686) -2% 103,871 13% (17,683) -17%
  Total interest-bearing deposits 541,364 69% 552,624 68% (11,260) -2% 525,881 68% 15,483  3%
Non-interest bearing demand 242,185 31% 262,529 32% (20,344) -8% 251,344 32% (9,159) -4%
  Total deposits$783,549 100% $815,153 100% $(31,604) -4% $777,225 100% $6,324  1%


Total deposits decreased from the linked quarter, due to seasonal deposit outflows as noted above. Time deposits continue to decline as a component of funding, as retail depositors are reluctant to lock in relatively low interest rates for an extended period. In addition, balances of brokered deposits also declined during these periods. The proportion of noninterest bearing deposits to total deposits remained stable year-over-year.

Brokered certificates of deposit totaled $29.6 million, down from $32.5 million at September 30, 2018, and $42.3 million at December 31, 2017. The brokered deposits were acquired during the latter part of 2015 and early 2016 with fixed rates and 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, and its subsidiary Bank of the Pacific, 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. All ratios have decreased compared to the linked, due to the declaration of an annual cash dividend during the current quarter. These ratios have increased versus the prior year quarter primarily due to the retention of earnings. This is despite the impact on capital of the unrealized gain/(loss) on investment securities classified as “Available for Sale”, which was $(901,000), $(2.0 million) and $(83,000) as of December 31, 2018, September 30, 2018, and December 31, 2017, respectively, due to the recent increase in interest rates. In addition, the decrease in tangible assets as compared to the linked quarter contributed to a 12-basis point increase in the Tangible Common Equity Ratio (TCE), despite the declaration of the cash dividend mentioned above. 

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,  2018 Sept 30,  2018 Change Dec 31,  2017 Change  Well Capitalized Under Prompt Correction Action Regulations*
Pacific Financial Corporation                
Total risk-based capital ratio13.36% 13.61%   (0.25) 12.69%   0.67  N/A
Tier 1 risk-based capital ratio12.17% 12.40%   (0.23) 11.46%   0.71  N/A
Common equity tier 1 ratio10.47% 10.67%   (0.20) 9.71%   0.76  N/A
Leverage ratio10.21% 10.30%   (0.09) 9.56%   0.65  N/A
                 
Tangible common equity ratio8.83% 8.43%   0.40  8.16%   0.67  N/A
                 
Bank of the Pacific                
Total risk-based capital ratio13.30% 13.49%   (0.19) 12.63%   0.67  10.5%
Tier 1 risk-based capital ratio12.09% 12.26%   (0.17) 11.40%   0.69  8.5%
Common equity tier 1 ratio12.09% 12.26%   (0.17) 11.40%   0.69  7.0%
Leverage ratio10.14% 10.18%   (0.04) 9.51%   0.63  7.5%
                 
*Includes Basel III 2019 Capital Conservation Buffer               

 

Net Interest Margin

Net interest margin improved from the preceding quarter and from a year ago, primarily due to increases in average loan yields. Recent increases in interest rates initiated by the Federal Reserve had a positive impact on asset yields during the period. Net interest margin for the current year improved as compared to the prior year for similar reasons.

Cost of deposits remained relatively unchanged compared to the third quarter and year-over-year periods. The non-renewal of higher-cost long-term fixed rate brokered 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 as a result of rising interest rates 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,
                      
   Dec 31,
2018
 Sept 30,
2018
 
Change
 %
  Change
 Dec 31,
2017
 $
Change
 %
Change
Average Balances (Dollars in thousands)      
Gross loans$692,043 $695,011 $(2,968) 0%$682,688$9,355  1%
Loans held for sale$5,793 $8,860 $(3,067) -35%$9,475$(3,682) -39%
Investment securities$164,472 $149,028 $15,444  10%$147,863$16,609  11%
Total interest-earning assets$862,308 $852,899 $9,409  1%$840,026$22,282  3%
Non-interest bearing demand deposits$255,968 $251,847 $4,121  2%$265,002$(9,034) -3%
Interest bearing deposits$545,616 $543,436 $2,180  0%$519,595$26,021  5%
Borrowings$21,769 $21,943 $(174) -1%$21,919$(150) -1%
Total interest-bearing liabilities$567,385 $565,379 $2,006  0%$541,514$25,871  5%
Total Equity$93,560 $90,903 $2,657  3%$88,466$5,094  6%
                      
   For the Three Months Ended,      
   Dec 31,
2018
 Sept 30,
2018
 Change Dec 31,
2017
 Change      
Yield on average gross loans (1) 5.42% 5.35%   0.07  5.08%   0.34      
Yield on average investment securities (1) 2.66% 2.57%   0.09  2.37%   0.29      
Cost of average interest bearing deposits 0.37% 0.37%   -   0.34%   0.03      
Cost of average borrowings 3.39% 3.34%   0.05  2.73%   0.66      
Cost of average total deposits and borrowings 0.34% 0.33%   0.01  0.29%   0.05      
                      
Yield on average interest-earning assets 4.90% 4.86%   0.04  4.60%   0.30      
Cost of average interest-bearing liabilities 0.49% 0.48%   0.01  0.43%   0.06      
Net interest spread 4.41% 4.38%   0.03  4.17%   0.24      
                      
Net interest margin (1) 4.58% 4.55%   0.03  4.32%   0.26      
                      
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a rate of 21% as of December 31, 2018 and September 30, 2018 and 34% as of December 31, 2017.


   For the Year Ended,
   Dec 31,  2018 Dec 31,  2017 $  Change %  Change
Average Balances (Dollars in thousands)
Gross loans$693,408 $672,991 $20,417  3%
Loans held for sale$7,405 $7,702 $(297) -4%
Investment securities$139,152 $135,352 $3,800  3%
Interest-earning assets$839,965 $816,045 $23,920  3%
Non-interest bearing demand deposits$249,255 $242,290 $6,965  3%
Interest bearing deposits$533,541 $523,007 $10,534  2%
Borrowings$22,241 $22,080 $161  1%
Interest-bearing liabilities$555,782 $545,087 $10,695  2%
Total Equity$89,676 $84,976 $4,700  6%
              
              
    For the Year Ended,   
   Dec 31,  2018 Dec 31,  2017 Change   
Net Interest Margin            
Yield on average gross loans (1) 5.27% 5.01%   0.26    
Yield on average investment securities (1) 2.60% 2.40%   0.20    
Cost of average interest bearing deposits 0.35% 0.35%   -     
Cost of average borrowings 3.29% 2.64%   0.65    
Cost of average total deposits and borrowings 0.32% 0.30%   0.02    
              
Yield on average interest-earning assets 4.83% 4.58%   0.25    
Cost of average interest-bearing liabilities 0.47% 0.44%   0.03    
Net interest spread 4.36% 4.14%   0.22    
              
Net interest margin (1) 4.52% 4.28%   0.24    
              
(1) Tax-exempt income has been adjusted to a tax equivalent basis at a rate of 21% and 34% as of December 31, 2018 and December 31, 2017, respectively.    


ASSET QUALITY

Asset quality continues to be strong as levels of adversely classified and non-performing assets remain at low levels. Total 30-89-day delinquencies did increase primarily due a delay in payoff of a $1.3 million commercial relationship from another bank. Subsequently, the relationship has been brought current. The payoff is contingent on an assumption of a government guarantee by the new lender. Approval of the assumption by the SBA has been held up due to the partial federal government shutdown. The relationship is now current. However, delinquencies remained below 0.50%, a positive leading indicator of future credit quality. Adversely classified loans remained unchanged from the linked and prior year quarter. Adversely classified loans to total gross loans was 1.10% the end of the quarter compared to 1.12% at the linked quarter and 1.10% in the year ago quarter. 

                      
Adversely Classified Loans and Securities
(Unaudited)
                      
  Dec 31,  2018  Sept 30,  2018  $  Change  % Change  Dec 31,  2017  $  Change  % Change 
  (Dollars in thousands)
Rated substandard or worse, but not impaired$6,723 $6,733 $(10) 0%$5,017 $1,706  34%
Impaired 1,043  1,044  (1) 0% 2,529  (1,486) -59%
Total adversely classified loans¹$7,766 $7,777 $(11) 0%$7,546 $220  3%
                      
                      
Gross loans (excluding deferred loan fees)$704,097 $693,106 $10,991  2%$688,415 $15,682  2%
Adversely classified loans to gross loans 1.10% 1.12%       1.10%      
Allowance for loan losses$9,049 $9,067 $(18) 0%$9,092 $(43) 0%
Allowance for loan losses as a percentage of adversely classified loans 116.52% 116.59%       120.49%      
Allowance for loan losses to total impaired loans 867.59% 868.49%       359.51%      
Adversely classified loans to total assets 0.86% 0.83%       0.84%      
Delinquent loans to gross loans, not in nonaccrual status 0.36% 0.18%       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 remained relatively unchanged from three months ago. As a result, there was no change in the percentage of nonperforming assets to total assets between those periods. Similarly, nonperforming assets were below the amount of the prior year quarter, primarily due to various payoffs and reductions achieved during the intervening quarters.

Nonperforming Assets
(Unaudited)
                      
  Dec 31,  2018 Sept 30,  2018 $  Change  %  Change  Dec 31,  2017 $  Change  % Change 
  (Dollars in thousands)
Loans on nonaccrual status$700 $696 $4  1%$2,163 $(1,463) -68%
Total nonaccrual loans 700  696  4  1% 2,163  (1,463) -68%
                      
Other real estate owned and foreclosed assets -  50  (50) -100% 50  (50) -100%
Total nonperforming assets$700 $746 $(46) -6%$2,213 $(1,513) -68%
                      
                      
Restructured performing loans$343 $348 $(5) -1%$366 $(23) -6%
Accruing loans past due 90 days or more$- $- $-  0%$- $-  0%
                      
Percentage of nonperforming assets to total assets 0.08% 0.08%       0.25%      
Nonperforming loans to total loans 0.10% 0.10%       0.31%      

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is managed in concert with loan growth, credit quality and market conditions. 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 were minimal in the fourth quarter, a decline from the linked quarter and the fourth quarter a year ago. Net charge-offs were below those from like periods for 2017, which included a $121,000 charge-off related to the payoff of a $2.0 million adversely classified commercial loan participation. Charge-offs incurred during the twelve months ending December 31, 2018, were comprised primarily of consumer loans, all of which were modest in size. “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,
  Dec 31,  2018 Sept 30,  2018 $  Change  % Change  Dec 31,  2017 $  Change  % Change 
  (Dollars in thousands)       
Gross loans outstanding at end of period$704,097 $693,106 $10,991  2%$688,415 $15,682  2%
Average loans outstanding, gross$692,043 $695,011 $(2,968) 0%$682,688 $9,355  1%
Allowance for loan losses, beginning of period$9,067 $9,143 $(76) -1%$9,212 $(145) -2%
Commercial -  (4) 4  -100% (10) 10  -100%
Commercial Real Estate -  -  -  0% -  -  0%
Residential Real Estate -  -  -  0% -  -  0%
Consumer (22) (103) 81  -79% (113) 91  -81%
Total charge-offs (22) (107) 85  -79% (123) 101  -82%
Commercial -  23  (23) -100% 2  (2) -100%
Commercial Real Estate -  -  -  0% -  -  0%
Residential Real Estate -  -  -  0% -  -  0%
Consumer 4  8  (4) -50% 1  3  300%
Total recoveries 4  31  (27) -87% 3  1  NM 
Net recoveries/(charge-offs)  (18) (76) 58  -76% (120) 102  -85%
Provision charged to income -  -  -  0% -  -  0%
Allowance for loan losses, end of period$9,049 $9,067 $(18) 0%$9,092 $(43) 0%
Ratio of net loans charged-off to average                     
gross loans outstanding, annualized 0.01% 0.04% -0.03%    0.07% -0.06%   
Ratio of allowance for loan losses to                      
gross loans outstanding 1.29% 1.31% -0.02%    1.32% -0.03%   


  For the Year Ended, 
  Dec 31,  2018  Dec 31,  2017  $  Change   % Change  
  (Dollars in thousands)
Gross loans outstanding at end of period$704,097 $688,415 $15,682  2%
Average loans outstanding, gross$693,408 $672,991 $20,417  3%
Allowance for loan losses, beginning of period$9,092 $9,192 $(100) -1%
Commercial (4) (246) 242  -98%
Commercial Real Estate   -     -   -  0%
Residential Real Estate   -   (3) 3  -100%
Consumer (177) (187) 10  -5%
Total charge-offs (181) (436) 255  -58%
Commercial 77  46  31  67%
Commercial Real Estate   -     -   -  0%
Residential Real Estate   -