UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
/X/ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 2003; or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
Commission file number 000-29829
PACIFIC FINANCIAL CORPORATION
(Exact Name of Registrant as specified in its Charter)
Washington 91-1815009
(State or Other Jurisdiction (IRS Employer Identification No.)
of Incorporation or Organization)
300 East Market Street
Aberdeen, Washington 98520-5244
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code:
(360) 533-8870
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
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 periods that the Registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days. Yes__X___ No______
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined by Exchange Act Rule 12b-2). Yes [ ] No [X ]
The aggregate market value of the common stock held by non-affiliates of the
registrant at June 30, 2003 was $59,176,189.
The number of shares outstanding of the registrant's common stock, $1.00 par
value as of February 29, 2004, was 3,159,712 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement filed in connection with its annual
meeting of shareholders to be held April 28, 2004 are incorporated by reference
into Part III of this Form 10-K.
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PACIFIC FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2003
TABLE OF CONTENTS
PART I Page
Item 1. Business 4
Item 2. Properties 14
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 14
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 14
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 31
Item 8. Financial Statements and Supplementary Data 33
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 33
Item 9A. Controls and Procedures 33
PART III
Item 10. Directors and Executive Officers of the Registrant 33
Item 11. Executive Compensation 34
Item 12. Security Ownership of Certain Beneficial Owners and
Management And Related Stockholder Matters 34
Item 13. Certain Relationships and Related Transactions 34
Item 14. Principal Accountant Fees and Services 34
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K 35
SIGNATURES 36
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PART I
Forward Looking Information
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 that may impede our ability to attract and retain borrowers,
depositors and other customers, retain our key employees, and/or maintain
our interest margins and fee income;
2. changes in the interest rate environment that may reduce margins
and demand for our products and services;
3. our proposed acquisition of BNW Bancorp Inc. that may be dilutive
to earnings per share if we do not realize expected cost savings or
successfully integrate BNW Bancorp into the Company in a timely manner and
without significant customer or employee disruptions or losses;
4. our growth strategy, particularly if accomplished through
acquisitions, which 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 or opening new branches or similar offices;
5. general economic or business conditions, either nationally or in
the state or regions in which we do business, that may be less favorable
than expected, resulting in, among other things, a deterioration in credit
quality, including as a result of lower prices in the real estate market,
or a reduced demand for credit;
6. decreases in real estate prices that may reduce the value of our
security for some loans; and
7. a lack of liquidity in the market for our common stock that 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 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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ITEM 1. Business
Pacific Financial Corporation (the Company or Pacific) is a financial holding
company headquartered in Aberdeen, Washington. The Company owns one bank, Bank
of the Pacific (sometimes referred to as the Bank), which is located in
Washington. The Company conducts its banking business through 10 branches
located in communities throughout Grays Harbor County, Pacific County, and
Wahkiakum County in Southwest Washington. The Company also operates a loan
production office in Gearhart, OR. At December 31, 2003, the Company had total
consolidated assets of $306.7 million, loans of $199.7 million, deposits of
$260.8 million and total shareholders' equity of $25.6 million. The Company was
incorporated in the State of Washington on February 12, 1997, pursuant to a
holding company reorganization of the Bank. Although a reporting company with
the Securities and Exchange Commission (SEC), the Company's stock is not listed
on any exchange or quoted actively on any stock market.
Effective February 27, 2004, the Company completed the acquisition of BNW
Bancorp, Inc. (BNW) in a merger in which each share of BNW common stock held by
BNW shareholders was converted into the right to receive 0.85 shares of Pacific
common stock, resulting in the issuance of 636,673 shares of Pacific stock.
Simultaneous with the merger of BNW into Pacific, BNW's subsidiary Bank
NorthWest was merged into Bank of the Pacific. The merger will be accounted for
as a purchase transaction.
BNW, through its operating subsidiary Bank NorthWest, operated five locations in
Whatcom County, Washington, including its largest city, Bellingham, Washington.
At December 31, 2003, BNW had total assets of approximately $104.6 million,
total loans receivable of approximately $94.1 million, total deposits of
approximately $88.6 million and total shareholders' equity of approximately $7
million.
The Company does not anticipate significant changes in products and services
offered to customers of Bank of the Pacific following the merger, but it will be
able to offer higher lending limits to its customers, particularly those who
were formerly BNW customers.
Pacific's filings with the SEC, including its annual report on Form 10-K,
quarterly reports on Form 10-Q, periodic current reports on Form 8-K and
amendments to these reports, are available free of charge through links from our
website at http://www.thebankofpacific.com to the SEC's site at
http://www.sec.gov, as soon as reasonably practicable after filing with the SEC.
You may also access our filings with the SEC directly from the Edgar database
found on the SEC's website. By making reference to our website above and
elsewhere in this report, we do not intend to incorporate all information from
our site into this report.
The Bank
Bank of the Pacific was organized in 1978 and opened for business in 1979 to
meet the need for a regional community bank with local interests to serve the
small to medium-sized local businesses and professionals in the coastal region
of Western Washington. Services offered by the Bank include commercial loans,
agriculture loans, installment loans, real estate loans, residential mortgage
loans and personal and business deposit products.
The Bank originates loans primarily in its local markets. Its underwriting
policies focus on assessment of each borrower's ability to service and repay the
debt, and the availability of collateral that can be used to secure the loan.
Depending on the nature of the borrower and the purpose and amount of the loan,
the Bank's loans may be secured by a variety of collateral, including business
assets, real estate, and personal assets.
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The Bank's commercial and agricultural loans consist primarily of secured
revolving operating lines of credit and business term loans, some of which may
be partially guaranteed by the Small Business Administration or the U.S.
Department of Agriculture.
Consumer installment loans and other loans represent a small percentage of total
outstanding loans and include home equity loans, auto loans, boat loans, and
personal lines of credit.
The Bank's primary sources of deposits are from individuals and businesses in
its local markets. A concerted effort has been made to attract deposits in the
local market areas through competitive pricing and delivery of quality products.
These products include demand accounts, negotiable order of withdrawal accounts,
money market investment accounts, savings accounts and time deposits. The Bank
traditionally has not sought brokered deposits and does not intend to do so in
the future.
The Bank provides 24 hour online banking to its customers with access to account
balances and transaction histories, plus an electronic check register to make
account management and reconciliation simple. The online banking system is
compatible with budgeting software like Intuit's Quicken or Microsoft's Money.
In addition, the online banking system includes the ability to transfer funds,
make loan payments, reorder checks, and request statement reprints, provides
loan calculators and allows for e-mail exchanges with The Bank. Also for a
nominal fee, customers can request stop payments and pay an unlimited number of
bills online. These services along with rate information and other information
can be accessed through the Bank's website at http://www.thebankofpacific.com.
The Bank's deposits are insured by the Federal Deposit Insurance Corporation
(FDIC) up to applicable legal limits under the Bank Insurance Fund. The Bank is
a member of the Federal Home Loan Bank (FHLB) and is regulated by the Washington
Department of Financial Institutions, Division of Banks (Division), and the
FDIC.
Competition
Competition in the banking industry is significant and has intensified as the
regulatory environment has grown more permissive. Banks face a growing number of
competitors and greater degree of competition with respect to the provision of
banking services and the attracting of deposits. The Company competes in Grays
Harbor County with well-established thrifts which are headquartered in the area
along with branches of large banks and with headquarters outside the area. The
Company competes with well-established small community banks, branches of large
banks, thrifts and credit unions in Pacific and Wahkiakum Counties in the state
of Washington and Clatsop County in the state of Oregon. Other non-bank and
non-depository institutions can be expected to increase competition further as
they offer bank type products.
As a result of its acquisition of BNW in February 2004, the Company entered a
new market in Whatcom County, Washington, including the Bellingham area. This
market is very competitive and includes large regional and super-regional
financial institutions that do not have a significant presence in the Company's
historical market areas. The Company believes its newest territory provides
opportunities for expansion, but in pursuing that expansion it expects to face
greater competitive challenges than it faces in its historical market area.
The adoption of the Gramm-Leach-Bliley Act of 1999 (the Financial Services
Modernization Act) eliminated many of the barriers to affiliation among
providers of financial services and further opened the door to business
combinations involving banks, insurance companies, securities or brokerage
firms, and others. This regulatory change has led to further consolidation in
the financial services industry and the creation of financial conglomerates
which frequently offer multiple financial services, including deposit
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services, brokerage and others. When combined with technological developments
such as the Internet that have reduced barriers to entry faced by companies
physically located outside the Company's market area, changes in the market have
resulted in increased competition and can be expected to result in further
increases in competition in the future.
Although it cannot guarantee that it will continue to do so, the Company has
been able to maintain a competitive advantage in its historical markets as a
result of its status as a local institution, offering products and services
tailored to the needs of the community. Further, because of the extensive
experience of management in its market area and the business contacts of
management and the Company's directors, management believes the Company can
continue to compete effectively.
According to the Market Share Report compiled by the FDIC, as of June 30, 2003,
the Company held a deposit market share of 26.9% in Pacific County, 47.1% in
Wahkiakum County and 17.3% in Grays Harbor County.
Employees
As of December 31, 2003, the Bank employed 95 full time equivalent employees.
The Bank acquired 52 additional employees in the merger with BNW completed in
February 2004. Management believes relations with its employees are good.
SUPERVISION AND REGULATION
The following is a general description of certain significant statutes and
regulations affecting the banking industry. This regulation is intended
primarily for the protection of depositors and not for the benefit of the
Company's shareholders. The following discussion is intended to provide a brief
summary and, therefore, is not complete and is qualified by the statutes and
regulations referenced. Changes in applicable laws or regulations may have a
material effect on the business and prospects of the Company.
The operations of the Company may also be affected by changes in the policies of
banking and other government regulators. The Company cannot accurately predict
the nature or extent of the effects on its business and earnings that fiscal or
monetary policies, or new federal or state laws or regulations, may have in the
future.
The Company
General
As a financial holding company, the Company is subject to the Bank Holding
Company Act of 1956, as amended (BHCA), which places the Company under the
supervision of the Board of Governors of the Federal Reserve System (the Federal
Reserve). The Company must file annual reports with the Federal Reserve and must
provide it with such additional information as it may require. In addition, the
Federal Reserve periodically examines the Company and the Bank.
Bank Holding Company Regulation
In general, the BHCA limits a bank holding company to owning or controlling
banks and engaging in other banking-related activities. Bank holding companies
must obtain approval of the Federal Reserve before they: (1) acquire direct or
indirect ownership or control of any voting shares of any bank that results in
total ownership or control, directly or indirectly, of more than 5% of the
voting shares of such bank; (2) merge or consolidate with another bank holding
company; or (3) acquire substantially all of the assets of another bank or bank
holding company.
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Control of Nonbanks. With certain exceptions, the BHCA prohibits bank holding
companies from acquiring direct or indirect ownership or control of more than 5%
of the voting shares in any company that is not a bank or a bank holding company
unless the Federal Reserve determines that the activities of such company are
incidental or closely related to the business of banking. If a bank holding
company is well-capitalized and meets certain criteria specified by the Federal
Reserve, it may engage de novo in certain permissible nonbanking activities
without prior Federal Reserve approval.
Control Transactions. The Change in Bank Control Act of 1978, as amended,
requires a person (or group of persons acting in concert) acquiring control of a
bank holding company to provide the Federal Reserve with 60 days' prior written
notice of the proposed acquisition. Following receipt of this notice, the
Federal Reserve has 60 days within which to issue a notice disapproving the
proposed acquisition, but the Federal Reserve may extend this time period for up
to another 30 days. An acquisition may be completed before expiration of the
disapproval period if the Federal Reserve issues written notice of its intent
not to disapprove the transaction. In addition, any company must obtain approval
of the Federal Reserve before acquiring 25% (5% if the company is a bank holding
company) or more of the outstanding shares or otherwise obtaining control over
the Company.
Source of Strength Requirements. Under Federal Reserve policy, the Company is
expected to act as a source of financial and managerial strength to the Bank.
This means that the Company is required to commit, as necessary, resources to
support the Bank. Any capital loans made by the Company to the Bank would be
subordinate in priority to deposits and to certain other indebtedness of the
Bank.
Financial Services Modernization Act
On November 12, 1999, the Financial Services Modernization Act was signed into
law. The Financial Services Modernization Act repeals the two affiliation
provisions of the Glass-Steagall Act: Section 20, which restricted the
affiliation of Federal Reserve member banks with firms "engaged principally" in
specified securities activities; and Section 32, which restricts officer,
director, or employee interlocks between a member bank and any company or person
"primarily engaged" in specified securities activities. In addition, the
Financial Services Modernization Act contains provisions that expressly preempt
any state law restricting the establishment of financial affiliations, primarily
related to insurance. The general effect of the law is to establish a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the bank holding company framework to permit a holding company
system to engage in a full range of financial activities through a new entity
known as a financial holding company.
The Company received approval to become a financial holding company during 2000.
Bank holding companies that elect to become a financial holding company may
affiliate with securities firms and insurance companies and engage in other
activities that are financial in nature or are incidental or complementary to
activities that are financial in nature. "Financial in nature" activities
include securities underwriting, dealing, and market marking, sponsoring mutual
funds and investment companies, insurance underwriting and agency, merchant
banking, and activities that the Federal Reserve, in consultation with the
Secretary of Treasury, determines from time to time to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
The law and related regulations also:
* broadened the activities that may be conducted by national banks and by
banking subsidiaries of bank holding companies, and their financial
subsidiaries;
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* provided an enhanced framework for protecting the privacy of consumer
information; and
* modified the laws governing the implementation of the Community
Reinvestment Act.
The Company does not believe that the Financial Services Modernization Act has
had a material effect on its operations in the near-term. However, to the extent
that the legislation permits banks, securities firms, and insurance companies to
affiliate, the financial services industry may experience further consolidation.
The Financial Services Modernization Act is intended to grant to community banks
certain powers as a matter of right that larger institutions have accumulated on
an ad hoc basis. Nevertheless, this legislation may have the result of
increasing the amount of competition that the Company faces from larger
institutions and other types of companies with substantially greater resources
than the Company and offering a wider variety of financial products than the
Bank currently offers.
During 2000, the federal banking regulations adopted certain privacy and
information security requirements. Adopted rules require, among other things,
disclosure of privacy policies to consumers and implementation of information
security programs designed to identify and assess the risks that may threaten
customer information. In addition, as part of each institution's information
security, it must develop a written plan to manage and control risks to consumer
information, and implement, test and adjust the plan on a continuing basis. The
Company believes that it is in compliance with the guidelines and that they will
not adversely affect its operations.
In December 2000, pursuant to the requirements of the Financial Services
Modernization Act, the federal bank and thrift regulatory agencies adopted
consumer protection rules for the sale of insurance products by depository
institutions. The rule was effective on April 1, 2001. The regulation requires
oral and written disclosure before the completion of the sale of an insurance
product that such product:
* is not a deposit or other obligation of, or guaranteed by, the depository
institution or its affiliates;
* is not insured by the FDIC or any other agency of the United States, the
depository institution or its affiliates; and
* involves certain investment risks, including the possible loss of value.
The depository institution may not condition an extension of credit on the
consumer's purchase of an insurance product or annuity from the depository
institution. The rule also addresses cross marketing and referral fees.
USA Patriot Act of 2001
On October 26, 2001, President Bush signed the Uniting and Strengthening America
by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA
Patriot Act) of 2001. Among other things, the USA Patriot Act (1) prohibits
banks from providing correspondent accounts directly to foreign shell banks; (2)
imposes due diligence requirements on banks opening or holding accounts for
foreign financial institutions or wealthy foreign individuals; (3) requires
financial institutions to establish an anti-money-laundering compliance program,
and (4) eliminates civil liability for persons who file suspicious activity
reports. The USA Patriot Act also increases governmental powers to investigate
terrorism, including expanded government access to account records. The
Department of the Treasury is empowered to administer and make rules to
implement the act. We do not believe that compliance with the USA Patriot Act
has had a material effect on our business and operations.
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Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 was adopted in response to public concerns
regarding corporate accountability in connection with the recent accounting
scandals at various large publicly traded companies. The stated goals of the act
are to increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies, and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally
applies to all companies such as the Company that file periodic reports with the
SEC under the Securities Exchange Act of 1934, as amended (Exchange Act).
The Sarbanes-Oxley Act includes additional disclosure requirements and new
corporate governance rules, and has resulted in significant rulemaking by the
SEC and the securities exchanges relating to corporate governance, independence
of board members, internal control over financial reporting, disclosure
controls, and other matters. Most rulemaking initiatives were completed by the
close of 2003. Sarbanes-Oxley represents significant federal involvement in
matters traditionally left to state regulatory systems, such as the regulation
of the accounting profession, and to state corporate law, such as the
relationship between a board of directors and management and between a board of
directors and its committees.
The Sarbanes-Oxley Act addresses, among other matters, (1) board audit
committees; (2) certification of Exchange Act reports by the chief executive
officer and the chief financial officer; (3) the forfeiture of bonuses or other
incentive-based compensation and securities trading profits by directors and
executive officers in the twelve-month period following initial publication of
any financial statements that later require restatement; (4) disclosure of
off-balance sheet transactions; (5) expedited reporting of stock transactions by
insiders; (6) disclosure of whether an issuer has a code of ethics, and changes
or waivers of such code; (7) the formation of a Public Company Accounting
Oversight Board; (8) auditor independence; and (9) increased criminal penalties
for violations of securities laws.
We believe the Sarbanes-Oxley Act has resulted in increases in our reporting
expenses and audit and audit related costs; nonetheless, we do not believe that
the Act has had or will have a material adverse effect on our business and
operations.
Transactions With Affiliates
The Company and the Bank are deemed affiliates within the meaning of the Federal
Reserve Act, and transactions between affiliates are subject to certain
restrictions. Accordingly, the Company and the Bank must comply with Sections
23A and 23B of the Federal Reserve Act. Generally, Sections 23A and 23B (1)
limit the extent to which a financial institution or its subsidiaries may engage
in covered transactions with an affiliate, as defined, to an amount equal to 10%
of such institution's capital and surplus and an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital and
surplus, and (2) require all transactions with an affiliate to be on terms
substantially the same, or at least as favorable to the institution or
subsidiary, as those provided to a non-affiliate. Regulation W, which collected
many existing interpretations of provisions of the Federal Reserve Act, became
effective in April 2003. The regulation restricts loans, asset purchases and
other transactions between a depository institution and its affiliated entities.
Regulation of Management
Federal law (1) sets forth the circumstances under which officers or directors
of a financial institution may be removed by the institution's federal
supervisory agency; (2) places restraints on lending by an institution to its
executive officers, directors, principal shareholders, and their related
interests; and (3) prohibits management personnel from serving as a director or
in other management positions with another financial
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institution which has assets exceeding a specified amount or which has an office
within a specified geographic area.
Tie-In Arrangements
The Company and the Bank cannot engage in certain tie-in arrangements in
connection with any extension of credit, sale or lease of property or furnishing
of services. For example, with certain exceptions, neither the Company nor the
Bank may condition an extension of credit to a customer on either (1) a
requirement that the customer obtain additional services provided by it or (2)
an agreement by the customer to refrain from obtaining other services from a
competitor.
State Law Restrictions
As a Washington business corporation, the Company may be subject to certain
limitations and restrictions as provided under applicable Washington corporate
law. In addition, Washington banking law restricts and governs certain
activities of the Bank.
The Bank
General
The Bank, as an FDIC insured state-chartered bank, is subject to regulation and
examination by the FDIC and the Department of Financial Institutions of the
State of Washington. The federal laws that apply to the Bank regulate, among
other things, the scope of its business, its investments, its reserves against
deposits, the timing of the availability of deposited funds and the nature and
amount of and collateral for loans.
CRA. The Community Reinvestment Act (the CRA) requires that, in connection with
examinations of financial institutions within their jurisdiction, the FDIC
evaluate the record of the financial institutions in meeting the credit needs of
their local communities, including low and moderate income neighborhoods,
consistent with the safe and sound operation of those banks. These factors are
also considered in evaluating mergers, acquisitions, and applications to open a
branch or facility. In connection with the FDIC's assessment of the record of
financial institutions under the CRA, it assigns a rating of either,
"outstanding," "satisfactory," "needs to improve," or "substantial
noncompliance" following an examination. The Bank received a CRA rating of
"outstanding" during its most recent examination.
Insider Credit Transactions. Banks are also subject to certain restrictions
imposed by the Federal Reserve Act on extensions of credit to executive
officers, directors, principal shareholders, or any related interests of such
persons. Extensions of credit (i) must be made on substantially the same terms,
including interest rates and collateral, and follow credit underwriting
procedures that are not less stringent than those prevailing at the time for
comparable transactions with persons not covered above and who are not employees
and (ii) must not involve more than the normal risk of repayment or present
other unfavorable features. Banks are also subject to certain lending limits and
restrictions on overdrafts to such persons. A violation of these restrictions
may result in the assessment of substantial civil monetary penalties on the
affected bank or any officer, director, employee, agent, or other person
participating in the conduct of the affairs of that bank, the imposition of a
cease and desist order, and other regulatory sanctions.
FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA), each federal banking agency has prescribed, by regulation, noncapital
safety and soundness standards for institutions under its authority. These
standards cover internal controls, information systems, and internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, compensation, fees and benefits, such other operational and managerial
standards as the agency determines to be appropriate, and standards for asset
quality, earnings and stock valuation. An institution
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which fails to meet these standards must develop a plan acceptable to the
agency, specifying the steps that the institution will take to meet the
standards. Failure to submit or implement such a plan may subject the
institution to regulatory sanctions. Management believes that the Bank meets all
such standards and, therefore, does not believe that these regulatory standards
will materially affect the Company's business or operations.
Interstate Banking and Branching
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
Interstate Act) permits nationwide interstate banking and branching under
certain circumstances. This legislation generally authorizes interstate
branching and relaxes federal law restrictions on interstate banking. Currently,
bank holding companies may purchase banks in any state, and states may not
prohibit such purchases. Additionally, banks are permitted to merge with banks
in other states as long as the home state of neither merging bank has opted out.
The Interstate Act requires regulators to consult with community organizations
before permitting an interstate institution to close a branch in a low-income
area.
With regard to interstate bank mergers, Washington has opted in to the
Interstate Act and allows in-state banks to merge with out-of-state banks
subject to certain aging requirements. Washington law generally authorizes the
acquisition of an in-state bank by an out-of-state bank through merger with a
Washington financial institution that has been in existence for at least 5 years
prior to the acquisition. With regard to interstate bank branching, out-of-state
banks that do not already operate a branch in Washington may not establish de
novo branches in Washington or establish and operate a branch by acquiring a
branch in Washington. Under FDIC regulations, banks are prohibited from using
their interstate branches primarily for deposit production. The FDIC has
accordingly implemented a loan-to-deposit ratio screen to ensure compliance with
this prohibition.
Deposit Insurance
The deposits of the Bank are currently insured to a maximum of $100,000 per
depositor through the Bank Insurance Fund administered by the FDIC. All insured
banks are required to pay semi-annual deposit insurance premium assessments to
the FDIC.
FDICIA included provisions to reform the Federal deposit insurance system,
including the implementation of risk-based deposit insurance premiums. FDICIA
also permits the FDIC to make special assessments on insured depository
institutions in amounts determined by the FDIC to be necessary to give it
adequate assessment income to repay amounts borrowed from the U.S. Treasury and
other sources, or for any other purpose the FDIC deems necessary. The FDIC has
implemented a risk-based insurance premium system under which banks are assessed
insurance premiums based on how much risk they present to the insurance fund.
Banks with higher levels of capital and a low degree of supervisory concern are
assessed lower premiums than banks with lower levels of capital or a higher
degree of supervisory concern. The Bank presently qualifies for the lowest
premium level.
Dividends
The principal source of the Company's cash revenues is dividends received from
the Bank. The payment of dividends is subject to government regulation, in that
regulatory authorities may prohibit banks and bank holding companies from paying
dividends in a manner that would constitute an unsafe or unsound banking
practice. In addition, a bank may not pay cash dividends if that payment could
reduce the amount of its capital below that necessary to meet minimum applicable
regulatory capital requirements. Other than the laws and regulations noted
above, which apply to all banks and bank holding companies, neither the Company
nor the Bank are currently subject to any regulatory restrictions on their
dividends.
-11-
Under applicable restrictions, as of December 31, 2003, the Bank could declare
dividends totaling $4,579,000 without obtaining prior regulatory approval.
Capital Adequacy
Federal bank regulatory agencies use capital adequacy guidelines in the
examination and regulation of bank holding companies and banks. If capital falls
below minimum guideline levels, the holding company or bank may be denied
approval to acquire or establish additional banks or non-bank businesses or to
open new facilities.
The FDIC and Federal Reserve use risk-based capital guidelines for banks and
bank holding companies. These are designed to make such capital requirements
more sensitive to differences in risk profiles among banks and bank holding
companies, to account for off-balance sheet exposure and to minimize
disincentives for holding liquid assets. Assets and off-balance sheet items are
assigned to broad risk categories, each with appropriate weights. The resulting
capital ratios represent capital as a percentage of total risk-weighted assets
and off-balance sheet items. The guidelines are minimums, and the Federal
Reserve has noted that bank holding companies contemplating significant
expansion programs should not allow expansion to diminish their capital ratios
and should maintain ratios well in excess of the minimum. The current guidelines
require all bank holding companies and federally-regulated banks to maintain a
minimum risk-based total capital ratio equal to 8%, of which at least 4% must be
Tier I capital. Tier I capital for bank holding companies includes common
shareholders' equity, certain qualifying perpetual preferred stock and minority
interests in equity accounts of consolidated subsidiaries, less intangibles
except as described above and accumulated other comprehensive income (loss).
The Federal Reserve also employs a leverage ratio, which is Tier I capital as a
percentage of total assets less intangibles, to be used as a supplement to
risk-based guidelines. The principal objective of the leverage ratio is to
constrain the maximum degree to which a bank holding company may leverage its
equity capital base. The Federal Reserve requires a minimum leverage ratio of
3%. However, for all but the most highly rated bank holding companies and for
bank holding companies seeking to expand, the Federal Reserve expects an
additional cushion of at least 1% to 2%.
FDICIA created a statutory framework of supervisory actions indexed to the
capital level of the individual institution. Under regulations adopted by the
FDIC, an institution is assigned to one of five capital categories depending on
its total risk-based capital ratio, Tier I risk-based capital ratio, and
leverage ratio, together with certain subjective factors. Institutions which are
deemed to be undercapitalized depending on the category to which they are
assigned are subject to certain mandatory supervisory corrective actions. The
Company does not believe that these regulations had a material effect on its
operations.
Effects of Government Monetary Policy
The earnings and growth of the Company are affected not only by general economic
conditions, but also by the fiscal and monetary policies of the federal
government, particularly the Federal Reserve. The Federal Reserve can and does
implement national monetary policy for such purposes as curbing inflation and
combating recession, but its open market operations in U.S. government
securities, control of the discount rate applicable to borrowings from the
Federal Reserve, and establishment of reserve requirements against certain
deposits, influence the growth of bank loans, investments and deposits, and also
affect interest rates charged on loans or paid on deposits. The nature and
impact of future changes in monetary policies and their impact on the Company
and the Bank cannot be predicted with certainty.
-12-
ITEM 2. Properties
The Company's administrative offices are located in Aberdeen, Washington. The
building located at 300 East Market Street is owned by the Bank and houses the
main branch and the administrative and operations offices of the Bank and the
Company. The Bank completed construction and occupied the building in December
of 1979.
Pacific owns the land and buildings occupied by its nine branches in Grays
Harbor, Pacific and Wahkiakum Counties, as well as its data processing
operations in Long Beach, Washington. Four of the five branches acquired in the
merger with BNW operate in leased facilities, and the Everson, WA branch land
and building is owned.
In addition to the land and buildings owned by Pacific, it also owns all of its
furniture, fixtures and equipment, including data processing equipment, at
December 31, 2003. The net book value of the Company's premises and equipment
was $3.9 million at that date.
ITEM 3. Legal Proceedings
The Company and the Bank from time to time are party to various legal
proceedings arising in the ordinary course of business. Management believes that
there are no threatened or pending proceedings against the Company or the Bank
which, if determined adversely, would have a material effect on its business or
financial condition.
In addition, a lawsuit was filed in Wahkiakum County Superior Court against the
Bank, which seeks damages for soil contamination. The subject property was sold
by the Bank to the plaintiff several years ago. Plaintiff now alleges that the
property was contaminated by petroleum products that seeped from an adjacent
parcel owned by the Bank. The adjacent parcel had been a service station and
garage for many years prior to its acquisition by the Bank. The Bank has
completed remediation of the contaminated soil. The levels of contamination of
the property were minimal. Based on information known to management at this
time, the Company does not believe that this litigation will result in a
material adverse effect on the Company's results of operations or financial
condition.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders in the fourth quarter of
2003.
-13-
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's common stock is not listed on any exchange or traded on the
over-the-counter market, and as of January 1, 2004, no broker made a market in
the stock. Trading in our stock has been very limited, and the trades that have
occurred cannot be characterized as amounting to an established public trading
market. The Company's common stock is traded by individuals on a personal basis
and the prices reported reflect only the transactions known to Company
management. Because only limited information is available, the following data
may not accurately reflect the actual market value of the Company's common
stock. The following data includes trades between individual investors, as
reported to the Company as its own transfer agent.
2003 2002
Shares Traded High Low Shares Traded High Low
First Quarter 5,887 $ 27.00 $ 24.75 7,399 $ 25.00 $ 23.50
Second Quarter 21,945 $ 30.00 $ 28.00 9,265 $ 23.75 $ 22.50
Third Quarter 4,110 $ 31.00 $ 30.00 36,554 $ 24.50 $ 21.50
Fourth Quarter 1,865 $ 33.50 $ 31.00 10,106 $ 25.00 $ 23.75
As of December 31, 2003, there were approximately 920 shareholders of record of
the Company's common stock.
The Company's Board of Directors declared dividends on its common stock in
December 2003 and 2002 in the amounts per share of $1.40 and $1.35,
respectively. The Board of Directors has adopted a dividend policy which is
reviewed annually. There can be no assurance the Company will continue to
increase its dividend or declare and pay dividends at historical rates.
Payment of dividends is subject to regulatory limitations. Under federal banking
law, the payment of dividends by the Company and the Bank is subject to capital
adequacy requirements established by the Federal Reserve and the FDIC. Under
Washington general corporate law as it applies to the Company, no cash dividend
may be declared or paid if, after giving effect to the dividend, the Company is
insolvent or its liabilities exceed its assets. Payment of dividends on the
Common Stock is also affected by statutory limitations, which restrict the
ability of the Bank to pay upstream dividends to the Company. Under Washington
banking law as it applies to the Bank, no dividend may be declared or paid in an
amount greater than net profits then available, and after a portion of such net
profits have been added to the surplus funds of the Bank. Under applicable
restrictions, as of December 31, 2003, the Bank could declare dividends totaling
$4,579,000 without obtaining prior regulatory approval.
-14-
ITEM 6. Selected Financial Data
The following table sets forth certain selected consolidated financial data of
the Company at and for the years ended December 31:
2003 2002 2001 2000 1999
-------------------------------------------------
($ in thousands, except per share data)
Operations Data
Net interest income $ 12,541 $ 11,788 $ 11,572 $ 11,675 $ 11,430
Provision for credit losses -- 954 580 635 60
Noninterest income 1,846 2,059 1,529 1,217 1,255
Noninterest expense 7,945 7,414 7,193 7,530 7,011
Provision for income taxes 1,863 1,563 1,521 1,424 1,692
Net income 4,579 3,916 3,807 3,303 3,922
Net income per share:
Basic 1.82 1.57 1.53 1.33 1.60(1)
Diluted 1.79 1.56 1.52 1.31 1.59(1)
Dividends declared 3,530 3,392 3,289 3,204 3,105
Dividends declared per share 1.40 1.35 1.32 1.28 1.25(1)
Dividends paid ratio 77% 87% 86% 97% 79%
(1) Restated to reflect the 5 for 1 stock split effected in July 2000.
Performance Ratios
Net interest margin 4.75% 5.05% 5.16% 5.14% 5.10%
Efficiency ratio 55.22% 53.54% 54.90% 58.41% 55.27%
Return on average assets 1.61% 1.54% 1.55% 1.34% 1.64%
Return on average equity 17.10% 15.81% 15.57% 14.95% 17.26%
Balance Sheet Data
Total assets $ 306,715 268,534 243,617 253,313 242,189
Loans, net 197,500 183,031 174,495 175,142 150,734
Total deposits 260,800 225,254 214,644 213,511 206,139
Other borrowings 14,500 12,800 -- 11,358 9,675
Shareholders' equity 25,650 24,683 23,514 22,743 21,438
Book value per share 10.17 9.82 9.44 9.09 8.63(1)
Equity to assets ratio 8.36% 9.19% 9.65% 8.98% 8.85%
(1) Restated to reflect the 5 for 1 stock split effected in July 2000.
Asset Quality Ratios
Nonperforming loans to total loans .27% 1.00% .71% 1.93% .21%
Allowance for loan losses
to total loans 1.12% 1.33% 1.19% 1.14% 1.26%
Allowance for loan losses
to nonperforming loans 411.40% 132.67% 168.18% 59.24% 612.69%
Nonperforming assets to
total assets .18% .69% .51% 1.35% .13%
-15-
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with Pacific's audited
consolidated financial statements and related notes appearing elsewhere in this
report. In addition, please refer to Pacific's forward-looking statement
disclosure included on the first page of this report.
RESULTS OF OPERATIONS
Years ended December 31, 2003, 2002, and 2001
General. The Company's net income for 2003 was $4,579,000, a 16.9% increase
compared to $3,916,000 in 2002, and an increase of 20.3% from $3,807,000 in
2001. Basic earnings per share were $1.82, $1.57, and $1.53 for 2003, 2002, and
2001, respectively. Return on average assets was 1.61%, 1.54%, and 1.55% in
2003, 2002, and 2001, respectively. Return on average equity was 17.10%, 15.81%,
and 15.57%, respectively, in 2003, 2002, and 2001. The increased earnings for
the current year are primarily a result of the absence of a provision for credit
losses due to improvement in nonperforming loans, coupled with increased
interest income and a decrease in interest expense.
The following table presents condensed consolidated statements of income for the
Company for each of the years in the three-year period ended December 31, 2003.
Increase Increase
(Decrease) (Decrease)
(Dollars in thousands) 2003 Amount % 2002 Amount % 2001
-----------------------------------------------------------------------------------------------
Interest income $15,949 $170 1.1 $15,779 $(2,323) (12.8) $18,102
Interest expense 3,408 (583) (14.6) 3,991 (2,539) (38.9) 6,530
Net interest income 12,541 753 6.4 11,788 216 1.9 11,572
Provision for credit losses -- (954) (100.0) 954 374 64.5 580
Net interest income after
provision for credit losses 12,541 1,707 15.8 10,834 (158) (1.4) 10,992
Other operating income 1,846 (213) (10.3) 2,059 530 34.7 1,529
Other operating expense 7,945 531 7.2 7,414 221 3.1 7,193
Income before income taxes 6,442 963 17.6 5,479 151 2.8 5,328
Income taxes 1,863 300 19.2 1,563 42 2.8 1,521
Net income 4,579 663 16.9 3,916 109 2.9 3,807
-16-
Net Interest Income. The Company derives the majority of its earnings from net
interest income, which is the difference between interest income earned on
interest earning assets and interest expense incurred on interest bearing
liabilities. The following table sets forth information with regard to average
balances of the interest earning assets and interest bearing liabilities and the
resultant yields or cost, net interest income, and the net interest margin.
Year Ended December 31,
2003 2002 2001
Interest Interest Interest
Average Income Avg Average Income Avg Average Income Avg
Balance (Expense) Rate Balance (Expense) Rate Balance (Expense) Rate
Assets (dollars in thousands)
Earning assets:
Loans $188,267 $ 13,381* 7.11% $178,765 $ 13,212* 7.39% $170,628 $ 15,032* 8.81%
Investment Securities:
Taxable 48,206 1,738 3.61% 32,991 1,541 4.67% 27,360 1,638 5.99%
Tax-Exempt 14,721 1,050* 7.13% 14,510 1,165* 8.03% 15,042 1,225* 8.14
Total investment
securities 62,927 2,788 4.43% 47,501 2,706 5.70% 42,402 2,863 6.75
Federal Home Loan Bank Stock 887 49 5.52% 3,102 186 6.01% 3,657 251 6.86%
Federal funds sold and
deposits in banks 11,855 118 1.00% 5,644 107 1.90% 11,339 410 3.61
Total earning assets/interest
income $263,936 $ 16,336 6.18% $235,013 $ 16,211 6.90% $228,026 $ 18,556 8.14%
Cash and due from banks 7,930 8,331 8,448
Bank premises and equipment
(net) 3,780 3,930 4,104
Other assets 10,448 9,552 6,822
Allowance for credit losses (2,357) (2,515) (1,912)
Total assets $283,737 $254,310 $245,488
======== ======== ========
Liabilities and Shareholders' Equity
Interest bearing liabilities:
Deposits:
Savings and interest-
bearing demand $112,129 $ (827) .74% $104,111 $ (1,080) 1.04% $105,846 $ (2,395) 2.26
Time 86,634 (2,096) 2.42% 79,664 (2,667) 3.35% 75,819 (3,945) 5.20
Total deposits $198,763 (2,923) 1.47% 183,775 (3,747) 2.04% 181,665 (6,340) 3.49
Short-term borrowings -- -- -- 174 (4) 2.48% 3,065 (190) 6.20
Long-term borrowings 14,071 (485) 3.45% 6,548 (240) 3.67% -- ---- ----
Total interest-bearing liabilities/
Interest expense $212,834 $ (3,408) 1.60% $190,497 $ (3,991) 2.10% $184,730 $ (6,530) 3.53
Demand deposits 42,864 36,180 33,419
Other liabilities 1,253 2,867 2,888
Shareholders' equity 26,786 24,766 24,451
Total liabilities and shareholders'
equity $283,737 $254,310 $245,488
======== ======== ========
Net interest income $ 12,928* $ 12,220* $ 12,026*
========= ========= ======
Net interest income as a percentage of
average earning assets
Interest income 6.18% 6.90% 8.14%
Interest expense 1.29% 1.72% 2.86%
Net interest income 4.89% 5.18% 5.28%
==== ==== ====
* Tax equivalent basis - 34% tax rate used
Nonaccrual loans are included in "loans."
Interest income on loans include loan fees of $1,003,182, $778,605, and $708,270
in 2003, 2002, and 2001, respectively.
For purposes of computing the average yield, the Company used historical cost
balances which do not give effect to changes in fair value that are reflected as
a component of shareholders' equity.
-17-
Net interest income increased 6.4% to $12,541,000 in 2003 compared to 2002. The
increase is primarily the result of no provision for credit losses during the
year reflecting an improvement in the quality of the credit portfolio. The
Company's interest income increased 1.1% to $15,949,000 in 2003 from $15,779,000
in 2002. This increase is due to the increased balances in interest bearing
deposits in banks, fed funds sold, securities and loans. Although average
earning assets balances increased, the continued overall decline in market
interest rates resulted in a reduction in average interest rates for all
interest earning categories. However, lower interest rates also led to a 14.6%
decrease in interest expense to $3,408,000 in 2003, compared to $3,991,000 in
2002. Net interest income decreased 1.4% to $10,834,000 in 2002 compared to
2001. The decrease is primarily the result of a decreased interest rate
environment in addition to an increase of $374,000 in the provision for credit
losses during 2002. The Company's interest income decreased 12.8% to $15,779,000
in 2002 from $18,102,000 in 2001. The decrease was substantially offset by a
38.9% decrease in interest expense from $6,530,000 in 2001 to $3,991,000 in
2002.
The Company's average loan portfolio increased $9,502,000, or 5.3%, from yearend
2002 to yearend 2003, and increased $8,137,000, or 4.8%, from 2001 to 2002. The
growth in 2003 is primarily due to the opening of a loan production office on
August 1, 2003 in Gearhart, Oregon. A large portion of the Company's loan
portfolio rates are tied to variable rate indexes. Given the unprecedented drop
in rates experienced in both years 2001 and 2002 and the continued low interest
rate environment, the decrease in rates overshadowed the growth in the
portfolio, causing a further decline in the average interest rates earned.
The Company's average investment portfolio increased $15,426,000 or 32.5% from
2002. These investments were invested in various long-term investment products,
resulting in an increase in earnings on the investment portfolio due to the
change in yield earned on long-term products versus short-term products. The
Company's average investment portfolio increased $5,099,000, or 12%, during 2002
from 2001. The changes in 2002 were primarily during the third quarter of 2002
and were in U.S. Government mortgage backed securities.
The Company's average deposits increased $14,988,000 or 8.2% from 2002, and
increased $2,110,000 or 1.2% in 2002 from 2001. The primary reason for the
increase in 2003 is due to an increase of $16,357,000 in the Company's N.O.W.
checking accounts and an increase of $10,177,000 in money market accounts.
Management attributes the deposit growth to its targeted marketing program and
to consumer uncertainty regarding alternative investment options. Along with the
increase in average deposits, the Company was able to reprice its deposit
offerings to current market rates, yielding a decrease in interest expense.
The Company increased its average borrowings during 2003 by $7,523,000 or
114.9%. These borrowings consist of advances from the Federal Home Loan Bank of
Seattle. The proceeds were used to fund loan growth and for investment purposes.
The Company increased its average borrowings during 2002 by $6,548,000 or 100%.
Net interest margins were 4.75%, 5.05%, and 5.16% for the years ended December
31, 2003, 2002, and 2001, respectively.
-18-
The following table presents changes in net interest income attributable to
changes in volume or rate. Changes not solely due to volume or rate are
allocated to volume and rate based on the absolute values of each.
2003 compared to 2002 2002 compared to 2001
------------------------- --------------------------
Increase (decrease) due to Increase (decrease) due to
-------------------------- --------------------------
(dollars in thousands) Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
Interest earned on:
Loans $687 $(518) $169 $690 $(2,510) $(1,820)
Securities:
Taxable 602 (405) 197 301 (398) (97)
Tax-exempt 17 (132) (115) (43) (17) (60)
Total securities 619 (537) 82 258 (415) (157)
Federal Home Loan Bank Stock (123) (14) (137) (35) (30) (65)
Fed funds sold and
interest bearing deposits
in other banks 79 (68) 11 (156) (147) (303)
Total interest earning assets 1,262 (1,137) 125 757 (3,102) (2,345)
Interest paid on:
Savings and interest bearing
demand deposits (78) 331 253 39 1,276 1,315
Time deposits (218) 789 571 (191) 1,469 1,278
Other borrowings (254) 13 (241) (157) 103 (54)
Total interest bearing liabilities (550) 1,133 583 (309) 2,848 2,539
Change in net interest income 712 (4) 708 448 (254) (194)
Non-Interest Income. Non-interest income was $1,846,000 for 2003, a decrease of
$213,000 or 10.3% from 2002 when it totaled $2,059,000. The 2002 amount was an
increase of $530,000 or 34.7% compared to the 2001 total of $1,529,000.
In 2003, service charges on deposit accounts decreased $42,000 or 3.9% to a
total of $1,027,000 compared to $1,069,000 in 2002. The 2002 total was up
$241,000 or 29.1% compared to the 2001 total of $828,000. During the second half
of 2001, a new customer overdraft protection program was implemented which
contributed to the increase in service charges on deposit accounts during both
2001 and 2002. The decrease in 2003 was attributed to system changes related to
commercial deposit relationships in which one month's charges were not assessed.
Income from sources other than service charges on deposit accounts totaled
$819,000 in 2003, a decrease of $171,000 from 2002, or 17.3%. The primary reason
for the decrease was income and gains on sale from foreclosed real estate, which
decreased $266,000. The Company sold several foreclosed real estate properties
in 2002 that recognized gains. Other major components of non-interest income
were mortgage broker fees, gain on sale of loans and bank owned life insurance
income. Income from other sources for 2002 was $990,000, an increase of $289,000
or 41.2% compared to 2001, primarily due to collecting operating revenues from a
motel that was brought into foreclosed real estate and earnings from bank owned
life insurance.
-19-
The following table represents the principal categories of non-interest income
for each of the years in the three-year period ended December 31, 2003.
Increase Increase
(Decrease) (Decrease)
---------- ----------
(Dollars in thousands) 2003 Amount % 2002 Amount % 2001
------------------------------------------------------------------------------------------------------------
Service charges on deposit accounts $1,027 $(42) (3.9%) $1,069 $241 29.1% $828
Mortgage broker fees 101 98 326.7% 3 (29) (90.6%) 32
Income from and gains on sale of
foreclosed real estate 26 (266) (91.1%) 292 153 110.1% 139
Net gains from sales of loans 34 34 100.0% -- -- -- --
Net gain on sale of securities 4 4 100.0% -- -- -- --
Earnings on bank owned life insurance 328 (22) (6.3%) 350 183 109.6% 167
Other operating income 326 (19) (5.5%) 345 (18) (4.9%) 363
Total non-interest income 1,846 (213) (10.3%) 2,059 530 34.7% 1,529
Non-Interest Expense. Total non-interest expense in 2003 was $7,945,000, an
increase of $531,000 or 7.2% compared to $7,414,000 in 2002. In 2002
non-interest expense increased $221,000 or 3.1% compared to $7,193,000 in 2001.
Salary and employee benefits increased by $568,000, or 13.5%, in 2003 to
$4,764,000 and increased by $138,000, or 3.4%, in 2002 compared to 2001. Salary
and benefits increased primarily due to a larger employee base in 2003, as the
Company opened a loan production office during the year and increased staffing
levels in other areas, in addition to normal merit increases.
Occupancy and equipment expense decreased $19,000 or 1.9% in 2003 and increased
$21,000 or 2.2% in 2002. The decrease in 2003 was due to reduced equipment
depreciation expenses. The 2002 increase was the result of costs associated with
maintenance of buildings and equipment.
State taxes paid in 2003 totaled $69,000, a decrease of $137,000 or 66.5%
compared to 2002. This was the result of a tax refund pertaining to an
application filed by the Company with the Washington State Department of Revenue
for overpayment of business and occupation tax. State taxes decreased $21,000 in
2002 or 9.3% compared to 2001.
Data processing expense increased $37,000 or 13.8% compared to 2002, and
increased $54,000 or 25.2% in 2002 compared to 2001. The increases are primarily
due to costs associated with the opening of the loan production office and costs
related to continued enhancement of the Company's technology and security
systems.
Other expense increased $82,000 or 4.7% in 2003 compared to an increase of
$29,000 or 1.7% in 2002 over 2001. The increase in 2003 is due primarily to
increased advertising and marketing expenses, as the Company embarked on a
direct marketing program and implemented a community oriented advertising
program. The increase in 2002 is related primarily to an increase in advertising
expense of $30,000, professional fees of $35,000 and data processing costs of
$47,000, which offset decreases in legal expense of $33,000, travel expenses of
$10,000 and loan collection expense of $22,000.
-20-
The following table represents the principal categories of non-interest expense
for each of the years in the three-year period ended December 31, 2003.
Increase Increase
(Decrease) (Decrease)
---------- ----------
(Dollars in thousands) 2003 Amount % 2002 Amount % 2001
--------------------------------------------------------------------------------------------------------------
Salaries and employee benefits $4,764 $ 568 13.5% $4,196 $ 138 3.4% $4,058
Occupancy and equipment 965 (19) (1.9%) 984 21 2.2% 963
State taxes 69 (137) (66.5%) 206 (21) (9.3%) 227
Data processing 305 37 13.8% 268 54 25.2% 214
Other expense 1,842 82 4.7% 1,760 29 1.7% 1,731
Total non-interest expense $7,945 $ 531 7.2% $7,414 $ 221 3.1% $7,193
====== ====== ==== ====== ====== ==== ======
CRITICAL ACCOUNTING POLICY
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America. The
financial information contained within these statements is, to a significant
extent, financial information that is based on approximate measures of the
financial effects of transactions and events that have already occurred. Based
on its evaluation of accounting policies that involve the most complex and
subjective decisions and assessments, management has identified its most
critical accounting policy as related to the allowance for credit losses. The
Company's allowance for credit loss methodology incorporates a variety of risk
considerations, both quantitative and qualitative, in establishing an allowance
for credit losses that management believes is appropriate at each reporting
date. Quantitative factors include the Company's historical loss experience,
delinquency and charge-off trends, collateral values, changes in nonperforming
loans, and other factors. Quantitative factors also incorporate known
information about individual loans, including borrowers' sensitivity to interest
rate movements. Qualitative factors include the general economic environment in
the Company's markets, including economic conditions and, in particular, the
state of certain industries. Size and complexity of individual credits in
relation to loan structure, existing loan policies and pace of portfolio growth
are other qualitative factors that are considered in the methodology. As the
Company adds new products and increases the complexity of its loan portfolio, it
intends to enhance its methodology accordingly. A materially different amount
could be reported for the provision for credit losses in the statement of
operations to change the allowance for credit losses if management's assessment
of the above factors were different. This discussion and analysis should be read
in conjunction with the Company's financial statements and the accompanying
notes presented elsewhere herein, as well as the portion of this Management's
Discussion and Analysis section entitled "Lending - Allowance and Provision for
Credit Losses". Although management believes the levels of the allowance as of
both December 31, 2003 and 2002 were adequate to absorb losses inherent in the
loan portfolio, a decline in local economic conditions, or other factors, could
result in increasing losses that cannot reasonably be predicted at this time.
ASSET AND LIABILITY MANAGEMENT
The largest component of the Company's earnings is net interest income. Interest
income and interest expense are affected by general economic conditions,
competition in the market place, market interest rates and repricing and
maturity characteristics of the Company's assets and liabilities. Exposure to
interest rate risk is primarily a function of differences between the maturity
and repricing schedules of assets (principally loans and investment securities)
and liabilities (principally deposits). Assets and liabilities are described as
interest sensitive for a given period of time when they mature or can reprice
within that period. The difference between the amount of interest sensitive
assets and interest sensitive liabilities is referred to as the interest
sensitive "GAP" for any given period. The "GAP" may be either positive or
negative. If positive, more assets reprice than liabilities. If negative, the
reverse is true.
-21-
Certain shortcomings are inherent in the interest sensitivity "GAP" method of
analysis. Complexities such as prepayment risk and customer responses to
interest rate changes are not taken into account in the "GAP" analysis.
Accordingly, management also utilizes a net interest income simulation model to
measure interest rate sensitivity. Simulation modeling gives a broader view of
net interest income variability, by providing various rate shock exposure
estimates. Management regularly reviews the interest rate risk position and
provides measurement reports to the Board of Directors.
The following table shows the dollar amount of interest sensitive assets and
interest sensitive liabilities at December 31, 2003 and differences between them
for the maturity or repricing periods indicated.
Due after
Due in one one through Due after
(dollars in thousands) year or less five years five years Total
--------------------------------------------------------------------------------------------
Interest earning assets
Loans $ 78,261 $ 43,407 $ 78,070 $199,738
Investment securities 27,136 21,652 16,673 65,461
Fed Funds and interest
bearing balances with banks 20,392 -- -- 20,392
Federal Home Loan Bank Stock -- -- 915 915
Total interest earning assets $125,789 $ 65,059 $ 95,658 $286,506
Interest bearing liabilities
Interest bearing demand deposits $ 47,388 $ -- $ -- $ 47,388
Savings deposits 84,105 -- -- 84,105
Time deposits 59,040 26,405 -- 85,445
Long term borrowings 2,000 6,500 6,000 14,500
Total interest bearing liabilities $192,533 $ 32,905 $ 6,000 $231,438
Net interest rate sensitivity GAP $(66,744) $ 32,154 $ 89,658 $ 55,068
Cumulative interest rate sensitivity GAP $(34,590) $ 55,068 $ 55,068
Cumulative interest rate sensitivity GAP
as a % of earning assets (12.1%) 19.2% 19.2%
-22-
The following table shows the dollar amount of interest sensitive assets and
interest sensitive liabilities at December 31, 2002 and difference between them
for the maturity or repricing periods indicated.
Due after
Due in one one through Due after
(dollars in thousands) year or less five years five years Total
------------------------------------------------------------------------------------------
Interest earning assets
Loans $ 70,081 $ 45,383 $ 70,326 $185,790
Investment securities 23,856 18,445 20,291 62,592
Fed Funds and interest
bearing balances with banks 373 -- -- 373
Federal Home Loan Bank Stock -- -- 866 866
Total interest earning assets $ 94,310 $ 63,828 $ 91,483 $249,621
Interest bearing liabilities
Interest bearing demand deposits $ 31,030 $ -- $ -- $ 31,030
Savings deposits 72,163 -- -- 72,163
Time deposits 71,441 10,536 -- 81,977
Short term borrowings 1,800 0 -- 1,800
Long term borrowings -- 5,000 6,000 11,000
Total interest bearing liabilities $176,434 $ 15,536 $ 6,000 $197,970
Net interest rate sensitivity GAP $(82,124) $ 48,292 $ 85,483 $ 51,651
Cumulative interest rate sensitivity GAP $ 33,832) $ 51,651 51,651
Cumulative interest rate sensitivity GAP
as a % of earning assets (13.6%) 20.7% 20.7%
Effects of Changing Prices. The results of operations and financial conditions
presented in this report are based on historical cost information, and are
unadjusted for the effects of inflation. Since the assets and liabilities of
financial institutions are primarily monetary in nature, the performance of the
Company is affected more by changes in interest rates than by inflation.
Interest rates generally increase as the rate of inflation increases, but the
magnitude of the change in rates may not be the same.
The effects of inflation on financial institutions is normally not as
significant as its influence on businesses which have investments in plants and
inventories. During periods of high inflation there are normally corresponding
increases in the money supply, and financial institutions will normally
experience above-average growth in assets, loans and deposits. Inflation does
increase the price of goods and services, and therefore operating expenses
increase during inflationary periods.
-22-
INVESTMENT PORTFOLIO
The Company's investment securities portfolio increased $2,869,000, or 4.6%
during 2003 to $65,461,000 at year end from $62,592,000 in 2002, which was a
$25,974,000 increase over 2001. The changes in 2003 were primarily in U.S.
Government agency mortgaged backed securities. Based on the low interest rate
environment during 2002, the Bank borrowed long term funds from the Federal Home
Loan Bank of Seattle totaling $7,000,000 and purchased U.S. Government agency
mortgage backed securities. The transaction resulted in a yield spread of 195
basis points.
The carrying values of investment securities at December 31 in each of the last
three years are as follows:
HELD TO MATURITY
(dollars in thousands) 2003 2002 2001
--------------------------------------------------------------------------------
U.S. Agencies securities $ 2,944 $ 6,611 $ -0-
Obligations of states and political subdivisions 5,044 3,751 4,945
Total $ 7,988 $10,362 $ 4,945
AVAILABLE FOR SALE
U.S. Agencies securities 18,030 19,164 6,872
Obligations of states and political subdivisions 14,751 12,098 11,713
Other securities 24,692 20,968 13,088
Total $57,473 $52,230 $31,673
The following table presents the maturities of investment securities at December
31, 2003. Taxable equivalent values are used in calculating yields assuming a
tax rate of 34%.
HELD TO MATURITY
Due after Due after
Due in one one through five through Due after
(dollars in thousands) year or less five years ten years ten years Total
----------------------------------------------------------------------------------------------------------
U.S. Agency securities $ -- $ -- $ -- $ 2,944 $ 2,944
Weighted average yield -- -- -- 4.05%
Obligations of states and political
subdivisions $ 449 $ 1,598 $ 964 $ 2,033 $ 5,044
Weighted average yield 4.01% 4.15% 7.14% 7.06%
Total $ 449 $ 1,598 $ 964 $ 4,977 $ 7,988
AVAILABLE FOR SALE
U.S. Agency securities $ 1,620 $ 498 $ 3,220 $12,692 $18,030
Weighted average yield 5.63% 2.62% 3.56% 3.97%
Obligations of states and political
subdivisions $ 2,226 $ 7,663 $ 3,126 $ 1,736 $14,751
Weighted average yield 7.23% 6.61% 6.53% 6.60%
Other securities $20,459 $ 3,134 $ 1,099 0 $24,692
Weighted average yield 2.35% 5.83% 4.06% 0
Total $24,305 $11,295 $ 7,445 $14,428 $57,473
-23-
LENDING
General. The Company's policy is to originate loans primarily in its local
markets. Depending on the purpose of the loan, the loans may be secured by a
variety of collateral, including business assets, real estate, and personal
assets.
The following table sets forth the composition of the Company's loan portfolio
at December 31 in each of the past five years.
(dollars in thousands) 2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Commercial $ 64,344 $ 69,794 $ 72,427 $ 68,827 $ 56,198
Real Estate Construction 11,894 9,697 6,554 6,118 3,325
Real Estate Mortgage 117,940 101,151 91,714 96,334 88,905
Installment 4,625 4,114 4,941 4,612 3,379
Credit cards and overdrafts 935 1,034 968 1,277 857
Total $199,738 $185,790 $176,604 $177,168 $152,664
Loan Maturities and Sensitivity in Interest Rates. The following table presents
information related to maturity distribution and interest rate sensitivity of
commercial and real estate construction loans outstanding, based on scheduled
repayments at December 31, 2003.
Due after
Due in one one through Due after
(dollars in thousands) year or less five years five year Total
------------ ----------- ---------- --------
Commercial $ 38,964 $ 13,648 $ 11,732 $ 64,344
Real estate construction 7,967 726 3,201 11,894
Total $ 46,931 $ 14,374 $ 14,933 $ 76,238
Total loans maturing after one year with
Predetermined interest rates (fixed) $ 27,484 $115,665 $143,149
Floating or adjustable rates (variable) 13,323 2,358 15,681
Total
$ 40,807 $118,023 $158,830
At December 31, 2003, 39.2% of the total loan portfolio presented above was due
in one year or less.
Risk Elements. Risk elements include accruing loans past due ninety days or
more, non-accrual loans, and loans which have been restructured to provide
reduction or deferral of interest or principal for reasons related to the
debtor's financial difficulties. The Company's policy for placing loans on
non-accrual status is based upon management's evaluation of the ability of the
borrower to meet both principal and interest payments as they become due.
Generally, loans with interest or principal payments which are ninety or more
days past due are placed on non-accrual, unless they are well-secured and in the
process of collection, and the interest accrual is reversed against income.
The following table presents information related to the Company's non-accrual
loans and other non-performing assets at December 31 in each of the last five
years.
(dollars in thousands) 2003 2002 2001 2000 1999
--------------------------------------------------------------------------------
Non-accrual loans $ 465 $1,864 $1,254 $3,128 $ 175
Accruing loans past due
90 days or more -- 2 79 292 140
Restructured loans -- -- -- -- 0
Foreclosed real estate owned 98 686 1,040 -- 177
-24-
Non-accrual loans decreased approximately $1,399,000 to $465,000 in 2003 from
2002. The total is net of charge-offs based on management's estimate of fair
market value or the result of appraisals. The properties consist of real estate
and commercial real estate properties. During 2003, sales of foreclosed real
estate owned totaled $1,363,000. At December 31, 2003, the balance remaining in
foreclosed real estate owned totaled $98,000. Non-accrual loans decreased
$1,874,000 to $1,254,000 at year-end 2001 after increasing to $3,128,000 in 2000
from $175,000 in 1999. The increase in non-accrual loans experienced in 2000 was
attributable to the decline in the regional and national economies and the local
agriculture economy. Interest income on non-accrual loans that would have been
recorded had those loans performed in accordance with their initial terms, as of
December 31, was $37,000 for 2003, $118,000 for 2002, $75,000 for 2001, $168,000
for 2000 and $10,000 for 1999. Interest income recognized on impaired loans for
2003 was $19,000, for 2002 was $13,000, for 2001 was $2,000, for 2000 was
$31,000, and for 1999 was $11,000.
Loan Concentrations. The Company has credit risk exposure related to real estate
loans. The Company makes real estate loans for construction and loans for other
purposes which are secured by real estate. At December 31, 2003, loans secured
by real estate totaled $129,834,000, which represents 65% of the total loan
portfolio. Real estate construction loans comprised $11,894,000 of that amount,
while real estate loans secured by residential properties totaled $26,615,000.
As a result of these concentrations of loans, the loan portfolio is susceptible
to changes in economic and market conditions in the Company's market areas. The
Company generally requires collateral on all real estate exposures and typically
maintains loan-to-value ratios of no greater than 80%.
Allowance and Provision 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
loan 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.
Periodic provisions for loan 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.
-25-
Transactions in the allowance for credit losses for the five years ended
December 31, 2003 are as follows:
(dollars in thousands) 2003 2002 2001 2000 1999
--------------------------------------------------------------------------------
Balance at beginning of year $2,473 $2,109 $2,026 $1,930 $1,864
Charge-offs:
Commercial 17 131 170 554 114
Real estate loans 239 461 366 -- --
Credit card 6 16 13 6 13
Installment 3 24 15 8 7
Total charge-of $ 265 $ 632 $ 564 $ 568 $ 134
Recoveries:
Commercial $ 5 $ 11 $ 54 $ 15 $ 23
Real estate loans 23 28 12 110
Credit card 1 2 -- -- 6
Installment 1 1 13 2 1
Total recoveries $ 30 $ 42 $ 67 $ 29 $ 140
Net charge-offs (recoveries) 235 590 497 539 (6)
Provision for credit losses 0 954 580 635 60
Balance at end of year $2,238 $2,473 $2,109 $ 2,026 $1,930
Ratio of net charge-offs (recoveries)
to average loans outstanding .12% .33% .29% .33% --
The allowance for credit losses was $2,238,000 at year-end 2003, compared with
$2,473,000 at year-end 2002, a decrease of $235,000 or 9.5%. The aggregate
decrease resulted from the net charge-offs totaling $235,000 in 2003. The
decreased level of allowance for credit losses was primarily due to improvement
in the quality of the loan portfolio and decreased loss factors utilized in the
allowance for loan loss analysis. Changes in the composition of the loan
portfolio included a 7.8% decrease in commercial loans, while real estate
construction and real estate mortgage loans increased 39.3%. Estimated loss
factors used in the allowance for credit loss analysis are established based in
part on historic charge-off data by loan category and economic conditions. Based
on the trends in historical charge-offs analysis, the loss factors used in the
allowance for credit loss analysis for commercial loans and real estate loans
were increased during the year ended December 31, 2003.
Based on the methodology used for credit loss analysis, management deemed the
allowance for credit losses of $2,238,000 at December 31, 2003 (1.12% of total
loans outstanding and 411.40% of non-performing loans) adequate to provide for
estimated losses based on an evaluation of known and inherent risks in the loan
portfolio at that date.
In May 1993, the Financial Accounting Standards Board (FASB) issued SFAS No.
114, "Accounting by Creditors for Impairment of a Loan" and in October 1996,
issued SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income
Recognition Disclosures, an amendment to SFAS No. 114". The Company measures
impaired loans based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, as a practical expedient,
at the loan's observable market price or the fair market value of the collateral
if the loan is collateral dependent. The Company excludes loans that are
currently measured at fair value or at the lower of cost or fair value, and
certain large groups of smaller balance homogeneous loans that are collectively
measured for impairment. The Company's Board of Directors approved a change in
definition of impaired loans during 2003. Impaired loans now include all loans
in non-accrual status over $5,000 and loans in excess of $1,000,000 that meet at
least watch status risk characteristics.
-26-
The following table summarizes the Bank's impaired loans at December 31:
(dollars in thousands) 2003 2002 2001 2000 1999
-------------------------------------------------------------------------------------------
Total Impaired Loans $11,147 $ 2,314 $ 1,662 $ 3,128 $ 175
Total Impaired Loans with Valuation Allowance 123 18 1,180 1,114 --
Valuation Allowance related to Impaired Loans 23 2 143 412 --
No allocation of the allowance for credit losses was considered necessary for
the remaining impaired loans. The balance of the allowance for credit losses in
excess of these specific reserves is available to absorb losses from all loans.
It is the Company's policy to charge-off any loan or portion of a loan that is
deemed uncollectible in the ordinary course of business. The entire allowance
for credit losses is available to absorb such charge- offs. The Company
allocates its allowance for credit losses primarily on the basis of historical
data. Based on certain characteristics of the portfolio, losses can be
anticipated for major loan categories.
The following table presents the allocation of the allowance for credit losses
among the major loan categories based primarily on their historical net
charge-off experience and other business considerations at December 31 in each
of the last five years.
% of % of % of % of % of
2003 Total 2002 Total 2001 Total 2000 Total 1999 Total
(Dollars in thousands) Reserve Loans Reserve Loans Reserve Loans Reserve Loans Reserve Loans
-----------------------------------------------------------------------------------------------------------------------------
Commercial loans $ 764 32% 967 37% $ 548 41% $ 689 39% $ 720 37%
Real estate loans 1,399 65% $1,406 60% 1,413 56% 1,256 58% 1,153 60%
Consumer loans 75 3% 100 3% 148 3% 81 3% 58 3%
Total allowance $2,238 100% $2,473 100% $2,109 100% $2,026 100% $1,930 100%
Ratio of allowance for credit
losses to loans outstanding
at end of year 1.12% 1.33% 1.19% 1.14% 1.26%
The table indicates a decrease of $203,000 in the allowance related to
commercial loans from December 31, 2002 to December 31, 2003, a decrease of
$7,000 relating to real estate loans, and a decrease of $25,000 related to
consumer loans. There was an increase of $419,000 from December 31, 2001 to
December 31, 2002 in the allowance related to commercial loans, which was offset
by decreases of $7,000 in real estate loans and $48,000 in consumer loans during
the same period.
-27-
DEPOSITS
The Company's primary source of funds has historically been customer deposits. A
variety of deposit products are offered to attract customer deposits. The
products include non-interest bearing demand accounts, negotiable order of
withdrawal (NOW) accounts, savings accounts, and time deposits. Interest-bearing
accounts earn interest at rates established by management, based on competitive
market factors and the need to increase or decrease certain types of maturities
of deposits. The Company has succeeded in growing its deposit base over the last
three years despite increasing competition for deposits in our markets. The
Company believes that it has benefited from its local identity and superior
customer service. Attracting deposits remains integral to the Company's business
as it is the primary source of funds for loans and a major decline in deposits
or failure to attract deposits in the future could have an adverse effect on
operations.
The following table sets forth the average balances for each major category of
deposits and the weighted average interest rate paid for deposits for the
periods indicated.
(dollars in thousands) 2003 RATE 2002 RATE 2001 RATE
---------------------------------------------------------------------------------------------
Demand deposits $ 42,864 0.00% $ 36,180 0.00% $ 33,419 0.00%
Interest bearing demand deposits 33,251 .42% 29,137 .76% 26,949 2.09%
Savings deposits 78,878 .87% 74,974 1.15% 78,897 2.32%
Time deposits 86,634 2.42% 79,664 3.35% 75,819 5.20%
Total $241,627 1.20% $219,955 1.70% $215,084 3.49%
Maturities of time certificates of deposit as of December 31, 2003 are
summarized as follows:
Under Over
(dollars in thousands) $100,000 $100,000 Total
--------- --------- --------
3 months or less $ 9,030 $11,866 $20,895
Over 3 through 6 months 7,453 8,201 15,654
Over 6 through 12 months 11,788 10,702 22,490
Over 12 months 13,566 12,839 26,405
Total 41,837 43,608 85,445
SHORT-TERM BORROWINGS
The following is information regarding the Company's short-term borrowings for
the years ended December 31, 2003, 2002 and 2001.
(dollars in thousands) 2003 2002 2001
--------------------------------------------------------------------------------
Amount outstanding at end of period $-- $1,800 $ --
Weighted average interest rate thereon 0% 1.35% 0%
Maximum amount outstanding at any month end during period $-- $2,790 $7,580
Average amounts outstanding during the period -- 174 963
Weighted average interest rate during period 0% 2.48% 5.68%
-28-
CONTRACTUAL OBLIGATIONS
The following is information regarding the Company's long-term obligations,
which consists of borrowings from the Federal Home Loan Bank, for the year ended
December 31, 2003.
Payments due by Period
----------------------
Less than 1-3 3-5 More than
Total 1 year years years 5 years
----- --------- ----- ----- ---------
Contractual obligations
------------------------------------------------------------------------------
Other Long-term Liabilities $14,500 2,000 3,000 9,500 0
KEY FINANCIAL RATIOS
Year ended December 31, 2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Return on average assets 1.61% 1.54% 1.55% 1.34% 1.64%
Return on average equity 17.10% 15.81% 15.57% 14.95% 17.26%
Average equity to average assets ratio 9.44% 9.74% 9.96% 8.96% 9.49%
Dividend payout ratio 77% 87% 86% 97% 79%
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The primary concern of depositors, creditors and regulators is the
Company's ability to have sufficient funds readily available to repay
liabilities as they mature. In order to ensure adequate funds are available at
all times, the Company monitors and projects the amount of funds required on a
daily basis. Through the Bank, the Company obtains funds from its customer base,
which provides a stable source of "core" demand and consumer deposits.
Other sources are available with borrowings from the Federal Home Loan Bank of
Seattle and correspondent banks. Liquidity requirements can also be met through
disposition of short-term assets. In management's opinion, the Company maintains
an adequate level of liquid assets, consisting of cash and due from banks,
interest bearing deposits with banks, and federal funds sold to support the
daily cash flow requirements.
Management expects to continue to rely on customer deposits as the primary
source of liquidity, but may also obtain liquidity from maturity of its
investment securities, sale of securities currently available for sale, net
income, and other borrowings. Although deposit balances have shown historical
growth, deposit habits of customers may be influenced by changes in the
financial services industry, interest rates available on other investments,
general economic conditions, consumer confidence, and competition. Borrowings
may be used on a short-term basis to compensate for reductions in deposits, but
are generally not considered a long term solution to liquidity issues.
Therefore, reductions in deposits could adversely affect the Company's results
of operations.
Capital. The Company endeavors to maintain equity capital at an adequate level
to support and promote investor confidence. The Company conducts its business
through the Bank. Thus, the Company needs to be able to provide capital and
financing to the Bank should the need arise. The primary sources for obtaining
capital are additional stock sales and retained earnings. Total shareholders'
equity averaged $26,786,000 in 2003, compared to $24,766,000 in 2002, an
increase of 8.2%, and $24,451,000 in 2001, an increase of 10.7% compared to
2000.
-29-
The Company's Board of Directors considers financial results, growth plans, and
anticipated capital needs in formulating its dividend policy. The payment of
dividends is subject to adequate financial results of the Bank, and limitations
imposed by law and governmental regulations.
The Federal Reserve has established guidelines that mandate risk-based capital
requirements for bank holding companies. Under the guidelines, one of four risk
weights is applied to balance sheet assets, each with different capital
requirements based on the credit risk of the asset. The Company's capital ratios
include the assets of the Bank on a consolidated basis in accordance with the
requirements of the Federal Reserve. The Company's capital ratios have exceeded
the minimum required to be classified "well capitalized" for each of the past
three years.
The following table sets forth the minimum required capital ratios and actual
ratios for December 31, 2003 and 2002.
Capital
Adequacy
Actual Purposes
(dollars in thousands) Amount Ratio Amount Ratio
--------------------------------------------------------------------------------
December 31, 2003
Tier 1 capital (to average assets) $25,093 8.46% $11,864 4.00%
Tier 1 capital (to risk-weighted 25,093 11.56% 8,686 4.00%
assets)
Total capital (to risk-weighted 27,331 12.59% 17,372 8.00%
assets)
December 31, 2002
Tier 1 capital (to average assets) $23,966 8.92% $10,753 4.00%
Tier 1 capital (to risk-weighted 23,966 11.73% 8,172 4.00%
assets)
Total capital (to risk-weighted 26,457 12.95% 16,344 8.00%
assets)
OTHER EVENTS
On October 22, 2003, the Company announced the signing of a definitive agreement
for the acquisition of BNW Bancorp, Inc. ("BNW") by merger. Upon completion of
the transaction on Februaruy 27, 2004, each share of BNW common stock was
converted into the right to receive 0.85 shares of the Company's common stock,
resulting in the issuance of approximately 636,673 of the Company's common
stock. Simultaneous with the merger of BNW into Pacific, BNW's subsidiary Bank
NorthWest was merged into Bank of the Pacific.
As a result of the merger of BNW into Pacific, the Company had assets of
approximately $407 million, deposits of approximately $339 million, and
shareholders equity of approximately $44 million, at February 29, 2004. BNW had
net interest income of $4,822,622, noninterest income of $1,259,821, and
noninterest expense of $5,078,774 for fiscal year 2003. There is no assurance
that the five branches acquired from BNW in the merger will achieve similar
results in 2004, or future years.
-30-
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company's results of operations are largely dependent upon its ability to
manage interest rate risk. Management considers interest rate risk to be a
significant market risk that could have a material effect on the Company's
financial condition and results of operations. The Company does not currently
use derivatives to manage market and interest rate risks. All of the Company's
transactions are denominated in U.S. dollars. Approximately 30% of the Company's
loans have interest rates that float with the Company's reference rate. Fixed
rate loans generally are made with a term of five years or less.
In the Asset and Liability section of the Management's Discussion and Analysis
in Item 7 is a table presenting estimated maturity or pricing information
indicating the Company's exposure to interest rate changes. The assumptions and
description of the process used to manage interest rate risk is further
discussed in the Asset and Liability Management section. The following table
discloses the balances of financial instruments held by the Company, including
the fair value as of December 31, 2003.
The expected maturities are disclosed based on contractual schedules. Principal
repayments are not considered. The expected maturities for financial liabilities
with no stated maturity reflect estimated future roll-off rates. The roll-off
rates for non-interest bearing deposits, interest bearing demand deposits, money
market accounts, and savings deposits are 15%, 25%, 25% and 20%, respectively.
The interest rates disclosed are based on rates in effect at December 31, 2003.
Fair values are estimated in accordance with generally accepted accounting
principles as disclosed in the financial statements.
Expected Maturity
Year ended December 31, 2003 there Fair
(dollars in thousands) 2004 2005 2006 2007 2008 after Total Value
-------------------------------------------------------------------------------------------------------------------------------
Financial Assets
Cash and cash equivalents
Non-interest bearing $ 9,280 -- -- -- -- -- $ 9,280 $ 9,280
Interest bearing deposits in banks $15,392 -- -- -- -- -- $ 15,392 $ 15,392
Weighted average interest rate 1.24%
Federal funds sold
Fixed rate $ 5,000 -- -- -- -- -- $ 5,000 $ 5,000
Weighted average interest rate .90%
Securities available for sale
Fixed rate $ 3,846 $ 4,156 $ 3,188 $ 984 $ 1,151 $21,308 $ 34,633 $ 34,633
Weighted average interest rate 6.33% 6.03% 4.27% 3.92% 4.28% 3.48%
Adjustable rate $20,459 -- -- -- -- $ 2,381 $ 22,840 $ 22,840
Weighted average interest rate 2.35% 2.19%
Securities held to maturity
Fixed rate $ 449 -- $ 56 $ 854 $ 688 $ 5,941 $ 7,988 $ 8,097
Weighted average interest rate 3.02% 4.50% 2.50% 2.90% 3.71%
Loans receivable
Fixed rate $35,250 $ 5,484 $ 9,120 $8,528 $ 6,769 $75,299 $140,450 $141,161
Weighted average interest rate 6.49% 7.78% 6.94% 7.20% 7.04% 7.06%
Adjustable rate $43,207 $ 399 $ 5,686 $ 1,744 $ 5,894 $ 2,358 $ 59,288 $ 59,288
Weighted average interest rate 5.27% 3.53% 5.97% 7.08% 5.23% 6.08%
Federal Home Loan Bank stock $ 915 -- -- -- -- -- $ 915 $ 915
Weighted average interest rate 5.52%
-31-
Expected Maturity
Year ended December 31, 2002 there Fair
(dollars in thousands) 2004 2005 2006 2007 2008 after Total Value
--------------------------------------------------------------------------------------------------------------------------------
Financial Liabilities
Non-interest bearing deposits $ 6,579 $ 9,321 $ 6,990 $ 4,194 $ 3,355 $13,423 $ 43,862 $ 43,862
Interest bearing checking accounts $ 7,108 $10,070 $ 7,552 $ 5,664 $ 3,399 $13,595 $ 47,388 $ 47,388
Weighted average interest rate .54% .54% .54% .54% .54% .54%
Money Market accounts $ 4,770 $ 6,756 $ 5,067 $ 3,801 $ 2,280 $ 9,123 $ 31,797 $ 31,797
Weighted average interest rate .86% .86% .86% .86% .86% .86%
Savings accounts $ 7,846 $11,115 $ 8,336 $ 5,002 $ 4,002 $16,007 $ 52,308 $ 52,308
Weighted average interest rate .80% .80% .80% .80% .80% .80%
Certificates of deposit
Fixed rate $56,274 $ 8,319 $ 2,007 $ 3,318 $ 5,584 -- $ 75,502 $ 76,218
Weighted average interest rate 1.61% 2.13% 2.97% 4.66% 3.91%
Variable rate $ 9,943 -- -- -- -- -- $ 9,943 $ 9,943
Weighted average interest rate 3.31%
Borrowings
Fixed rate $ 2,000 $ 2,000 $ 1,000 -- $ 3,500 $ 6,000 $ 14,500 $ 12,905
Weighted average interest rate 3.20% 4.41% 3.48% 2.94% 3.49%
As illustrated in the tables above, our balance sheet is currently sensitive to
decreasing interest rates, meaning that more interest bearing assets mature or
re-price than interest earning liabilities. Therefore, if our asset and
liability mix were to remain unchanged, and there was a decrease in market rates
of interest, the Company would expect that its net income would be adversely
affected. In contrast, an increasing interest rate environment would positively
affect such income. While the table presented above provides information about
the Company's interest sensitivity, it does not predict the trends of future
earnings. For this reason, financial modeling is used to forecast earnings under
varying interest rate projections. While this process assists in managing
interest rate risk, it does require significant assumptions for the projection
of loan prepayments, loan origination volumes and liability funding sources that
may prove to be inaccurate.
ITEM 8. Financial Statements and Supplementary Data
Information required for this item is included in Item 15 of this report.
ITEM 9. Changes in and disagreements with accountants on accounting and
financial disclosure
Not applicable.
ITEM 9A. Controls and Procedures
Pacific's disclosure controls and procedures are designed to ensure that
information the Company must disclose in its reports filed or submitted under
the 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
-32-
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 Pacific'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.
Part III
ITEM 10. Directors and Executive Officers of the Registrant
Information concerning directors and executive officers requested by this item
is contained in the registrant's 2004 Proxy Statement for its annual meeting of
shareholders to be held on April 28, 2004 ("2004 Proxy Statement"), in the
sections entitled "MANAGEMENT-Certain Executive Officers," "Proposal No. 1 -
Election of Directors," and "Compliance with Section 16(a) of the Exchange Act"
and is incorporated into this report by reference.
The Board of Directors adopted a Code of Ethics for the Company's executive
officers that requires the Company's officers to maintain the highest standards
of professional conduct. A copy of the Code of Ethics is available on the
Company's Web site www.thebankofpacific.com under the link called Stockholder
Information and President's Letter.
The Company has a separately designated Audit Committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act. The committee is
composed of Directors Duane E. Hagstrom, Gary C. Forcum, Robert Hall, Ed Ketel,
Randy Rognlin, Walter Westling and David Woodland, each of whom is independent
as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act.
In determining independence of board members, the Company's board of directors
has applied the definition of independence found in the Nasdaq listing
standards.
The Company's Board of Directors has determined that Duane E. Hagstrom and Gary
Forcum are audit committee financial experts as defined in Item 401(h) of the
SEC's Regulation S-K. Directors Hagstrom and Forcum are independent as that term
is used in Item 7(d)(3)(iv) of Schedule 14A.
ITEM 11. Executive Compensation
Information concerning executive compensation requested by this item is
contained in the registrant's 2004 Proxy Statement in the sections entitled
"DIRECTOR COMPENSATION" and "EXECUTIVE COMPENSATION" (not including "Audit
Committee Report," "Report of the Compensation Committee" and "Stock Performance
Graph"), and is incorporated into this report by reference.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information concerning security ownership of certain beneficial owners and
management requested by this item is contained in the registrant's 2004 Proxy
Statement in the section entitled "MANAGEMENT - Security Ownership of Certain
Beneficial Owners and Management," and is incorporated into this report by
reference.
-33-
Equity Compensation Plan Information. The following table summarizes share and
exercise price information about the Company's equity compensation plans as of
December 31, 2003.
(a) (b) (c)
Number of securities Weighted-average Number remaining
to be issued upon exercise price available for future
exercise of of outstanding issuance under equity
outstanding options, options, warrants compensation plans
warrants and rights and rights (excluding securities
reflected in column (a)
Plan Category
------------- -------------------- ----------------- ------------------------
Equity compensation plans approved
by security holders: 232,950 $23.25 296,500
Equity compensation plans not approved
by security holders: -- -- --
Total 232,950 $23.25 296,500
======= ====== =======
ITEM 13. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions requested
by this item is contained in the registrant's 2004 Proxy Statement in the
section entitled "Compensation Committee Interlocks and Insider Participation"
and is incorporated into this report by reference.
ITEM 14. Principal Accountant Fees and Services
Information concerning fees paid to our accountants required by this item is
included under the heading "AUDITORS - Fees Paid to Auditors" in the
registrant's 2004 Proxy Statement and is incorporated into this report by
reference.
Part IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) The following financial statements are filed below:
Independent Auditor's Report
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
-34-
McGladrey & Pullen, LLP is a member firm of RSM International -
an affiliation of separate and independent legal entities.
Independent Auditor's Report
Board of Directors
Pacific Financial Corporation
Aberdeen, Washington
We have audited the accompanying consolidated balance sheets of Pacific
Financial Corporation and Subsidiary as of December 31, 2003 and 2002, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pacific Financial
Corporation and Subsidiary as of December 31, 2003 and 2002, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Tacoma, Washington
January 30, 2004
-35-
Consolidated Balance Sheets
--------------------------------------------------------------------------------
(Dollars in Thousands)
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
2003 2002
Assets
Cash and due from banks $ 9,280 $ 8,473
Interest bearing deposits in banks 15,392 373
Federal funds sold 5,000 --
Securities available for sale 57,473 52,230
Securities held to maturity (market value $8,097 and $10,414) 7,988 10,362
Federal Home Loan Bank stock, at cost 915 866
Loans held for sale -- 286
Loans 199,738 185,504
Allowance for credit losses 2,238 2,473
Loans - net 197,500 183,031
Premises and equipment 3,967 3,850
Foreclosed real estate 98 686
Accrued interest receivable 1,275 1,493
Cash surrender value of life insurance 6,193 5,898
Other assets 1,634 986
Total assets $306,715 $268,534
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand, non-interest bearing 43,862 $ 40,084
Savings and interest-bearing demand 131,493 103,193
Time, interest-bearing 85,445 81,977
Total deposits 260,800 225,254
Accrued interest payable 234 318
Short-term borrowings -- 1,800
Long-term borrowings 14,500 11,000
Other liabilities 5,531 5,479
Total liabilities 281,065 243,851
Commitments and Contingencies -- --
Shareholders' Equity
Common stock (par value $1); authorized: 25,000,000 shares;
issued and outstanding: 2003 - 2,521,539 shares; 2,522 2,513
2002 - 2,512,659 shares
Additional paid-in capital 10,005 9,839
Retained earnings 12,663 11,614
Accumulated other comprehensive income 460 717
Total shareholders' equity 25,650 24,683
Total liabilities and shareholders' equity $306,715 $268,534
See notes to consolidated financial statements.
-36-
Consolidated Statements of Income
--------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
Interest Income
Loans $13,350 $13,175 $14,994
Federal funds sold and deposits in banks 118 107 410
Securities available for sale:
Taxable 1,570 1,401 1,638
Tax-exempt 484 501 545
Securities held to maturity:
Taxable 168 139 --
Tax-exempt 210 270 264
Federal Home Loan Bank stock dividends 49 186 251
Total interest income 15,949 15,779 18,102
====== ====== ======
Interest Expense
Deposits 2,923 3,747 6,340
Short-term borrowings -- 4 190
Long-term borrowings 485 240 --
Total interest expense 3,408 3,991 6,530
====== ====== ======
Net interest income 12,541 11,788 11,572
====== ====== ======
Provision for Credit Losses -- 954 580
Net interest income after provision for credit losses 12,541 10,834 10,992
====== ====== ======
Non-Interest Income
Service charges on deposit accounts 1,027 1,069 828
Mortgage broker fees 101 3 32
Income from and gains on sale of foreclosed real estate 26 292 139
Net gains from sales of loans 34 -- --
Net gains on sales of securities available for sale 4 -- --
Earnings on bank owned life insurance 328 350 167
Other operating income 326 345 363
Total non-interest income 1,846 2,059 1,529
====== ====== ======
Non-Interest Expense
Salaries and employee benefits 4,764 4,196 4,058
Occupancy 433 419 409
Equipment 532 565 554
State taxes 69 206 227
Data processing 305 268 214
Other 1,842 1,760 1,731
Total non-interest expense 7,945 7,414 7,193
====== ====== ======
Income before income taxes 6,442 5,479 5,328
====== ====== ======
Income Taxes 1,863 1,563 1,521
Net income $ 4,579 $ 3,916 $ 3,807
====== ====== ======
Earnings Per Share
Basic $ 1.82 $ 1.57 $ 1.53
Diluted 1.79 1.56 1.52
See notes to consolidated financial statements.
-37-
Consolidated Statements of Shareholders' Equity
--------------------------------------------------------------------------------
(Dollars in Thousands)
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2003, 2002 and 2001
Accumulated
Shares of Additional Other
Common Common Paid-in Retained Comprehensive
Stock Stock Capital Earnings Income (Loss) Total
Balance at December 31, 2000 2,503,130 $ 2,503 $ 9,859 $10,572 ($191) $22,743
Comprehensive income:
Net income -- -- -- 3,807 -- 3,807
Other comprehensive income,
net of tax:
Change in fair value of
securities available for sale -- -- -- -- 599 599
Comprehensive income 4,406
Stock options exercised 12,750 13 150 -- -- 163
Repurchase of common stock (24,281) (24) (486) -- -- (510)
Issuance of common stock 30 -- 1 -- -- 1
Cash dividends declared
($1.32 per share) -- -- -- (3,289) -- (3,289)
Balance at December 31, 2001 2,491,629 2,492 9,524 11,090 408 23,514
========= ====== ====== ====== === ======
Comprehensive income:
Net income -- -- -- 3,916 -- 3,916
Other comprehensive income,
net of tax:
Change in fair value of
securities available for sale -- -- -- -- 309 309
Comprehensive income 4,225
Stock options exercised 21,000 21 275 -- -- 296
Issuance of common stock 30 --- 1 -- -- 1
Cash dividends declared
($1.35 per share) -- -- --- (3,392) -- (3,392)
Tax benefit from exercise of
stock options -- -- 39 -- -- 39
Balance at December 31, 2002 2,512,659 2,513 9,839 11,614 717 24,683
========= ====== ====== ====== === ======
Comprehensive income:
Net income -- -- -- 4,579 -- 4,579
Other comprehensive income,
net of tax:
Change in fair value of
securities available for sale -- -- -- -- (257) (257)
Comprehensive income 4,322
=====
Stock options exercised 8,850 9 165 -- -- 174
Issuance of common stock 30 -- 1 -- -- 1
Cash dividends declared
($1.40 per share) -- -- -- (3,530) -- (3,530)
Balance at December 31, 2003 2,521,539 $ 2,522 $10,005 $12,663 $460 $25,650
========= ====== ====== ====== === ======
See notes to consolidated financial statements.
-38-
Consolidated Statements of Cash Flows
--------------------------------------------------------------------------------
(Dollars in Thousands)
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
Cash Flows from Operating Activities
Net income $ 4,579 $ 3,916 $ 3,807
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 404 433 423
Provision for credit losses -- 954 580
Deferred income tax (benefit) (144) (82) 225
Originations of loans held for sale -- (548) --
Proceeds from sales of loans held for sale 286 262 --
Stock dividends received (49) (186) (251)
Gain on sales of loans (34) -- --
Gain on sale of securities available for sale (4) -- --
Gain on sales of foreclosed real estate (10) (178) --
Loss on sale of premises and equipment 11 -- --
Earnings on bank owned life insurance (328) (350) (167)
(Increase) decrease in interest receivable 218 (88) 897
Decrease in interest payable (84) (123) (338)
Write-down of foreclosed real estate 173 420 18
Other - net (49) 929 (748)
Net cash provided by operating activities 4,969 5,359 4,446
====== ====== ======
Cash Flows from Investing Activities
Net (increase) decrease in interest bearing deposits in banks (15,019) 1,095 (988)
Net (increase) decrease in federal funds sold (5,000) 3,505 (2,935)
Activity in securities available for sale:
Sales 2,994 -- 10,694
Maturities, prepayments and calls 12,343 14,109 36,987
Purchases (21,275) (34,338) (24,828)
Activity in securities held to maturity:
Maturities 3,919 3,481 190
Purchases (1,654) (8,920) (1,123)
Federal Home Loan Bank stock redemption -- 3,133 --
Proceeds from sales of SBA loan pools 2,006 -- 1,407
Increase in loans made to customers, net of principal collections (16,709) (10,046) (5,165)
Purchases of premises and equipment (511) (261) (509)
Proceeds from sales of premises and equipment 2 -- 50
Additions to foreclosed real estate (21) -- --
Proceeds from sales of foreclosed real estate 734 707 161
Purchase of bank owned life insurance -- -- (3,000)
Net cash provided by (used in) investing activities (38,191) (27,535) 10,941
====== ====== ======
(continued)
See notes to consolidated financial statements.
-39-
Consolidated Statements of Cash Flows
--------------------------------------------------------------------------------
(concluded) (Dollars in Thousands)
Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
Cash Flows from Financing Activities
Net increase in deposits $35,546 $10,610 $ 1,133
Net increase (decrease) in short-term borrowings (1,800) 1,800 (11,358)
Proceeds from issuance of long-term debt 3,500 11,000 3,000
Repayments of long-term debt -- -- (3,000)
Common stock issued 175 297 164
Cash dividends paid (3,392) (3,289) (3,204)
Repurchase of common stock and fractional shares -- -- (510)
Net cash provided by (used in) financing activities 34,029 20,418 (13,775)
====== ====== ======
Net change in cash and due from banks 807 (1,758) 1,612
====== ====== ======
Cash and Due from Banks
Beginning of year 8,473 10,231 8,619
End of year $ 9,280 $ 8,473 $10,231
====== ====== ======
Supplemental Disclosures of Cash Flow Information
Interest paid $ 3,492 $ 4,114 $ 6,868
Income taxes paid 2,087 1,260 1,375
Supplemental Disclosures of Non-Cash Investing Activities
Fair value adjustment of securities available for sale, net of tax $ 257 $ 309 $ 599
Transfer of loans to foreclosed real estate 1,127 1,198 1,733
Financed sales of foreclosed real estate 839 629 514
Reclassification of loan receivable to securities available for sale -- -- 2,636
See notes to consolidated financial statements.
-40-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Pacific Financial
Corporation (the Company) and its wholly owned subsidiary, The Bank of the
Pacific (the Bank). All significant intercompany transactions and balances have
been eliminated.
Nature of Operations
The Company is a holding company which operates primarily through its subsidiary
bank. The Bank operates ten branches located in Grays Harbor, Pacific and
Wahkiakum Counties in western Washington and one loan production office in
Clatsop County Oregon. The Bank provides loan and deposit services to customers,
who are predominately small- and middle-market businesses and middle-income
individuals in western Washington and Oregon.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
practices within the banking industry. The preparation of consolidated financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities, as of the date of the balance sheet, and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Material estimates that are particularly
susceptible to significant change in the near term relate to the determination
of the allowance for credit losses and the valuation of foreclosed real estate
and deferred tax assets.
Certain prior year amounts have been reclassified, with no change to net income
or shareholders' equity, to conform to the 2003 presentation. All dollar
amounts, except per share information, are stated in thousands.
Securities Available for Sale
Securities available for sale consist of debt securities, marketable equity
securities and mutual funds that the Bank intends to hold for an indefinite
period, but not necessarily to maturity. Such securities may be sold to
implement the Bank's asset/liability management strategies and in response to
changes in interest rates and similar factors. Securities available for sale are
reported at fair value. Unrealized gains and losses, net of the related deferred
tax effect, are reported as a net amount in a separate component of
shareholders' equity entitled "accumulated other comprehensive income (loss)."
Realized gains and losses on securities available for sale, determined using the
specific identification method, are included in earnings. Amortization of
premiums and accretion of discounts are recognized in interest income over the
period to maturity.
(continued)
-41-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Securities Held to Maturity
Debt securities for which the Company has the positive intent and ability to
hold to maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts, which are recognized in interest income over the period
to maturity.
Declines in the fair value of individual securities held to maturity and
available for sale below their cost that are other than temporary result in
write-downs of the individual securities to their fair value. Such write-downs
are included in earnings as realized losses.
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank (FHLB) system, is
required to maintain an investment in capital stock of the FHLB in an amount
equal to the greater of 1% of its outstanding home loans or 5% of advances from
the FHLB. The recorded amount of FHLB stock equals its fair value because the
shares can only be redeemed by the FHLB at the $100 per share par value.
Loans Held for Sale
Mortgage loans originated for sale in the foreseeable future in the secondary
market are carried at the lower of aggregate cost or estimated market value.
Gains and losses on sales of loans are recognized at settlement date and are
determined by the difference between the sales proceeds and the carrying value
of the loans. All sales are made without recourse. Net unrealized losses are
recognized through a valuation allowance established by charges to income.
Loans
Loans are stated at the amount of unpaid principal, reduced by an allowance for
credit losses. Interest on loans is accrued daily based on the principal amount
outstanding.
Generally, the accrual of interest on loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they become
due or when they are past due 90 days as to either principal or interest, unless
they are well secured and in the process of collection. When interest accrual is
discontinued, all unpaid accrued interest is reversed against current income. If
management determines that the ultimate collectibility of principal is in doubt,
cash receipts on nonaccrual loans are applied to reduce the principal balance on
a cash-basis method, until the loans qualify for return to accrual status. Loans
are returned to accrual status when all principal and interest amounts
contractually due are brought current and future payments are reasonably
assured. The interest on these loans is accounted for on the cash-basis method,
until qualifying for return to accrual.
(continued)
-42-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Credit Losses
The allowance for credit losses is maintained at a level sufficient to provide
for probable credit losses based on evaluating known and inherent risks in the
loan portfolio. The allowance is provided based upon management's continuing
analysis of the pertinent factors underlying the quality of the loan portfolio.
These factors include changes in the size and composition of the loan portfolio,
delinquency levels, actual loan loss experience, current economic conditions,
and detailed analysis of individual loans for which full collectibility may not
be assured. The detailed analysis includes techniques to estimate the fair value
of loan collateral and the existence of potential alternative sources of
repayment. The allowance consists of specific, general and unallocated
components. The specific component relates to loans that are classified as
either doubtful, substandard or special mention. For such loans that are also
classified as impaired, an allowance is established when the discounted cash
flows (or collateral value or observable market price) of the impaired loan is
lower than the carrying value of that loan. The general component covers
non-classified loans and is based on historical loss experience adjusted for
qualitative factors. An unallocated component is maintained to cover
uncertainties that could affect management's estimate of probable losses. The
unallocated component of the allowance reflects the margin of imprecision
inherent in the underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio. The appropriateness of the
allowance for losses on loans is estimated based upon these factors and trends
identified by management at the time consolidated financial statements are
prepared.
When available information confirms that specific loans or portions thereof are
uncollectible, identified amounts are charged against the allowance for credit
losses. The existence of some or all of the following criteria will generally
confirm that a loss has been incurred: the loan is significantly delinquent and
the borrower has not demonstrated the ability or intent to bring the loan
current; the Bank has no recourse to the borrower, or if it does, the borrower
has insufficient assets to pay the debt; the estimated fair value of the loan
collateral is significantly below the current loan balance, and there is little
or no near-term prospect for improvement.
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a
Loan, and SFAS No. 118, an amendment of SFAS No. 114, a loan is considered
impaired when it is probable that a creditor will be unable to collect all
amounts (principal and interest) due according to the contractual terms of the
loan agreement. Smaller balance homogenous loans, such as residential mortgage
loans and consumer loans, are collectively evaluated for potential loss. When a
loan has been identified as being impaired, the amount of the impairment is
measured by using discounted cash flows, except when, as a practical expedient,
the current fair value of the collateral, reduced by costs to sell, is used.
When the measurement of the impaired loan is less than the recorded investment
in the loan including accrued interest, an impairment is recognized by creating
or adjusting an allocation of the allowance for loan losses.
A provision for credit losses is charged against income and is added to the
allowance for credit losses based on quarterly assessments of the loan
portfolio. The allowance for credit losses is allocated to certain loan
categories based on the relative risk characteristics, asset classifications and
actual loss experience of the loan portfolio. While management has allocated the
allowance for credit losses to various loan portfolio segments, the allowance is
general in nature and is available for the loan portfolio in its entirety.
The ultimate recovery of all loans is susceptible to future market factors
beyond the Bank's control. These factors may result in losses or recoveries
differing significantly from those provided in the consolidated financial
statements. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for credit losses,
and may require the Bank to make additions to the allowance based on their
judgment about information available to them at the time of their examinations.
(continued)
-43-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation, which
is computed on the straight-line method over the estimated useful lives of the
assets. Leasehold improvements are amortized over the terms of the respective
leases or the estimated useful lives of the improvements, whichever is less.
Gains or losses on dispositions are reflected in earnings.
Foreclosed Real Estate
Real estate properties acquired through, or in lieu of, foreclosure are to be
sold and are initially recorded at the lower of cost or fair value of the
properties less estimated costs of disposal. Any write-down to fair value at the
time of transfer to other real estate owned is charged to the allowance for
credit losses. Properties are evaluated regularly to ensure that the recorded
amounts are supported by their current fair values, and that valuation
allowances to reduce the carrying amounts to fair value less estimated costs to
dispose are recorded as necessary. Any subsequent reductions in carrying values,
and revenue and expense from the operations of properties, are charged to
operations.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Bank, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Bank does not maintain effective control over the transferred assets through
an agreement to repurchase them before their maturity.
Income Taxes
Deferred tax assets and liabilities result from differences between the
financial statement carrying amounts and the tax bases of assets and
liabilities, and are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
The Bank provides for income taxes separately and remits to the Company amounts
currently due.
(continued)
-44-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Stock-Based Compensation
At December 31, 2003, the Company has three stock-based employee compensation
plans, which are described more fully in Note 14. The Company accounts for those
plans under the recognition and measurement principles of APB No. 25, Accounting
for Stock Issued to Employees, and related interpretations. Accordingly, no
stock-based compensation cost is reflected in net income, as all options granted
under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. The following illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, to stock-based compensation awards for the effects of all options
granted on or after January 1, 1995 for the years ended December 31:
2003 2002 2001
Net income, as reported $4,579 $3,916 $3,807
Less total stock-based compensation expense determined
under fair value method for all qualifying awards, 86 93 10
net of tax
Pro forma net income $4,493 $3,823 $3,797
===== ===== =====
Earnings Per Share
Basic:
As reported $ 1.82 $ 1.57 $ 1.53
Pro forma 1.79 1.54 1.52
Diluted:
As reported 1.79 1.56 1.52
Pro forma 1.76 1.53 1.50
Fair Values of Financial Instruments
The following methods and assumptions were used by the Company in estimating the
fair values of financial instruments disclosed in these consolidated financial
statements:
Cash, Interest Bearing Deposits at Other Financial Institutions, and
Federal Funds Sold
The carrying amounts of cash, interest bearing deposits at other financial
institutions, and federal funds sold approximate their fair value.
Securities Available for Sale and Held to Maturity
Fair values for securities are based on quoted market prices.
(continued)
-45-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Fair Values of Financial Instruments (concluded)
Federal Home Loan Bank Stock
The carrying value of Federal Home Loan Bank stock approximates its fair
value.
Loans
For variable rate loans that reprice frequently and have no significant
change in credit risk, fair values are based on carrying values. Fair
values for fixed rate loans are estimated using discounted cash flow
analysis, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. Fair values of loans
held for sale are based on their estimated market prices. Fair values for
impaired loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
Deposit Liabilities
The fair value of deposits with no stated maturity date is included at the
amount payable on demand. Fair values for fixed rate certificates of
deposit are estimated using a discounted cash flow calculation based on
interest rates currently offered on similar certificates.
Short-Term Borrowings
The carrying amounts of federal funds purchased and other short-term
borrowings maturing within 90 days approximate their fair values. Fair
values of other short-term borrowings are estimated using discounted cash
flow analyses based on the Bank's current incremental borrowing rates for
similar types of borrowing arrangements.
Long-Term Borrowings
The fair values of the Bank's long-term borrowings are estimated using
discounted cash flow analyses based on the Bank's incremental borrowing
rates for similar types of borrowing arrangements.
Accrued Interest
The carrying amounts of accrued interest approximate their fair values.
Off-Balance-Sheet Instruments
The fair value of commitments to extend credit and standby letters of
credit was estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the customers. Since the
majority of the Bank's off-balance-sheet instruments consist of non-fee
producing, variable-rate commitments, the Bank has determined they do not
have a distinguishable fair value.
(continued)
-46-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (concluded)
Cash Equivalents and Cash Flows
The Company considers all amounts included in the balance sheet caption "Cash
and due from banks" to be cash equivalents. Cash flows from loans, interest
bearing deposits in banks, federal funds sold, short-term borrowings, and
deposits are reported net.
The Company maintains balances in depository institution accounts which, at
times, may exceed federally insured limits. The Company has not experienced any
losses in such accounts.
Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing net
income by the weighted average number of common shares outstanding. Diluted
earnings per share reflect the potential dilution that could occur if common
shares were issued pursuant to the exercise of options under the Company's stock
option plans.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on securities available for
sale, are reported as a separate component of the equity section of the
consolidated balance sheets, such items, along with net income, are components
of comprehensive income. Gains and losses on securities available for sale are
reclassified to net income as the gains or losses are realized upon sale of the
securities. Other-than-temporary impairment charges are reclassified to net
income at the time of the charge.
Recent Accounting Pronouncements
The Financial Accounting Standards Board has issued Statement No. 149,
Amendments of Statement No. 133 on Derivative Instruments and Hedging. This
Statement amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under Statement No. 133. The Statement was
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. Implementation of the
Statement on July 1, 2003 did not have a significant impact on the consolidated
financial statements.
The Financial Accounting Standards Board has issued Statement No.150, Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity. This Statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity, and requires that certain freestanding financial instruments be
reported as liabilities on the consolidated balance sheets. For the Company, the
Statement is effective for the fiscal year beginning January 1, 2005 and
implementation is not expected to have a significant impact on the consolidated
financial statements.
-47-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 2 - Restricted Assets
Federal Reserve Board regulations require that the Bank maintains certain
minimum reserve balances in cash and on deposit with the Federal Reserve Bank,
based on a percentage of deposits. The average amount of such balances for the
years ended December 31, 2003 and 2002 were approximately $650.
Note 3 - Securities
Investment securities have been classified according to management's intent. The
carrying amounts of securities and their approximate fair values are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Securities Available for Sale
December 31, 2003
U.S. Treasury and Government agency securities $ 1,738 $ 81 $ -- $ 1,819
Obligations of states and political subdivisions 14,239 600 88 14,751
Mortgage-backed securities 16,121 181 91 16,211
Corporate bonds 4,122 122 11 4,233
Mutual funds 20,556 --- 97 20,459
$56,776 $ 984 $287 $57,473
====== ===== === ======
December 31, 2002
U.S. Treasury and Government agency securities $ 2,165 $ 142 $ -- $ 2,307
Obligations of states and political subdivisions 11,502 609 13 12,098
Mortgage-backed securities 16,669 215 27 16,857
Corporate bonds 5,979 127 7 6,099
Mutual funds 14,828 47 6 14,869
$51,143 $1,140 $ 53 $52,230
====== ===== === ======
Securities Held to Maturity
December 31, 2003
State and municipal securities $ 5,044 $ 75 $ 20 $ 5,099
Mortgage-backed securities 2,944 54 -- 2,998
====== ===== === ======
December 31, 2002
State and municipal securities $ 3,751 $ 39 $ 28 $ 3,762
Mortgage-backed securities 6,611 41 -- 6,652
$10,362 $ 80 $ 28 $10,414
====== ===== === ======
(continued)
-48-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 3 - Securities (concluded)
Unrealized losses and fair value, aggregated by investment category and length
of time that individual securities have been in continuous unrealized loss
position, as of December 31, 2003 are summarized as follows:
Less than 12 Months More than 12 Months Total
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
Available for Sale
Obligations of states and
political subdivisions $1,546 $ 88 $ -- $ -- $ 1,546 $ 88
Mortgage-backed securities 3,375 67 2,942 24 6,317 91
Corporate bonds 1,094 11 --- --- 1,094 11
Mutual funds 3,855 44 16,604 53 20,459 97
Total $9,870 $210 $19,546 $ 77 $29,416 $287
===== === ====== === ====== ===
Held to Maturity
State and municipal securities $ 374 $ 16 $ 912 $ 4 $ 1,286 $ 20
===== === ====== === ====== ===
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 the
Company.
The contractual maturities of investment securities held to maturity and
available for sale at December 31, 2003 are as follows:
Held to Maturity Available for Sale
Amortized Fair Amortized Fair
Cost Value Cost Value
Due in one year or less $ 449 $ 456 $ 2,659 $ 2,733
Due from one year to five years 1,598 1,614 9,032 9,478
Due from five to ten years 964 1,011 5,263 5,437
Due after ten years 2,033 2,018 3,145 3,155
Mortgage-backed securities 2,944 2,998 16,121 16,211
Mutual funds -- -- 20,556 20,459
Total $7,988 $8,097 $56,776 $57,473
===== ===== ====== ======
Gross gains realized on sales of securities were $9 and gross losses realized
were $5 in 2003. There were no sales of securities in 2002 and 2001.
Securities carried at approximately $18,691 at December 31, 2003 and $25,622 at
December 31, 2002 were pledged to secure public deposits, borrowings at the
Federal Home Loan Bank of Seattle, for other purposes required or permitted by
law.
-49-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 4 - Loans
Loans at December 31 consist of the following:
2003 2002
Commercial and agricultural $ 64,344 $ 69,794
Real estate:
Construction 11,894 9,697
Residential 1-4 family 24,418 28,085
Multi-family 2,197 1,574
Commercial 85,933 65,336
Farmland 5,268 5,870
Consumer 5,684 5,148
$199,738 $185,504
======= =======
Changes in the allowance for credit losses for the years ended December 31 are
as follows:
2003 2002 2001
Balance at beginning of year $2,473 $2,109 $2,026
Provision for credit losses -- 954 580
Charge-offs (265) (632) (564)
Recoveries 30 42 67
Net charge-offs (235) (590) (497)
Balance at end of year $2,238 $2,473 $2,109
===== ===== =====
Following is a summary of information pertaining to impaired loans:
2003 2002 2001
December 31
Impaired loans without a valuation allowance $ 342 $2,296 $ 482
Impaired loans with a valuation allowance 123 18 1,180
Total impaired loans $ 465 $2,314 $1,662
===== ===== =====
Valuation allowance related to impaired loans $ 23 $ 2 $ 143
===== ===== =====
Years Ended December 31
Average investment in impaired loans $1,412 $2,390 $1,262
Interest income recognized on a cash basis on
impaired loans 12 13 2
(continued)
-50-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 4 - Loans (concluded)
At December 31, 2003, there were no commitments to lend additional funds to
borrowers whose loans have been modified. There were no loans 90 days and over
past due and still accruing interest at December 31, 2003 and 2002.
Certain related parties of the Company, principally directors and their
associates, were loan customers of the Bank in the ordinary course of business
during 2003 and 2002. Total loans outstanding at December 31, 2003 and 2002 to
key officers and directors were $6,483 and $5,698, respectively. During 2003,
new loans of $7,646 were made, and repayments totaled $6,861. In management's
opinion, these loans and transactions were on the same terms as those for
comparable loans and transactions with non-related parties. No loans to related
parties were on non-accrual, past due or restructured at December 31, 2003.
Note 5 - Premises and Equipment
The components of premises and equipment at December 31 are as follows:
2003 2002
Land $ 1,125 $ 1,125
Premises 4,309 3,992
Equipment, furniture and fixtures 4,122 4,074
9,556 9,191
Less accumulated depreciation and amortization 5,589 5,341
Total premises and equipment $ 3,967 $ 3,850
======= =======
Note 6 - Deposits
The composition of deposits at December 31 is as follows:
2003 2002
Demand deposits, non-interest bearing $ 43,862 $ 40,084
NOW and money market accounts 79,185 52,651
Savings deposits 52,308 50,542
Time certificates, $100,000 or more 43,608 35,086
Other time certificates 41,837 46,891
Total $260,800 $225,254
======= =======
(continued)
-51-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 6 - Deposits (concluded)
Scheduled maturities of time certificates of deposit are as follows for future
years ending December 31:
2004 $59,040
2005 15,463
2006 2,041
2007 3,318
2008 5,583
$85,445
Note 7 - Long-Term Borrowings
Long-term borrowings at December 31, 2003 represent advances from the Federal
Home Loan Bank bearing interest at 2.78% to 4.41% and maturing in various years
as follows: 2004 - $2,000; 2005 - $2,000; 2006 - $1,000; 2008 - $3,500; and 2009
- $6,000. The Bank has pledged $29,727 of securities and loans as collateral for
these borrowings and short-term borrowings at December 31, 2003.
Note 8 - Income Taxes
Income taxes are comprised of the following for the years ended December 31:
2003 2002 2001
Current $1,719 $1,645 $1,296
Deferred (benefit) 144 (82) 225
Total income taxes $1,863 $1,563 $1,521
===== ===== =====
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities at December 31 are:
2003 2002
Deferred Tax Assets
Allowance for credit losses $ 634 $ 730
Deferred compensation 159 161
Other 12 8
Total deferred tax assets 805 899
=== ===
(continued)
-52-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 8 - Income Taxes (concluded)
2003 2002
Deferred Tax liabilities
Unrealized gain on securities available for sale $ 237 $ 369
Depreciation 167 119
Deferred revenue 886 884
Total deferred tax liabilities 1,290 1,372
===== =====
Net deferred tax liabilities ($ 485) ($ 473)
===== =====
Net deferred tax liabilities are included in other liabilities on the
consolidated balance sheets.
The following is a reconciliation between the statutory and effective federal
income tax rate for the years ended December 31:
2003 2002 2001
Percent Percent Percent
of Pre-tax of Pre-tax of Pre-tax
Amount Income Amount Income Amount Income
Income tax at statutory rate $2,255 35.0% $1,918 35.0% $1,865 35.0%
Adjustments resulting from:
Tax-exempt income (232) (3.6) (276) (5.0) (272) (5.1)
Net earnings on life insurance
policies (103) (1.6) (111) (2.0) (26) (.5)
Other (57) (.9) 32 .5 (46) (.8)
Total income tax expense $1,863 28.9% $1,563 28.5% $1,521 28.6%
===== ==== ===== ==== ===== ====
Note 9 - Employee Benefits
Incentive Compensation Plan
The Bank has a plan that provides incentive compensation to key employees if the
Bank meets certain performance criteria established by the Board of Directors.
The cost of this plan was $602, $435 and $355 in 2003, 2002 and 2001,
respectively.
401(k) Plans
The Bank has established a 401(k) profit sharing plan for those employees who
meet the eligibility requirements set forth in the plan. Eligible employees may
contribute up to 15% of their compensation. Matching contributions by the Bank
are at the discretion of the Board of Directors. Contributions totaled $129,
$126 and $115 for 2003, 2002 and 2001, respectively.
(continued)
-53-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 9 - Employee Benefits (concluded)
Director and Employee Deferred Compensation Plans
The Company has director and employee deferred compensation plans. Under the
terms of the plans, a director or employee may participate upon approval by the
Board. The participant may then elect to defer a portion of his or her earnings
(directors' fees or salary) as designated at the beginning of each plan year.
Payments begin upon retirement, termination, death or permanent disability, sale
of the Company, the ten-year anniversary of the participant's participation
date, or at the discretion of the Company. There are currently two participants
in the plans. Total deferrals plus earnings were $105, $110 and $304 at December
31, 2003, 2002 and 2001, respectively. There is no expense to the Company for
this plan.
The directors of a bank acquired by the Company in 1999 adopted two deferred
compensation plans for directors - one plan providing retirement income benefits
for all directors and the other, a deferred compensation plan, covering only
those directors who have chosen to participate in the plan. At the time of
adopting these plans, the Bank purchased life insurance policies on directors
participating in both plans which may be used to fund payments to them under
these plans. Cash surrender values on these policies were $2,819 and $2,700 at
December 31, 2003 and 2002, respectively. In 2003, 2002 and 2001, the net
(benefit)/cost recorded from these plans, including the cost of the related life
insurance, was ($271), ($315) and ($104), respectively. Both of these plans were
fully funded and frozen as of September 30, 2000. Plan participants were given
the option to either remain in the plan until reaching the age of 70 or to
receive a lump-sum distribution. Participants electing to remain in the plan
will receive annual payments over a ten-year period upon reaching 70 years of
age.
Qualified Non-Contributory Defined Benefit Plan
The Company maintained a non-contributory defined benefit plan covering
substantially all employees of the former Bank of the Pacific, which was frozen
and terminated on December 31, 2000. The Bank made annual contributions to the
plan equal to the amount accrued for pension expenses, which were invested in
shares of registered investment companies. Final funding of the plan did not
occur until 2001 upon receipt of plan administrator distribution totals.
Contributions of $149 were made in 2001.
Non-Qualified Deferred Compensation Plan
The Company has a non-qualified deferred compensation plan to cover selected
employees. Its annual contributions to the plan totaled $6, $6 and $8 in 2003,
2002 and 2001, respectively. Covered employees may also contribute to the plan.
-54-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 10 - Commitments and Contingencies
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of their customers. These
financial instruments include commitments to extend credit and standby letters
of credit, and involve, to varying degrees, elements of credit risk in excess of
the amount recognized on the consolidated balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as they do for on-balance-sheet instruments. A summary of the Bank's
commitments at December 31 is as follows:
2003 2002
Commitments to extend credit $44,044 $23,638
Standby letters of credit 2,715 2,326
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since many
of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Bank's experience has been that approximately 67% of loan commitments is drawn
upon by customers. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Bank upon extension of credit, is based on management's credit evaluation of
the party. Collateral held varies, but may include accounts receivable,
inventory, property and equipment, residential real estate, and income-producing
commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
as specified above, and is required in instances where the Bank deems necessary.
Certain executive officers have entered into employment contracts with the Bank
which provide for contingent payments subject to future events.
The Bank has agreements with commercial banks for lines of credit totaling
$17,200, none of which was used at December 31, 2003. In addition, the Bank has
a credit line with the Federal Home Loan Bank of Seattle totaling 20% of assets,
$14,500 of which was used at December 31, 2003. These borrowings are
collateralized under blanket pledge and custody agreements.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these claims,
if any, will not have a material effect on the financial position of the
Company.
-55-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 11 - Significant Concentrations of Credit Risk
Most of the Bank's business activity is with customers and governmental entities
located in the state of Washington, including investments in state and municipal
securities. Loans are generally limited by state banking regulations to 20% of
the Bank's shareholder's equity, excluding accumulated other comprehensive
income (loss). As of December 31, 2003 the Bank's loans to companies in the
hotel\motel industry totaled $33,323 or 16% of total loans. Standby letters of
credit were granted primarily to commercial borrowers. The Bank, as a matter of
practice, generally does not extend credit to any single borrower or group of
borrowers in excess of $4.25 million.
Note 12 - Stock Options
The Company's three stock incentive plans provide for granting incentive stock
options, as defined under current tax laws, to key personnel and under the plan
adopted in 2000, options not qualified for favorable tax treatment and other
types of stock based awards. Under the first plan, options are exercisable 90
days from the date of grant. These options terminate if not exercised within ten
years from the date of grant. If after six years from the date of grant fewer
than 20% of the options have been exercised, they will expire at a rate of 20%
annually. Under the second plan, the options are exercisable one year from the
date of grant, at a rate of 10% annually. Options terminate if not exercised
when they become available, and no additional grants will be made under these
two plans. The plan adopted in 2000, authorizes the issuance of up to a total of
500,000 shares, (296,500 shares are available for grant at December 31, 2003).
Under the 2000 plan, options either become exercisable ratably over five years
or vest fully five years from the date of grant. Under the 2000 plan, the
Company may grant up to 75,000 options for its common stock to a single
individual in a calendar year.
The fair value of each option grant is estimated on the date of grant, based on
the Black-Scholes option pricing model and using the following weighted-average
assumptions:
2003 2002 2001
Dividend yield 5.31% 5.67% 5.76%
Expected life 10 years 10 years 10 years
Risk-free interest rate 4.38% 5.49% 4.93%
Expected volatility 17.73% 18.99% 19.13%
The weighted average fair value of options granted during 2003 and 2002 was
$2.86 and $3.03, respectively.
The Black-Scholes model used by the Company to calculate option values, as well
as other currently accepted option valuation models, were developed to estimate
the fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require highly subjective assumptions, including future stock
price volatility and expected time until exercise, which greatly affect the
calculated values. Accordingly, management believes that this model does not
necessarily provide a reliable single measure of the fair value of the Company's
option awards.
(continued)
-56-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 12 - Stock Options (concluded)
A summary of the status of the Company's stock option plans as of December 31,
2003, 2002 and 2001, and changes during the years ending on those dates, is
presented below:
2003 2002 2001
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
Outstanding at beginning of year 179,796 $22.26 184,300 $21.19 74,550 $18.21
Granted 62,004 25.61 23,996 23.34 126,000 22.22
Exercised (8,850) 19.65 (21,000) 14.09 (12,750) 12.82
Forfeited -- -- (7,500) 22.22 (3,500) 25.63
Outstanding at end of year 232,950 $23.25 179,796 $22.26 184,300 $21.19
Exercisable at end of year 76,999 $22.06 53,300 $21.08 32,165 $14.40
The following information summarizes information about stock options outstanding
and exercisable at December 31, 2003:
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (Years) Price Exercisable Price
$15.29 13,550 3 $15.29 13,550 $15.29
22.22 - 24.00 153,650 7 22.55 47,449 22.33
25.00 35,500 9 25.00 -- 25.00
27.00 20,250 6 27.00 16,000 27.00
31.00 10,000 9 31.00 -- 31.00
232,950 76,999
======= ======
-57-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 13 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's consolidated financial statements. Under
capital adequacy guidelines on the regulatory framework for prompt corrective
action, the Bank must meet specific capital adequacy guidelines that involve
quantitative measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital classification is also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of Tier 1 capital (as defined in the regulations) to
total average assets (as defined), and minimum ratios of Tier 1 and total
capital (as defined) to risk-weighted assets (as defined).
As of December 31, 2003, the most recent notification from the Bank's regulator
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Company and the Bank's actual capital amounts and ratios are also presented
in the table. Management believes, as of December 31, 2003, the Company and the
Bank meet all capital requirements to which they are subject.
To be Well Capitalized
Under Prompt
Corrective
Capital Adequacy Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
December 31, 2003
Tier 1 capital (to average assets):
Consolidated $25,190 8.49% $11,864 4.00% N/A N/A
Bank 24,651 8.31 11,864 4.00 $14,830 5.00%
Tier 1 capital (to risk-weighted assets):
Consolidated 25,190 11.62 8,675 4.00 N/A N/A
Bank 24,651 11.37 8,675 4.00 13,012 6.00
Total capital (to risk-weighted assets):
Consolidated 27,428 12.65 17,350 8.00 N/A N/A
Bank 26,889 12.40 17,350 8.00 21,687 10.00
(continued)
-58-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 13 - Regulatory Matters (concluded)
To be Well Capitalized
Under Prompt
Corrective
Capital Adequacy Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
December 31, 2002
Tier 1 capital (to average assets):
Consolidated $23,966 8.92% $10,753 4.00% N/A N/A
Bank 23,832 8.87 10,753 4.00 $13,441 5.00%
Tier 1 capital (to risk-weighted assets):
Consolidated 23,966 11.73 8,172 4.00 N/A N/A
Bank 23,832 11.67 8,171 4.00 12,257 6.00
Total capital (to risk-weighted assets):
Consolidated 26,457 12.95 16,344 8.00 N/A N/A
Bank 26,323 12.89 16,342 8.00 20,428 10.00
Note 14 - Comprehensive Income
Net unrealized gains and losses include, net of tax, $254 of unrealized losses
arising during 2003, $309 of unrealized gains arising during 2003 and $599 of
unrealized gains arising during 2002, less reclassification adjustments of $3,
$0 and $0 for gains included in net income in 2003, 2002 and 2001, respectively,
as follows:
Before- Tax
Tax Benefit Net-of-Tax
Amount (Expense) Amount
2003
Unrealized holding losses arising during the year ($384) $130 ($254)
Reclassification adjustments for gains realized in net income (4) 1 (3)
Net unrealized losses ($388) $131 ($257)
=== === ===
2002
Unrealized holding losses arising during the year $467 ($158) $309
Reclassification adjustments for gains realized in net income -- -- --
Net unrealized gains $467 ($158) $309
=== === ===
2001
Unrealized holding losses arising during the year $908 ($309) $599
Reclassification adjustments for gains realized in net income -- -- --
Net unrealized gains $908 ($309) $599
=== === ===
-59-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 15 - Fair Values of Financial Instruments
The estimated fair values of the Company's financial instruments at December 31
are as follows:
2003 2002
Carrying Fair Carrying Fair
Amount Value Amount Value
Financial Assets
Cash and due from banks,
interest-bearing deposits with
banks, and federal funds sold $ 29,672 $ 29,672 $ 8,846 $ 8,846
Securities available for sale 57,473 57,473 52,230 52,230
Securities held to maturity 7,988 8,097 10,362 10,414
Federal Home Loan Bank stock 915 915 866 866
Loans receivable, net 197,500 200,449 183,031 188,247
Loans held for sale -- -- 286 286
Accrued interest receivable 1,275 1,275 1,493 1,493
Financial Liabilities
Deposits $260,800 $261,516 $225,254 $226,146
Short-term borrowings -- -- 1,800 1,800
Long-term borrowings 14,500 14,319 11,000 11,105
Accrued interest payable 234 234 318 318
The Bank assumes interest rate risk (the risk that general interest rate levels
will change) as a result of its normal operations. As a result, the fair values
of the Bank's financial instruments will change when interest rate levels change
and that change may either be favorable or unfavorable to the Bank. Management
attempts to match maturities of assets and liabilities to the extent believed
necessary to minimize interest rate risk. However, borrowers with fixed rate
obligations are less likely to prepay in a rising rate environment and more
likely to prepay in a falling rate environment. Conversely, depositors who are
receiving fixed rates are more likely to withdraw funds before maturity in a
rising rate environment and less likely to do so in a falling rate environment.
Management monitors rates and maturities of assets and liabilities, and attempts
to minimize interest rate risk by adjusting terms of new loans, and deposits and
by investing in securities with terms that mitigate the Bank's overall interest
rate risk.
-60-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 16 - Earnings Per Share Disclosures
Following is information regarding the calculation of basic and diluted earnings
per share for the years indicated.
Net Income Shares Per Share
(Numerator) (Denominator) Amount
Year Ended December 31, 2003
Basic earnings per share:
Net income $4,579 2,512,844 $1.82
Effect of dilutive securities:
Options -- 47,003 (.03)
Diluted earnings per share:
Net income $4,579 2,559,847 $1.79
Year Ended December 31, 2002
Basic earnings per share:
Net income $3,916 2,492,526 $1.57
Effect of dilutive securities:
Options -- 17,869 (.01)
Diluted earnings per share:
Net income $3,916 2,510,395 $1.56
Year Ended December 31, 2001
Basic earnings per share:
Net income $3,807 2,491,426 $1.53
Effect of dilutive securities:
Options -- 19,736 (.01)
Diluted earnings per share:
Net income $3,807 2,511,162 $1.52
The number of shares shown for "options" is the number of incremental shares
that would result from the exercise of options and use of the proceeds to
repurchase shares at the average market price during the year.
-61-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 17 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - December 31
2003 2002
Assets
Cash $ 3,699 $ 3,467
Investment in the Bank 25,208 24,549
Due from the Bank 89 59
Other assets 184 --
Total assets $29,180 $28,075
====== ======
Liabilities and Shareholders' Equity
Dividends payable $ 3,530 $ 3,392
Shareholders' equity 25,650 24,683
Total liabilities and shareholders' equity $29,180 $28,075
====== ======
Condensed Statements of Income - Years Ended December 31
2003 2002 2001
Dividend Income from the Bank $ 3,729 $ 3,200 $ 3,670
Expenses (96) (59) (69)
Income before income tax benefit 3,633 3,141 3,601
====== ====== ======
Income Tax Benefit 30 20 23
Income before equity in undistributed income of the Bank 3,663 3,161 3,624
====== ====== ======
Equity in Undistributed Income of the Bank 916 755 183
Net income $ 4,579 $ 3,916 $ 3,807
====== ====== ======
(continued)
-62-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 17 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended December 31
2003 2002 2001
Operating Activities
Net income $ 4,579 $ 3,916 $ 3,807
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in undistributed income of subsidiary (916) (755) (183)
Other - net (214) (19) (1)
Net cash provided by operating activities 3,449 3,142 3,623
===== ====== ======
Investing Activities
Increase in amounts due from the Bank -- -- 3,178
======
Financing Activities
Common stock issued 175 297 164
Dividends paid (3,392) (3,289) (3,204)
Repurchase of common stock and fractional shares -- -- (510)
Net cash used in financing activities (3,217) (2,992) (3,550)
===== ====== ======
Net increase in cash 232 150 3,251
===== ====== ======
Cash
Beginning of year 3,467 3,317 66
End of year $ 3,699 $ 3,467 $ 3,317
===== ====== ======
-63-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 18 - Subsequent Event
On October 22, 2003, the Company announced the signing of a definitive agreement
for the acquisition of BNW Bancorp, Inc. by merger. Upon completion of the
transaction, each share of BNW Bancorp, Inc. common stock will be converted into
the right to receive 0.85 shares of the Company's common stock. The Company will
issue approximately 610,240 shares of its own stock to acquire all of BNW
Bancorp, Inc.'s outstanding shares at an exchange ratio of 0.85 of the Company's
shares. The merger, which has been unanimously approved by the directors of both
companies, is subject to certain conditions, including approval of the
shareholders of BNW Bancorp, Inc. and shareholders of the Company and the
receipt of regulatory approval. The merger is expected to be completed in the
first quarter of 2004. BNW Bancorp, Inc. will merge into Pacific Financial
Corporation, immediately followed by the merger of Bank Northwest, a subsidiary
of BNW Bancorp, Inc., into Bank of the Pacific. After the merger the combined
organization will have assets of approximately $407 million, deposits of
approximately $339 million, and shareholders' equity of approximately $44
million.
Note 19 - Quarterly Data (Unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
Year Ended December 31, 2003
Interest income $3,922 $3,991 $3,982 $4,054
Interest expense 899 896 824 789
Net interest income 3,023 3,095 3,158 3,265
===== ===== ===== =====
Provision for credit losses -- -- -- --
Non-interest income 444 457 539 406
Non-interest expenses 1,910 1,931 2,003 2,101
Income before income taxes 1,557 1,621 1,694 1,570
===== ===== ===== =====
Income taxes 445 470 500 448
Net income $1,112 $1,151 $1,194 $1,122
===== ===== ===== =====
Earnings per common share:
Basic $ .44 $ .46 $ .48 $ .44
Diluted .44 .45 .47 .43
(continued)
-64-
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiary
December 31, 2003 and 2002
Note 19 - Quarterly Data (Unaudited) (concluded)
First Second Third Fourth
Quarter Quarter Quarter Quarter
Year Ended December 31, 2002
Interest income $3,880 $3,930 $3,942 $4,027
Interest expense 971 981 1,046 993
Net interest income 2,909 2,949 2,896 3,034
===== ===== ===== =====
Provision for credit losses 954 -- -- --
Non-interest income 454 704 477 424
Non-interest expenses 1,819 1,873 1,848 1,874
Income before income taxes 590 1,780 1,525 1,584
===== ===== ===== =====
Income taxes 182 534 452 395
Net income $ 408 $1,246 $1,073 $1,189
===== ===== ===== =====
Earnings per common share:
Basic $ .16 $ .50 $ .43 $ .48
Diluted .16 .50 .43 .47
-65-
Notes to Consolidated Financial Statements
(a) (2) Schedules: None
(a) (3) Exhibits: See Exhibit Index immediately following the signature page.
(b) Reports on Form 8-K: During the three months ended December 31, 2003,
Pacific filed the following current reports on Form 8-K:
* Report on Form 8-K dated October 22, 2003, reporting that the Company
had entered into an Agreement and Plan of Merger dated October 22, 2003,
governing the terms and conditions under which BNW Bancorp, Inc., would
be merged into Pacific and Bank NorthWest, BNW Bancorp's banking
subsidiary, would be merged into the Bank of the Pacific; and
* Report on Form 8-K dated December 19, 2003, reporting that Pacific's
board of directors had declared a cash dividend of $1.40 per share
payable to shareholders of record as of December 31, 2003.
-66-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 19th day of March,
2004.
PACIFIC FINANCIAL CORPORATION
(Registrant)
/s/ Dennis A. Long /s/ John Van Dijk
------------------------------------ ----------------------------------------
Dennis A. Long, President and CEO John Van Dijk, Executive Vice President,
Treasurer (CFO) and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated, on the 19th day of March, 2004.
Principal Executive Officer and Principal Financial and Accounting
Director Officer
/s/ Dennis A. Long /s/ John Van Dijk
---------------------------------- ----------------------------------------
Dennis A. Long, President and CEO John Van Dijk, Treasurer (CFO)
and Director Principal Financial and Accounting
Principal Executive Officer Officer
Remaining Directors
/s/ Joseph A. Malik /s/ Sidney R. Snyder
---------------------------------- ----------------------------------------
Joseph A. Malik Sidney R. Snyder
(Chairman of the Board)
/s/ Gary C. Forcum /s/ Duane E. Hagstrom
---------------------------------- ----------------------------------------
Gary C. Forcum Duane E. Hagstrom
/s/ Walter L. Westling /s/ Robert A. Hall
---------------------------------- ----------------------------------------
Walter L. Westling Robert A. Hall
/s/ David L. Woodland /s/ Robert J. Worrell
---------------------------------- ----------------------------------------
David L. Woodland Robert J. Worrell
/s/ Susan C. Freese /s/ Randy W. Rognlin
---------------------------------- ----------------------------------------
Susan C. Freese Randy W. Rognlin
/s/ Randy Rust /s/ Edwin Ketel
---------------------------------- ----------------------------------------
Randy Rust Edwin Ketel
/s/ Douglas M. Schermer
---------------------------------- ----------------------------------------
Douglas M. Schermer John R. Ferlin
/s/ Stewart L. Thomas
---------------------------------- ----------------------------------------
G. Dennis Archer Stewart L. Thomas
-67-
Exhibit Index
EXHIBIT NO. EXHIBIT
----------- -------
2.1 Agreement and Plan of Merger between the Company and BNW
Bancorp, Inc. dated as of October 22, 2003(1)
3.1 Restated Articles of Incorporation (2)
3.2 Bylaws (3)
10 Executive Compensation Plans and Arrangements and Other
Management Contracts
10.1 Employment Agreement with Dennis A. Long dated January 27, 2004
10.2 Employment Agreement with John Van Dijk dated January 2, 2003
(4)
10.3 Employment Agreement with Bruce D. MacNaughton dated January 2,
2003 (4)
10.4 Bank of the Pacific Incentive Stock Option Plan (5)
10.5 The Bank of Grays Harbor Incentive Stock Option Plan (5)
10.6 2000 Stock Incentive Compensation Plan (6)
10.7 Bonus Program for Officers (6)
10.8 The Bank of Grays Harbor Employee Deferred Compensation Plan (7)
21 Subsidiaries of Registrant - Bank of the Pacific, organized
under Washington law
23 Consent of McGladrey & Pullen, LLP, Independent Auditors
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)
32 Certification Pursuant to 18 U.S.C. 1350
99 Description of common stock of the Company (8)
(1) Incorporated by reference to Exhibit 99.1 to the Company's current report on
Form 8-K dated October 22, 2003.
(2) Incorporated by reference to Exhibit 3.2 to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000.
(3) Incorporated by reference to Exhibit 2b to Form 8-A filed by the Company and
declared effective on March 7, 2000 (Registration No. 000-29329)
(4) Incorporated by reference to Exhibits 10.2 and 10.3 to the Company's Annual
Report on Form 10-K for the year ended December 31, 2002.
(5) Incorporated by reference to Exhibits 10.7 and 10.8 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999.
(6) Incorporated by reference to Exhibits 10.1 and 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2000.
-68-
(7) Incorporated by reference to Exhibit 10.10 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2000.
(8) Incorporated by reference to Exhibit 99 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2000.
-69-