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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarter ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 000-29829
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PACIFIC FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1815009
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
300 East Market Street
Aberdeen, Washington 98520-5244
(360) 533-8870
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Title of Class Outstanding at October 31, 2004
-------------- -------------------------------
Common Stock, par value $1.00 per share 3,184,339 shares
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-1-
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION 3
ITEM 1. FINANCIAL STATEMENTS 3
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2004 AND DECEMBER 31, 2003 3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 5
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS'
EQUITY NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 16
ITEM 4. CONTROLS AND PROCEDURES 17
PART II OTHER INFORMATION 17
ITEM 6. EXHIBITS 17
SIGNATURES 17
-2-
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
(Dollars in thousands)
Pacific Financial Corporation
September 30, 2004 and December 31, 2003
September 30, December 31,
2004 2003
(Unaudited)
Assets
Cash and due from banks $ 9,925 $ 9,280
Interest bearing balances with banks 1,508 15,392
Federal funds sold -- 5,000
Investment securities available for sale 39,124 57,473
Investment securities held-to-maturity 8,037 7,988
Federal Home Loan Bank stock, at cost 1,850 915
Loans held for sale 1,936 --
Loans 334,081 199,738
Allowance for credit losses 4,060 2,238
-------- --------
Loans, net 330,021 197,500
Premises and equipment 6,786 3,967
Foreclosed real estate 84 98
Accrued interest receivable 1,977 1,275
Cash surrender value of life insurance 8,947 6,193
Goodwill 10,651 --
Intangible assets 922 --
Other assets 1,571 1,634
-------- --------
Total assets $423,339 $306,715
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing $ 70,637 $ 43,862
Interest bearing 277,435 216,938
-------- --------
Total deposits 348,072 260,800
Accrued interest payable 345 234
Short-term borrowings 5,199 --
Long-term borrowings 19,500 14,500
Other liabilities 2,788 5,531
-------- --------
Total liabilities 375,904 281,065
Shareholders' Equity
Common Stock (par value $1); authorized: 3,184 2,522
25,000,000 shares; issued
September 30,2004-3,184,339 shares;
December 31, 2003-2,521,539 shares
Additional paid-in capital 27,108 10,005
Retained earnings 16,899 12,663
Accumulated other comprehensive income 244 460
-------- --------
Total shareholders' equity 47,435 25,650
Total liabilities and shareholders' equity $423,339 $306,715
-3-
Condensed Consolidated Statements of Income
(Dollars in thousands, except per share) THREE MONTHS ENDED NINE MONTHS ENDED
(Unaudited) SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------------ -----------------
Interest Income
Loans $ 5,730 $ 3,345 $ 15,547 $ 9,957
Securities held to maturity:
Taxable 23 23 75 141
Tax-exempt 64 54 182 154
Securities available for sale:
Taxable 295 387 1,038 1,205
Tax-exempt 131 119 401 355
Deposits with banks
and federal funds sold 8 54 25 83
--------- --------- --------- ---------
Total interest income 6,251 3,982 17,268 11,895
Interest Expense
Deposits 980 697 2,632 2,261
Other borrowings 170 127 474 358
--------- --------- --------- ---------
Total interest expense 1,150 824 3,106 2,619
Net Interest Income 5,101 3,158 14,162 9,276
Provision for credit losses 300 -- 670 --
--------- --------- --------- ---------
Net interest income after provision
for credit losses 4,801 3,158 13,492 9,276
Non-interest Income
Service charges 326 235 951 763
Gain on sale of loans 330 30 719 30
Mortgage loan origination fees 2 48 12 89
Gain on sale of foreclosed real estate -- 38 51 160
Gain on sale of investments held for sale -- -- 3 4
Other operating income 234 188 630 521
--------- --------- --------- ---------
Total non-interest income 892 539 2,366 1,440
Non-interest Expense
Salaries and employee benefits 2,185 1,206 5,890 3,519
Occupancy and equipment 425 240 1,136 718
Other 1,032 557 2,821 1,607
--------- --------- --------- ---------
Total non-interest expense 3,642 2,003 9,847 5,844
Income before income taxes 2,051 1,694 6,011 4,872
Provision for income taxes 616 500 1,775 1,415
--------- --------- --------- ---------
Net Income $ 1,435 $ 1,194 $ 4,236 $ 3,457
Comprehensive Income $ 1,783 $ 791 $ 4,020 $ 3,274
Earnings per common share:
Basic $ .45 $ .48 $ 1.40 $ 1.38
Diluted .44 .47 1.37 1.35
Average shares outstanding:
Basic 3,176,457 2,512,669 3,030,292 2,512,665
Diluted 3,258,064 2,564,017 3,098,150 2,553,785
-4-
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 2004 and 2003
(Dollars in thousands)
2004 2003
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net income $ 4,236 $ 3,457
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for credit losses 670 --
Depreciation and amortization 821 306
Deferred income tax (benefit) (292) --
Stock dividends received (48) (38)
Origination of loans held for sale (52,572) --
Proceeds of loans held for sale 48,046 286
Gain on sales of loans (719) (30)
Gain on sale of investment securities (3) (4)
Gain on sale of foreclosed real estate (51) (33)
Gain on sale of premises and equipment -- (2)
(Increase) decrease in accrued interest receivable (308) 31
Increase (decrease) in accrued interest payable 41 (83)
Write-down of foreclosed real estate -- 173
Other 116 (494)
------- -----
Net cash provided by (used in) operating activities (63) 3,569
INVESTING ACTIVITIES
Net (increase) decrease in federal funds 5,000 (5,590)
(Increase) decrease in interest bearing
deposits with banks 14,076 (6,940)
Purchase of securities held to maturity (1,169) (1,654)
Purchase of securities available for sale (3,062) (18,467)
Proceeds from maturities of investments held to maturity 1,088 3,126
Proceeds from sales of securities available for sale 19,060 2,994
Proceeds from maturities of
securities available for sale 6,482 8,597
Net increase in loans (14,850) (11,007)
Proceeds from sales of loans (5,735) 1,795
Additions to foreclosed real estate -- (21)
Proceeds from sales of foreclosed real estate 414 642
Additions to premises and equipment (2,138) (167)
Proceeds from sales of premises and equipment -- 2
Purchase of bank owned life insurance (2,500) --
Acquisition, net of cash received 3,146 --
------- -------
Net cash provided by (used in) investing activities 19,812 (26,690)
FINANCING ACTIVITIES
Net increase (decrease) in deposits (818) 27,500
Net decrease in short-term borrowings (20,134) (1,800)
Proceeds from issuance of long-term debt 7,000 3,500
Repayments of long-term debt (2,000) --
Stock options exercised 378 --
Payment of dividends (3,530) (3,392)
------- -------
Net cash provided by (used in) financing activities (19,104) 25,808
Net increase in cash and due from banks 645 2,687
CASH AND DUE FROM BANKS
Beginning of period 9,280 8,473
End of period $ 9,925 $11,160
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 2,995 $ 2,702
Income Taxes 1,174 1,728
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES
Foreclosed real estate acquired in settlement of loans $ (349) $(1,127)
Financed sale of foreclosed real estate -- 154
Change in fair value of securities available
for sale, net of tax 216 (183)
Common stock issued upon business combination 17,282 --
-5-
Condensed Consolidated Statements of Shareholders' Equity
Nine months ended September 30, 2004 and 2003
(Dollars in thousands) (Unaudited) ACCUMULATED
OTHER
ADDITIONAL COMPREHENSIVE
COMMON PAID-IN RETAINED INCOME
STOCK CAPITAL EARNINGS (LOSS) TOTAL
Balance December 31, 2002 $2,513 $ 9,839 $11,614 $717 $24,683
Other comprehensive income:
Net income 3,457 3,457
Change in fair value of
securities available for sale, net (183) (183)
Comprehensive income 3,274
------ ------- ------- ----- ------
Balance September 30, 2003 $2,513 $ 9,839 $15,071 $534 $27,957
Balance December 31, 2003 $2,522 $10,005 $12,663 $460 $25,650
Issuance of common stock 636 16,646 17,282
Stock options exercised 26 352 378
Stock option expense 30 30
Tax benefit from exercise of options 75 75
Other comprehensive income:
Net income 4,236 4,236
Change in fair value of (216) (216)
securities available for sale, net
Comprehensive income 4,020
------ ------- ------- ---- -------
Balance September 30, 2004 $3,184 $27,108 $16,899 $244 $47,435
-6-
NOTES TO FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
by Pacific Financial Corporation ("Pacific" or the "Company") in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine months ended September 30, 2004,
are not necessarily indicative of the results anticipated for the year ending
December 31, 2004. Certain information and footnote disclosures included in the
Company's consolidated financial statements for the year ended December 31,
2003, have been condensed or omitted from this report. Accordingly, these
statements should be read with the financial statements and notes thereto
included in the Company's December 31, 2003 Annual Report on Form 10-K.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
All dollar amounts in tables, except per share information, are stated in
thousands.
2. Investment Securities
Investment securities consist principally of short and intermediate term debt
instruments issued by the U.S. Treasury, other U.S. government agencies, state
and local government units, and other corporations.
-7-
SECURITIES HELD TO MATURITY AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
September 30, 2004
U.S. Government Securities $ 1,899 $ 44 $ -- $ 1,943
State and Municipal Securities 6,138 73 20 6,191
------- ---- ---- -------
TOTAL $8,037 $117 $20 $ 8,134
SECURITIES AVAILABLE FOR SALE AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
September 30, 2004
U.S. Government Securities $16,012 $135 $150 $15,997
State and Municipal Securities 14,656 417 44 15,029
Corporate Securities 4,102 93 2 4,193
Mutual Funds 3,986 -- 81 3,905
------- ---- ---- -------
TOTAL $38,756 $645 $277 $39,124
3. Allowance for Credit Losses
TWELVE
THREE MONTHS ENDED NINE MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
2004 2003 2004 2003 2003
------ ------ ------ ------ ------
Balance at beginning of period $3,761 $2,350 $2,238 $2,473 $2,473
BNW Bancorp, Inc. acquisition -- -- 1,172 -- --
Provision for possible credit losses 300 -- 670 -- --
Charge-offs (7) (16) (36) (141) (265)
Recoveries 6 19 16 21 30
Net charge-offs (1) 3 (20) (120) (235)
------ ------ ------ ------ ------
Balance at end of period $4,060 $2,353 $4,060 $2,353 $2,238
Ratio of net charge-offs to
average loans outstanding .00% .00% .01% .07% .12%
-8-
4. Computation of Basic Earnings per Share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------------ -----------------
Net Income $1,435,000 $1,194,000 $4,236,000 $3,457,000
Average Shares Outstanding 3,176,457 2,512,669 3,030,292 2,512,665
Basic Earnings Per Share $ .45 $ .48 $ 1.40 $ 1.38
5. Computation of Diluted Earnings Per Share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------------ -----------------
Net Income $1,435,000 $1,194,000 $4,236,000 $3,457,000
Average Shares Outstanding 3,176,457 2,512,669 3,030,292 2,512,665
Effect of dilutive securities 81,607 47,013 67,858 34,828
Average Shares Outstanding and
Assumed conversion of dilutive
Stock options 3,258,064 2,564,017 3,098,150 2,553,785
Diluted Earnings Per Share $ 0.44 $ 0.47 $ 1.37 $ 1.35
6. Equity Compensation Plans
At September 30, 2004, the Company had a stock-based employee compensation plan.
The Company accounts for the plan under recognition and measurement principles
of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net
income, other than the $30,000 expensed in the current period for accelerated
vesting on retiring director options, as all options granted under this plan had
an exercise price equal to the market value of the underlying common stock on
the date of grant. The following table illustrates the effect on net income and
earnings per share had the Company applied the fair value recognition provisions
of FASB Statement No. 123, Accounting for Stock-Based Compensation, to
stock-based employee compensation.
-9-
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------------ -----------------
Net Income, as reported $1,435,000 $1,194,000 $4,236,000 $3,457,000
Add stock compensation expensed 6,000 -- 30,000 --
Less total stock-based compensation
expense determined under fair value
method for all qualifying awards, net of 39,000 22,000 118,000 66,000
tax
Pro forma net income 1,402,000 1,172,000 4,148,000 2,391,000
Earnings per Share
Basic:
As reported .45 .48 1.40 1.38
Pro forma .44 .47 1.37 1.35
Diluted:
As reported .44 .47 1.37 1.35
Pro forma .43 .46 1.34 1.33
7. Acquisition
On February 27, 2004, the Company completed the acquisition of BNW Bancorp, Inc.
Each share of BNW Bancorp, Inc. was exchanged for 0.85 shares of the Company's
common stock resulting in the issuance of 636,562 new shares. The acquisition
was accounted for using the purchase method of accounting and, accordingly, the
assets and liabilities of BNW Bancorp, Inc. were recorded at their respective
fair value. Goodwill, the excess of the purchase price over the net fair value
of the assets and liabilities acquired, was recorded at $10,651,000. As part of
the accounting for the acquisition, the Company recorded a core deposit
identifiable intangible asset of $993,000. The allocation of the purchase price
will be adjusted as necessary if more current information becomes known to
management.
The Company will follow the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 provides that goodwill is no longer amortized
and the value of an identifiable intangible asset is amortized over its useful
life, unless the asset is determined to have an indefinite life. The Company
will review the recorded value of goodwill on an annual basis for impairment.
The annual test for impairment will be a two step process. The first step will
be to compare the current value of BNW Bancorp, Inc. with its fair value on the
purchase date. If the current value exceeds the purchase value, goodwill will
not be considered to be impaired and the test is completed. If the current value
is less than purchase value, the Company will perform an analysis of goodwill
and appropriate impairment losses will be taken at that time.
The core deposit intangible recorded as part of the acquisition has an estimated
life of seven years. Estimated amortization expense will be approximately
$118,000 for the year ended December 31, 2004 and $142,000 for the years ended
December 31, 2005 through 2010 and $23,000 for the year ended December 31, 2011.
-10-
The following unaudited pro forma financials for the three and nine months ended
September 30, 2004 and 2003 assume that the BNW acquisition occurred as of
January of each fiscal year, after giving effect to certain adjustments. The pro
forma results have been prepared for comparative purposes only and are not
necessarily indicative of the results of operations which may occur in the
future or that would have occurred had the BNW acquisition been consummated on
the date indicated.
Pro Forma Financial Information
for the Nine Months Ended
September 30,
2004 2003
-------------------------------
(in thousands)
Net Interest Income $15,053 $12,960
Non-interest Income 2,479 2,505
Non-interest Expense 11,294 9,452
------- -------
Net Income $ 3,857 $ 3,885
------- -------
Earnings Per Share:
Basic $ 1.22 $ 1.21
Diluted 1.19 1.19
Pro Forma Financial Information
for the Three Months Ended
September 30,
2004 2003
-------------------------------
(in thousands)
Net Interest Income $ 5,101 $ 4,467
Non-interest Income 892 897
Non-interest Expense 3,642 3,272
------- -------
Net Income $ 1,435 $ 1,349
======= =======
Earnings Per Share:
Basic $ 0.45 $ 0.41
------- -------
Diluted $ 0.44 0.40
------- -------
8. Commitments and Contingencies
The Company entered into a purchase and sale agreement during the third quarter
for property located in Lynden, WA. The purpose of the land purchase is to
construct a new full service branch facility which will provide a full range of
deposit services, commercial, real estate and agriculture lending services. The
Company estimates the total cost upon completion to be $815,985.00.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
A Warning About 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 key employees, and/or maintain our
interest margins and fee income;
-11-
2. changes in the interest rate environment that may reduce margins
or decrease the value of our securities;
3. our recent acquisition of BNW Bancorp may be dilutive to earnings
per share if we do not realize expected cost savings or successfully
integrate BNW Bancorp into the Company without significant customer or
employee disruptions or losses;
4. our growth strategy, particularly if accomplished through
acquisitions, may not be successful if we fail to accurately assess market
opportunities, asset quality, anticipated cost savings, and transaction
costs, or experience significant difficulty integrating acquired
businesses or assets;
5. general economic or business conditions, either nationally or in
the regions in which we do business, may be less favorable than expected,
resulting in, among other things, a deterioration in credit quality or a
reduced demand for credit; and
6. a lack of liquidity in the market for our common stock may make
it difficult or impossible for you to liquidate your investment in our
stock or lead to distortions in the market price of our stock.
Our management believes the forward-looking statements in this report are
reasonable; however, you should not place undue reliance on them.
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. Many of the factors that will determine
our future results and share value are beyond our ability to control or predict.
We undertake no obligation to update forward-looking statements.
Net income. For the three months ended September 30, 2004, Pacific's net income
was $1,435,000 compared to $1,194,000 for the same period in 2003. For the nine
months ended September 30, 2004, net income was $4,236,000 compared to
$3,457,000 for the same period in 2003. The most significant factor contributing
to the increase was the acquisition of BNW Bancorp ("BNW") effective as of the
close of business on February 27, 2004. We expect the BNW acquisition to
continue to have a significant effect on net income for the remainder of the
year 2004 due to strong loan demand in both new and historical markets served by
Bank of the Pacific ("Bank"), the Company's wholly owned banking subsidiary.
Net interest income. Net interest income for the three and nine months ended
September 30, 2004 increased $1,943,000, or 61.5%, and $4,886,000 or 52.7%,
respectively, compared to the same periods in 2003.
-12-
This is due primarily to increased interest income from loans and the effect of
the BNW acquisition at the end of February 2004. The Company acquired
$109,569,000 of net loans as part of the BNW acquisition. The portfolio
consisted of approximately $79,700,000 in real estate loans, $25,600,000 in
commercial loans and $4,269,000 in consumer loans, the average yield on the
portfolio was approximately 6.83% at September 30, 2004.
Interest income for the three and nine months ended September 30, 2004,
increased $2,269,000, or 57.0%, and $5,373,000, or 45.2%, respectively, compared
to the same period in 2003. Average total loans outstanding for the nine months
ended September 30, 2004, and September 30, 2003, were $329,483,000, and
$185,911,000, respectively, or an increase of 77.2% in 2004 over 2003.
Interest expense for the three and nine months ended September 30, 2004
increased $326,000, or 39.6%, and $487,000, or 18.6%, respectively, compared to
the same period in 2003. The increase is primarily attributable to increased
short term borrowings. Average interest-bearing deposit balances for the nine
months ended September 30, 2004 and September 30, 2003 were $277,151,000 and
$196,058,000, respectively, representing an increase of 41.4% compared to last
year's period. The increase is attributable primarily to the BNW acquisition
closed February 27, 2004. The Company acquired deposits valued at $88,853,000 as
part of the acquisition. The deposit composition consists of approximately
$15,600,000 in non-interest bearing accounts, $33,800,000 in certificates of
deposit, and approximately $39,400,000 in other savings deposits with an average
cost of total deposits of 1.39% at September 30, 2004.
Average short term borrowings for the nine months ended September 30, 2004 and
September 30, 2003 were $8,468,000 and none, respectively, an increase of 100.0%
over the 2003 period. The increase was applied primarily to funding the loan
commitments outstanding for the BNW acquisition. Average long term borrowings
for the nine months ended September 30, 2004 were $17,427,000 compared to
$13,926,000 for the same period in 2003.
Provision and allowance for credit losses. The allowance for credit losses
reflects management's current estimate of the amount required to absorb losses
on existing loans and commitments to extend credit. Loans deemed uncollectible
are charged against and reduce the allowance. Periodically, a provision for
credit losses is charged to current expense. This provision acts to replenish
the allowance for credit losses and to maintain the allowance at a level that
management deems adequate.
There is no precise method of predicting specific credit losses or amounts that
ultimately may be charged off on segments of the loan portfolio. The
determination that a loan may become uncollectible, in whole or in part, is a
matter of judgment. Similarly, the adequacy of the allowance for credit losses
can be determined only on a judgmental basis, after full review, including (a)
consideration of economic conditions and the effect on particular industries and
specific borrowers; (b) a review of borrowers' financial data, together with
industry data, the competitive situation, the borrowers' management capabilities
and other factors; (c) a continuing evaluation of the loan portfolio, including
monitoring by lending officers and staff credit personnel of all loans which are
identified as being of less than acceptable quality; (d) an in-depth appraisal,
on a monthly basis, of all loans judged to present a possibility of loss (if, as
a result of such monthly appraisals, the loan is judged to be not fully
collectible, the carrying value of the loan is reduced to that portion
considered collectible); and (e) an evaluation of the underlying collateral for
secured lending, including the use of independent appraisals of real estate
properties securing loans. A formal analysis of the adequacy of the allowance is
conducted quarterly and is reviewed by the Board of Directors. Based on this
analysis, management considers the allowance for credit losses to be adequate at
September 30, 2004.
-13-
Periodic provisions for credit losses are made to maintain the allowance for
credit losses at an appropriate level. The provisions are based on an analysis
of various factors including historical loss experience based on volumes and
types of loans, volumes and trends in delinquencies and non-accrual loans,
trends in portfolio volume, results of internal and independent external credit
reviews, and anticipated economic conditions. For additional information, please
see the discussion under the heading "Critical Accounting Policy" in Item 7 of
our Annual Report on Form 10-K for the year ended December 31, 2003.
During the three and nine months ended September 30, 2004, a provision of
$300,000 and $670,000, respectively, was provided for possible credit losses,
compared to no provision in the same periods in 2003. For the three and nine
months ended September 30, 2004, net charge-offs were $1,000, and $20,000,
respectively, compared to a net recovery of $3,000 and net charge-offs of
$120,000, during the same periods in 2003, and compared to $235,000 in net
charge-offs during the twelve months ended December 31, 2003.
At September 30, 2004, the allowance for credit losses stood at $4,060,000
compared to $2,238,000 at December 31, 2003, and $2,353,000 at September 30,
2003. Approximately $1,172,000 of this increase was attributable to the BNW
acquisition and a provision of $670,000 was allocated to the allowance for
credit losses as a result of continued growth in the loan portfolio. The ratio
of the allowance to total loans outstanding was 1.21%, 1.12% and 1.27%,
respectively, at September 30, 2004, December 31, 2003, and September 30, 2003.
Non-performing assets and foreclosed real estate owned. Non-performing assets
totaled $1,052,000 at September 30, 2004. This represents .31% of total loans,
compared to $563,000 or .28% at December 31, 2003, and $1,494,000 or .77% at
September 30, 2003. The increase during the period ended September 30, 2004, is
due primarily to a commercial loan that is guaranteed 100% by the USDA and was
subsequently paid off in October 2004. Non-accrual loans at September 30, 2004
totaled $456,000. Based on current analysis, management believes losses
associated with non-accrual loans will be minimal. Foreclosed real estate
consists of two properties secured by real estate with no individual material
balances.
ANALYSIS OF NON-PERFORMING ASSETS
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
(in thousands) 2004 2003 2003
Accruing loans past due 90 days or more $ 512 $ -- $ --
Non-accrual loans 456 465 596
Foreclosed real estate 84 98 898
------ ---- ------
TOTAL $1,052 $563 $1,494
Non-interest income and expense. Non-interest income for the three and nine
months ended September 30, 2004 increased $353,000, and $926,000, respectively,
compared to the same period in 2003. The primary reasons for the increases were
additional service charge income and
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gain on sale of loans. Service charges on deposit accounts increased $91,000,
and $188,000, respectively, compared to the three and nine months ended
September 30, 2003. This is due in part to the implementation of the Bank's
customer overdraft protection program in the branches acquired with the BNW
transaction. Gain on sale of loans totaled $330,000 for the three months ended
September 30, 2004, and totaled $719,000 for the nine month period in 2004.
Prior to 2004, the Company did not sell loans into the secondary market.
However, a real estate mortgage department was included with the BNW
acquisition, resulting in revenues relating to gain on sale of loans. Commitment
to sell and sale price is established at the time of origination of loans to
limit any potential price risk.
Non-interest expense for the three and nine months ended September 30, 2004
increased $1,639,000, or 81.8%, and $4,003,000, or 68.5%, respectively, compared
to the same periods in 2003. The BNW acquisition was the major contributing
factor to increased non-interest expense due to the increase of full time
equivalent employees, the addition of five branches, and expenses incurred in
connection with the acquisition.
Income taxes. The federal income tax provision for the three and nine months
ended September 30, 2004 was $616,000, and $1,775,000, respectively, an increase
of $116,000 for the three month period, and an increase of $360,000, for the
nine month period, compared to the same periods in 2003. The effective tax rate
for the three and nine months ended September 30, 2004 was 30.03% and 29.53%.
Financial Condition. Total assets were $423,339,000 at September 30, 2004, an
increase of $116,624,000, or 38.1%, over year-end 2003. Loans, including loans
held for sale, were $336,017,000 at September 30, 2004, an increase of
$136,279,000, or 68.2%, over year-end 2003. Total deposits were $348,072,000 at
September 30, 2004, an increase of $87,272,000, or 33.46%, compared to December
31, 2003. Increases in assets, loans and deposit balances were primarily the
result of the BNW acquisition, although the Company did see growth in each
category in its historical markets.
Loans. Loan detail by category, including loans held for sale, as of September
30, 2004 and December 31, 2003 follows:
September 30, December 31,
2004 2003
Commercial and industrial $ 86,475 $ 59,665
Agricultural 20,018 4,679
Real estate mortgage 172,644 117,940
Real estate construction 45,310 11,894
Installment 8,810 4,625
Credit cards and other 2,760 935
-------- --------
Total Loans 336,017 199,738
Allowance for credit losses (4,060) (2,238)
-------- --------
Net Loans $331,957 $197,500
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Liquidity. Adequate liquidity is available to accommodate fluctuations in
deposit levels, fund operations, and provide for customer credit needs and meet
obligations and commitments on a timely basis. The Company has generally been a
net seller of federal funds. When necessary, liquidity can be increased by
taking advances available from the Federal Home Loan Bank of Seattle.
Shareholders' equity. Total shareholders' equity was $47,435,000 at September
30, 2004, an increase of $21,785,000, or 84.9%, compared to December 31, 2003.
The increase was due to net income and the acquisition of BNW Bancorp effective
February 27, 2004, which was accounted for as a purchase transaction. Tangible
book value per share was $11.55 at September 30, 2004 compared to $10.17
December 31, 2003. Tangible book value is calculated by dividing total equity
capital minus goodwill, by total shares outstanding.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate, credit, and operations risks are the most significant market
risks which affect the Company's performance. The Company relies on loan review,
prudent loan underwriting standards and an adequate allowance for possible
credit losses to mitigate credit risk.
An asset/liability management simulation model is used to measure interest rate
risk. The model produces regulatory oriented measurements of interest rate risk
exposure. The model quantifies interest rate risk by simulating forecasted net
interest income over a 12 month time period under various interest rate
scenarios, as well as monitoring the change in the present value of equity under
the same rate scenarios. The present value of equity is defined as the
difference between the market value of assets less current liabilities. By
measuring the change in the present value of equity under various rate
scenarios, management is able to identify interest rate risk that may not be
evident from changes in forecasted net interest income.
The Company is currently asset sensitive, meaning that interest earning assets
mature or re-price more quickly than interest-bearing liabilities in a given
period. Therefore, a significant increase in market rates of interest could
improve net interest income. Conversely, a decreasing rate environment may
adversely affect net interest income.
It should be noted that the simulation model does not take into account future
management actions that could be undertaken should actual market rates change
during the year. Also, the model simulation results are not exact measures of
the Company's actual interest rate risk. They are rather only indicators of rate
risk exposure, based on assumptions produced in a simplified modeling
environment designed to heighten sensitivity to changes in interest rates. The
rate risk exposure results of the simulation model typically are greater than
the Company's actual rate risk. That is due to the conservative modeling
environment, which generally depicts a worst-case situation. Management has
assessed the results of the simulation reports as of September 30, 2004, and
believes that there has been no material change since December 31, 2003.
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ITEM 4. CONTROLS AND PROCEDURES
The Company's disclosure controls and procedures are designed to ensure that
information the Company must disclose in its reports filed or submitted under
the Securities Exchange Act of 1934 ("Exchange Act") is recorded, processed,
summarized, and reported on a timely basis. Our management has evaluated, with
the participation and under the supervision of our chief executive officer (CEO)
and chief financial officer (CFO), the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act)
as of the end of the period covered by this report. Based on this evaluation,
our CEO and CFO have concluded that, as of such date, the Company's disclosure
controls and procedures are effective in ensuring that information relating to
the Company, including its consolidated subsidiaries, required to be disclosed
in reports that it files under the Exchange Act is (1) recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (2) accumulated and communicated to our management, including our CEO
and CFO, as appropriate to allow timely decisions regarding required
disclosures.
No change in the Company's internal control over financial reporting occurred
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS
See Exhibit Index immediately following signatures below.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PACIFIC FINANCIAL CORPORATION
DATED: November 10, 2004 By: /s/ Dennis A. Long
-----------------------
Dennis A. Long
President
By: /s/ John Van Dijk
------------------------
John Van Dijk, Treasurer
(Principal Financial and
Accounting Officer)
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Exhibit Index
EXHIBIT NO. EXHIBIT
----------- -------
31.1 Certification of CEO under Rule 13a - 14(a) of the Exchange Act.
31.2 Certification of CFO under Rule 13a - 14(a) of the Exchange Act.
32 Certification of CEO and CFO under 18 U.S.C. Section 1350.
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