As Filed with the Securities & Exchange Commission on August 6, 2007
SECURITIES & EXCHANGE COMMISSION
FORM 10-Q
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2007.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to ________________
SEC File Number: 0-30106
PACIFIC CONTINENTAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
OREGON | 93-1269184 |
| (State or Other Jurisdiction of | (I.R.S. Employer |
| Incorporation or Organization) | Identification Number) |
111 West 7th Avenue
Eugene, Oregon 97401
(address of Principal Executive Offices) (Zip Code)
(541) 686-8685
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Large accelerated filer __ Accelerated filer X Non-accelerated filer __
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act Yes __ No X
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:
Common Stock outstanding as of July 31, 2007: 11,840,518
PACIFIC CONTINENTAL CORPORATION
FORM 10-Q
QUARTERLY REPORT
TABLE OF CONTENTS
PART I | FINANCIAL INFORMATION | Page | |
| Item 1. | Financial Statements | ||
| Three and six months ended June 30, 2007 and June 30, 2006 | |||
| Item 2. | |||
| Item 3. | |||
| Item 4. | |||
PART II | OTHER INFORMATION | ||
| Item 1. | Legal Proceedings | none | |
| Item 1a. | |||
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | none | |
| Item 3. | Defaults Upon Senior Securities | none | |
| Item 4. | |||
| Item 5. | Other Information | none | |
| Item 6. | |||
2
Amounts in $ 000’s, Except for Per Share Data
(Unaudited)
| Three months ended | Six months ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||
| Interest and dividend income | ||||||||||||||||
| Loans | $ | 17,315 | $ | 14,751 | $ | 33,522 | $ | 28,340 | ||||||||
| Securities | 419 | 405 | 838 | 807 | ||||||||||||
| Dividends on Federal Home Loan Bank stock | 6 | - | 9 | - | ||||||||||||
| Federal funds sold | 11 | 9 | 29 | 20 | ||||||||||||
| 17,751 | 15,165 | 34,398 | 29,167 | |||||||||||||
| Interest expense | ||||||||||||||||
| Deposits | 4,782 | 3,813 | 9,404 | 7,235 | ||||||||||||
| Federal Home Loan Bank borrowings | 1,854 | 1,244 | 3,389 | 2,229 | ||||||||||||
| Trust preferred securities | 127 | 125 | 252 | 253 | ||||||||||||
| Federal funds purchased | 50 | 87 | 97 | 194 | ||||||||||||
| 6,813 | 5,269 | 13,142 | 9,911 | |||||||||||||
| Net interest income | 10,938 | 9,896 | 21,256 | 19,256 | ||||||||||||
| Provision for loan losses | 125 | 200 | 325 | 450 | ||||||||||||
| Net interest income after provision | 10,813 | 9,696 | 20,931 | 18,806 | ||||||||||||
| Noninterest income | ||||||||||||||||
| Service charges on deposit accounts | 355 | 343 | 690 | 672 | ||||||||||||
| Other fee income, principally bankcard | 412 | 381 | 780 | 733 | ||||||||||||
| Loan servicing fees | 25 | 27 | 49 | 60 | ||||||||||||
| Mortgage banking income and gains | ||||||||||||||||
| on loan sales | 81 | 230 | 189 | 385 | ||||||||||||
| Other noninterest income | 76 | 75 | 189 | 163 | ||||||||||||
| 949 | 1,056 | 1,897 | 2,013 | |||||||||||||
| Noninterest expense | ||||||||||||||||
| Salaries and employee benefits | 3,820 | 3,500 | 7,835 | 6,748 | ||||||||||||
| Premises and equipment | 774 | 786 | 1,532 | 1,509 | ||||||||||||
| Bankcard processing | 133 | 126 | 256 | 247 | ||||||||||||
| Business development | 511 | 347 | 822 | 735 | ||||||||||||
| Other noninterest expense | 1,275 | 945 | 2,426 | 1,854 | ||||||||||||
| 6,513 | 5,704 | 12,871 | 11,093 | |||||||||||||
| Income before income taxes | 5,249 | 5,048 | 9,957 | 9,726 | ||||||||||||
| Provision for income taxes | 2,038 | 1,860 | 3,751 | 3,606 | ||||||||||||
| Net income | $ | 3,211 | $ | 3,188 | $ | 6,206 | $ | 6,120 | ||||||||
| Earnings per share | ||||||||||||||||
| Basic | $ | 0.27 | $ | 0.28 | $ | 0.53 | $ | 0.53 | ||||||||
| Diluted | $ | 0.27 | $ | 0.27 | $ | 0.52 | $ | 0.52 | ||||||||
| Weighted average shares outstanding | ||||||||||||||||
| Basic | 11,815 | 11,578 | 11,788 | 11,498 | ||||||||||||
| Common stock equivalents | ||||||||||||||||
| attributable to stock options | 155 | 203 | 174 | 195 | ||||||||||||
| Diluted | 11,970 | 11,781 | 11,962 | 11,693 | ||||||||||||
| See accompanying notes. | ||||||||||||||||
3
Amounts in $ 000’s
(Unaudited)
| Three months ended | Six months ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||
| Net income | $ | 3,211 | $ | 3,188 | $ | 6,206 | $ | 6,120 | ||||||||
| Other comprehensive income: | ||||||||||||||||
| Unrealized losses arising during the period | (234 | ) | (185 | ) | (171 | ) | (399 | ) | ||||||||
| Income tax benefit | 90 | 71 | 66 | 153 | ||||||||||||
| Net unrealized gains (losses) on securities | ||||||||||||||||
| available for sale | (144 | ) | (114 | ) | (105 | ) | (246 | ) | ||||||||
| Comprehensive Income | $ | 3,067 | $ | 3,074 | $ | 6,101 | $ | 5,874 | ||||||||
| See accompanying notes. | ||||||||||||||||
4
Amounts in $ 000’s
(Unaudited)
| Jun. 30, | Dec. 31, | Jun. 30, | ||||||||||
| 2007 | 2006 | 2006 | ||||||||||
ASSETS | ||||||||||||
| Cash and due from banks | $ | 27,150 | $ | 32,323 | $ | 24,477 | ||||||
| Interest-bearing deposits with banks | 408 | 406 | 400 | |||||||||
| Federal funds sold | 101 | 49 | 708 | |||||||||
| Total cash and cash equivalents | 27,659 | 32,778 | 25,585 | |||||||||
| Securities available-for-sale | 39,049 | 38,783 | 38,090 | |||||||||
| Loans held for sale | 615 | 2,140 | 1,469 | |||||||||
| Loans, less allowance for loan losses | 786,536 | 758,816 | 717,008 | |||||||||
| Interest receivable | 3,959 | 3,998 | 3,299 | |||||||||
| Federal Home Loan Bank stock | 3,480 | 3,480 | 3,480 | |||||||||
| Property, net of accumulated depreciation | 18,880 | 18,591 | 17,869 | |||||||||
| Goodwill and other intangible assets | 23,238 | 23,626 | 24,090 | |||||||||
| Deferred tax asset | 1,590 | 1,652 | - | |||||||||
| Other assets | 1,659 | 1,487 | 1,447 | |||||||||
| Total assets | $ | 906,665 | $ | 885,351 | $ | 832,337 | ||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||
| Deposits | ||||||||||||
| Noninterest-bearing demand | $ | 172,145 | $ | 187,834 | $ | 170,504 | ||||||
| Savings and interest-bearing checking | 426,255 | 355,863 | 336,181 | |||||||||
| Time $100,000 and over | 43,783 | 48,876 | 50,472 | |||||||||
| Other time | 57,219 | 48,699 | 58,953 | |||||||||
| Total deposits | 699,402 | 641,272 | 616,110 | |||||||||
| Federal funds purchased | - | 4,410 | 1,700 | |||||||||
| Federal Home Loan Bank borrowings | 94,054 | 131,804 | 113,554 | |||||||||
| Junior subordinated debenture | 8,248 | 8,248 | 8,248 | |||||||||
| Accrued merger consideration liability | 247 | 256 | 520 | |||||||||
| Accrued interest and other payables | 3,279 | 3,626 | 3,077 | |||||||||
| Total liabilities | 805,230 | 789,616 | 743,209 | |||||||||
| Stockholders' equity | ||||||||||||
| Common stock, no par value; 25,000,000 shares | 59,889 | 58,255 | 56,842 | |||||||||
| authorized; 11,835,380 outstanding as of | ||||||||||||
| June 30, 2007 | ||||||||||||
| Retained earnings | 41,897 | 37,725 | 32,891 | |||||||||
| Accumulated other comprehensive loss | (351 | ) | (245 | ) | (605 | ) | ||||||
| 101,435 | 95,735 | 89,128 | ||||||||||
| Total liabilities and stockholders’ equity | $ | 906,665 | $ | 885,351 | $ | 832,337 | ||||||
| See accompanying notes. | ||||||||||||
5
Amounts in $ 000’s
(Unaudited)
| For six months ended Jun. 30, | ||||||||
| 2007 | 2006 | |||||||
| Net cash provided by operating activities | $ | 8,426 | $ | 6,509 | ||||
| Cash flows from investing activities | ||||||||
| Proceeds from sales and maturities of investment securities | 2,897 | 3,479 | ||||||
| Purchase of investment securities | (3,293 | ) | (2,832 | ) | ||||
| Loans made net of principal collections received | (47,358 | ) | (46,802 | ) | ||||
| Proceeds from sale of loans | 20,031 | - | ||||||
| Purchase of loans | (98 | ) | (122 | ) | ||||
| Cash paid for acquisitions | (10 | ) | (12,485 | ) | ||||
| Purchase of property | (930 | ) | (1,510 | ) | ||||
| Proceeds on sale of foreclosed assets | - | 194 | ||||||
| Net cash paid for investing activities | (28,761 | ) | (60,078 | ) | ||||
| Cash flow from financing activities | ||||||||
| Change in deposits | 58,130 | 11,839 | ||||||
| Change in federal funds purchased and | ||||||||
| FHLB short-term borrowings | (52,410 | ) | 8,700 | |||||
| Proceeds from FHLB term advances | 356,500 | 162,000 | ||||||
| Repayment of FHLB advances | (346,250 | ) | (136,250 | ) | ||||
| Proceeds from stock options exercised | 1,156 | 2,555 | ||||||
| Excess tax benefit from stock options exercised | 125 | 149 | ||||||
| Dividends paid | (2,035 | ) | (1,682 | ) | ||||
| Net cash provided by financing activities | 15,216 | 47,311 | ||||||
| Net decrease in cash and cash equivalents | (5,119 | ) | (6,258 | ) | ||||
| Cash and cash equivalents, beginning of period | 32,778 | 31,843 | ||||||
| Cash and cash equivalents, end of period | $ | 27,659 | $ | 25,585 | ||||
| See accompanying notes. | ||||||||
6
(Unaudited)
A complete set of Notes to Consolidated Financial Statements is a part of the Company’s 2006 Form 10-K filed March 15, 2007. The notes below are included due to material changes in the financial statements or to provide the reader with additional information not otherwise available. All numbers in the following notes are expressed in thousands of dollars, except per share data.
1. Basis of Presentation
The accompanying interim consolidated financial statements include the accounts of Pacific Continental Corporation (the “Company”), a bank holding company, and its wholly-owned subsidiary, Pacific Continental Bank (the “Bank”) and the Bank’s wholly-owned subsidiaries, PCB Services Corporation and PCB Loan Services Corporation (both of which are presently inactive). All significant intercompany accounts and transactions have been eliminated in consolidation.
The accompanying consolidated financial statements have been prepared by the Company without audit and in conformity with generally accepted accounting principles in the United States of America for interim financial information. The financial statements include all adjustments and normal accruals, which the Company considers necessary for a fair presentation of the results of operations for such interim periods. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, as of the date of the balance sheets and income and expenses for the periods. Actual results could differ from those estimates.
The balance sheet data as of December 31, 2006 was derived from audited financial statements, but does not include all disclosures contained in the Company’s 2006 Form 10-K. The interim consolidated financial statements should be read in conjunction with the December 31, 2006 consolidated financial statements, including the notes thereto, included in the Company’s 2006 Form 10-K.
2. Equity and Liability Based Compensation Plans
The Company adopted Financial Accounting Standards Board Statement No. 123(R), “Share-Based Payment” (“SFAS 123R”) effective January 1, 2006. SFAS 123R establishes the accounting required for share-based compensation, and requires companies to measure and recognize compensation expense for all share-based payments at the grant date based on the fair value of the award, as defined in SFAS 123R, and include such costs as an expense in our income statements over the requisite service (vesting) period. The Company adopted SFAS 123R using a modified prospective application, whereby the provisions of the statement have applied prospectively only from the date of adoption for new (issued subsequent to December 31, 2005) and unvested stock option awards for which the requisite service is rendered after the date of adoption. Thus, the Company recognizes as expense the fair value of stock options issued prior to January 1, 2006, but vesting after January 1, 2006, over the remaining vesting period. In addition, compensation expense must be recognized for any awards modified, repurchased, or cancelled after the date of adoption. The Company uses the Black-Scholes option pricing model to measure fair value.
The Bank’s stock option plan and equity compensation plan information has been retroactively restated to reflect the 10% stock dividend declared and paid during the second quarter 2007.
Pursuant to the Company’s 1999 Employees’ Stock Option Plan, as amended (the “1999 ESOP Plan”), either incentive stock option or non-qualified option awards have been granted to employees. Subsequent to the annual shareholders’ meeting in April 2006, all shares available for future grants under this plan were cancelled and are no longer available for future grants. Stock options in the past had been granted at exercise prices not less than 100% of the fair market value of our common stock at the grant date. The Compensation Committee or the Board of Directors determined vesting provisions when stock options were granted, and stock options granted generally vested over three or four years. The maximum life of stock options granted under this plan was ten years from the grant date.
7
Pursuant to the Company’s 1999 Directors’ Stock Option Plan, as amended (the “1999 DSOP Plan”), non-qualified options awards had been granted to directors. Subsequent to the annual shareholders’ meeting in April 2006, all shares available for future grants under this plan were cancelled and are no longer available for future grants. Stock options had been granted at exercise prices of not less than 100% of the fair market value of our common stock at the grant date. The maximum life of options granted under this plan was ten years from the grant date.
Pursuant to the approval of the 2006 Stock Option and Equity Compensation Plan (the “2006 SOEC Plan”) at the annual shareholders’ meeting in April 2006, incentive stock options, nonqualified stock options, restricted stock, restricted stock units, or stock appreciation rights may be awarded to attract and retain the best available personnel for positions of responsibility with the corporation and its subsidiaries. The exercise price for shares of common stock subject to an option shall not be less than 100% of the fair market value of a share of common stock as of the date of grant of the option; provided, however, that in the case of an incentive stock option granted to an employee who immediately before the grant of such incentive stock option is a shareholder-employee, the incentive stock option exercise price shall be at least 110% of the fair value of the common stock as of the date of grant of the incentive stock option. The Compensation Committee of the Board of Directors may impose any terms and conditions on the vesting of an award that it determines to be appropriate. The first stock options, under this plan, were granted in the third quarter 2006. The Company issued no options during the second quarter 2007. However, the Company did issue 71 incentive stock options, with a fair value of $4.45 per unit, to selected employees during the six-month period ending June 30, 2007.
Pursuant to the Company’s 2006 SOEC Plan, stock appreciation rights (SARs) may be granted to employees. The stock appreciation rights may be settled in cash or cash and common stock as determined at the date of issuance. The Compensation Committee or the Board of Directors determines vesting provisions when awards are granted, and the awards granted generally vest over three or four years and have a maximum life of ten years. SARs settled in stock are recognized as equity-based awards while SARs settled in cash are recognized on the balance sheet as liability-based awards, both of which are granted at the fair market value of our common stock at the grant date. The grant-date fair value of the liability based awards vesting in the current period, along with the change in fair value of the awards during the period, are recognized as compensation expense and as an adjustment to the recorded liability. The Company began issuing SARS in the third quarter 2006 and issued no SARS during the second quarter 2007. For the six-month period ending June 30, 2007, the Company did issue 152 SARs, with a fair value of $4.45 per unit, of which 66 are to be settled in cash, while 86 are to be settled in stock. The conversion of SARs, to be settled in stock, is estimated to be one share of common stock for every 4.89 SARs. Therefore, 18 shares of common stock are expected to be issued if all 86 SARs are settled.
Also, pursuant to the Company’s 2006 SOEC Plan, non-qualified options awards have been granted to directors. Stock options have been granted at exercise prices of not less than 100% of the fair market value of our common stock at the grant date. The maximum life of options granted under this plan is ten years from the grant date. The Company issued no options during the second quarter 2007 and issued 18 nonqualified stock options, with a fair value of $3.09 per option, to the directors during the six-month period ending June 30, 2007.
8
The following tables identify the compensation expenses and tax benefits received by the Company according to the compensation plans and awards described above for the three and six month periods ending June 30, 2007 and 2006:
| 3-months ending Jun. 30, 2007 | 3-months ending Jun. 30, 2006 | |||||||||||||||
| Comp. Exp. | Tax Benefit | Comp. Exp. | Tax Benefit | |||||||||||||
| 1999 ESOP Plan | $ | 75 | $ | - | $ | 122 | $ | - | ||||||||
| 1999 DSOP Plan | - | - | 25 | 10 | ||||||||||||
| 2006 SOEC - ISOs | 28 | - | - | - | ||||||||||||
| 2006 SOEC - SARS stock | 34 | - | - | - | ||||||||||||
| 2006 SOEC - SARS cash | 19 | 7 | - | - | ||||||||||||
| 2006 SOEC - DSOs | 7 | 3 | - | - | ||||||||||||
| Total | $ | 163 | $ | 10 | $ | 147 | $ | 10 | ||||||||
| 6-months ending Jun. 30, 2007 | 6-months ending Jun. 30, 2006 | |||||||||||||||
| Comp. Exp. | Tax Benefit | Comp. Exp. | Tax Benefit | |||||||||||||
| 1999 ESOP Plan | $ | 153 | $ | - | $ | 243 | $ | - | ||||||||
| 1999 DSOP Plan | 7 | 3 | 42 | 16 | ||||||||||||
| 2006 SOEC - ISOs | 51 | - | - | - | ||||||||||||
| 2006 SOEC - SARS stock | 61 | - | - | - | ||||||||||||
| 2006 SOEC - SARS cash | 25 | 10 | - | - | ||||||||||||
| 2006 SOEC - DSOs | 12 | 5 | - | - | ||||||||||||
| Total | $ | 309 | $ | 17 | $ | 285 | $ | 16 | ||||||||
Stock Options –
The following table provides the weighted-average fair values for stock options granted during the three– and six-month periods ending June 30, 2007 and 2006. These values were estimated using the Black-Scholes option valuation model with the following weighted-average assumptions:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||
| 2007 | 2006 | 2007 | 2006 | |||||
| Expected life in years (1) | - | 4.02 | 5.61 | 4.01 | ||||
| Volatility (1) | 0.00% | 16.72% | 17.87% | 17.01% | ||||
| Interest Rate (2) | 0.00% | 4.91% | 4.81% | 4.76% | ||||
| Yield Rate (3) | 0.00% | 1.90% | 1.58% | 1.76% | ||||
| Average Fair-Value | $ - | $ 2.68 | $ 4.18 | $ 2.74 | ||||
| (1) | Estimate based on historical experience. Volatility is based on historical experience over a period equivalent to the expected life in years. |
| (2) | Based on the U.S. Treasury constant maturity interest rate with a term consistent with the expected life of the options granted. |
| (3) | The Company has paid cash dividends on common stock since 1985. Each grant’s dividend yield is calculated by annualizing the most recent quarterly cash dividend and dividing that amount by the market price of the Company’s common stock as of the grant date. |
For any future grants, as required by SFAS 123R, the Company will estimate the impact of forfeitures based on our historical experience with previously granted stock options, and consider the impact of the forfeitures when determining the amount of expense to record for the stock options granted. For stock options issued prior to the adoption of SFAS 123R, forfeitures were recognized when the stock option was actually forfeited. The Company generally issues new shares of common stock to satisfy stock option exercises.
9
A summary of stock option activity for all Company plans during the current fiscal year is presented below:
Total Stock Options | Shares | Average Price Per Share | Weighted-Average Remaining Contractual Life | Aggregate Intrinsic Value | ||||||||||||
| Outstanding at December 31, 2006 | 842 | $ | 11.68 | |||||||||||||
| Granted | 89 | 18.39 | ||||||||||||||
| Exercised | (124 | ) | 9.37 | |||||||||||||
| Forfeited or expired | (6 | ) | 13.79 | |||||||||||||
Outstanding at June 30, 2007 | 801 | $ | 12.77 | 3.56 | $ | 2,962 | ||||||||||
Exercisable at June 30, 2007 | 436 | $ | 10.47 | 2.19 | $ | 2,501 | ||||||||||
Nonvested Options | Shares | Weighted-Average Grant Date Fair Value | ||||||
| Outstanding at December 31, 2006 | 311 | $ | 2.88 | |||||
| Granted | 89 | 4.18 | ||||||
| Vested | (29 | ) | 2.18 | |||||
| Forfeited or expired | (6 | ) | 2.73 | |||||
Outstanding at June 30, 2007 | 365 | $ | 3.26 | |||||
A summary of value received by employees and directors exercising stock options for the three- and six-month periods ending June 30, 2007 and 2006 is presented below:
| Three months ended Jun. 30, | Six months ended Jun. 30, | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||
| Total intrinsic value of | ||||||||||||||||
| stock options exercised | $ | 278 | $ | 290 | $ | 991 | $ | 2,040 | ||||||||
Stock Appreciation Rights -
The following table provides the weighted-average fair values for stock appreciation rights (SARs) to be settled in stock granted during the six months ended June 30, 2007. These are considered to be equity-based awards. No activity was recognized during the second quarter 2007 and no activity was recognized during the first six months of 2006 since this type of award was first introduced in the third quarter 2006. The values were estimated using the Black-Scholes option valuation model with the following weighted-average assumptions:
| 2007 | ||||
| Expected life in years (1) | 6.00 | |||
| Volatility (1) | 18.68 | % | ||
| Interest Rate (2) | 4.81 | % | ||
| Yield Rate (3) | 1.58 | % | ||
| Average Fair-Value | $ | 4.45 | ||
10
| (1) | Estimate based on historical experience. Volatility is based on historical experience over a period equivalent to the expected life in years. |
| (2) | Based on the U.S. Treasury constant maturity interest rate with a term consistent with the expected life of the options granted. |
| (3) | The Company has paid cash dividends on common stock since 1985. Each grant’s dividend yield is calculated by annualizing the most recent quarterly cash dividend and dividing that amount by the market price of the Company’s common stock as of the grant date. |
A summary of SAR – stock award activity during the current fiscal year is presented below:
Total SAR - Stock Awards | Awards | Average Price Per Award | Weighted-Average Remaining Contractual Life | Aggregate Intrinsic Value | ||||||||||||
| Outstanding at December 31, 2006 | 75 | $ | 16.34 | |||||||||||||
| Granted | 86 | 18.39 | ||||||||||||||
| Exercised | - | - | ||||||||||||||
| Forfeited or expired | (2 | ) | 17.13 | |||||||||||||
Outstanding at June 30, 2007 | 159 | $ | 17.44 | 9.44 | $ | - | ||||||||||
Exercisable at June 30, 2007 | - | $ | - | - | $ | - | ||||||||||
Nonvested SAR - Stock Awards | Awards | Weighted-Average Grant Date Fair Value | ||||||
| Outstanding at December 31, 2006 | 75 | $ | 3.88 | |||||
| Granted | 86 | 4.45 | ||||||
| Vested | - | - | ||||||
| Forfeited or expired | (2 | ) | - | |||||
Outstanding at June 30, 2007 | 159 | $ | 4.18 | |||||
The stock appreciation rights (SARs) to be settled in cash awarded February 13, 2007 have the same weighted –average fair value inputs as the SARs settled in stock mentioned above.
A summary of SAR – cash awards activity during the current fiscal year is presented below:
Total SAR - Cash Awards | Shares | Average Price Per Share | Weighted-Average Remaining Contractual Life | Aggregate Intrinsic Value | ||||||||||||
| Outstanding at December 31, 2006 | 60 | $ | 16.34 | |||||||||||||
| Granted | 66 | 18.39 | ||||||||||||||
| Exercised | - | - | ||||||||||||||
| Forfeited or expired | (3 | ) | 17.13 | |||||||||||||
Outstanding at June 30, 2007 | 123 | $ | 17.43 | 9.44 | $ | - | ||||||||||
Exercisable at June 30, 2007 | - | $ | - | - | $ | - | ||||||||||
11
Nonvested SAR - Cash Awards | Shares | Weighted-Average Grant Date Fair Value | ||||||
| Outstanding at December 31, 2006 | 60 | 3.88 | ||||||
| Granted | 66 | 4.45 | ||||||
| Vested | - | - | ||||||
| Forfeited or expired | (3 | ) | - | |||||
Outstanding at June 30, 2007 | 123 | $ | 4.18 | |||||
For any future grants, as required by SFAS 123R, the Company will estimate the impact of forfeitures based on our historical experience with previously granted stock options, and consider the impact of the forfeitures when determining the amount of expense to record for both stock and cash settled SARs.
At June 30, 2007, the Company has estimated unrecognized compensation expense of $780, $459 and $251 for unvested stock options, SAR – stock awards and SAR – cash awards, respectively. These amounts are based on a forfeiture rate assumption of 20% for all awards granted to employees. The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested stock options, SAR – stock awards and SAR – cash awards is approximately 2.3, 3.4 and 3.4 years, respectively.
3. Loans
Major classifications of loans at June 30, 2007, December 31, 2006, and June 30, 2006 are as follows:
June 30, 2007 | December 31, 2006 | June 30, 2006 | ||||||||||
| Commercial loans | $ | 180,160 | $ | 169,566 | $ | 149,522 | ||||||
| Real estate loans | 610,097 | 590,855 | 565,420 | |||||||||
| Consumer loans | 7,046 | 9,168 | 12,982 | |||||||||
| 797,303 | 769,589 | 727,924 | ||||||||||
| Deferred loan origination fees | (2,172 | ) | (2,489 | ) | (2,666 | ) | ||||||
| 795,131 | 767,100 | 725,258 | ||||||||||
| Allowance for loan losses | (8,595 | ) | (8,284 | ) | (8,250 | ) | ||||||
| $ | 786,536 | $ | 758,816 | $ | 717,008 | |||||||
Allowance for loan losses
Below is a summary of additions and charges against the allowance for loan losses for the six month period ending June 30, 2007 and 2006:
2007 | 2006 | |||||||
| Balance, December 31 | $ | 8,284 | $ | 7,792 | ||||
| Provision charged to income | 325 | 450 | ||||||
| Loans charged against allowance | (43 | ) | (59 | ) | ||||
| Recoveries credited to allowance | 29 | 67 | ||||||
| Balance, June 30 | $ | 8,595 | $ | 8,250 | ||||
The recorded investment in restructured and other impaired loans totaled $581 and $528 at June 30, 2007 and 2006, respectively. Impaired loans at June 30, 2007 include $103 of nonaccrual loans and $478 of loans to a single borrower performing under revised terms. The specific valuation allowance for loan losses related to these impaired loans was $27 and $116 at June 30, 2007 and 2006, respectively, and is included in the ending allowance shown above. The average recorded investment in impaired loans for the first six months of 2007 and 2006 was approximately $766 and $611, respectively. Interest income recognized on restructured and impaired loans was $44 and $11 in the first six months of 2007 and 2006, respectively.
12
A substantial portion of the loan portfolio is collateralized by real estate, and is, therefore, susceptible to changes in local market conditions. Management believes that the loan portfolio is diversified among industry groups. At June 30, 2007, outstanding residential construction loans totaled $116,375 and represented 14.8% of total outstanding loans. In addition, at June 30, 2007, unfunded loan commitments for residential construction totaled approximately $47,994. Outstanding residential construction loans at December 31, 2006 were $100,996 or 13.3% of total outstanding loans, and unfunded commitments for residential construction totaled approximately $59,642. There are no other industry concentrations in excess of 10% of total outstanding loans. It is management’s opinion that the allowance for loan losses is adequate to absorb known and inherent risks in the loan portfolio. However, actual results may differ from estimates.
The following discussion contains a review of Pacific Continental Corporation and its wholly-owned subsidiary Pacific Continental Bank operating results and financial condition for the six and three months ended June 30, 2007. When warranted, comparisons are made to the same period in 2006 and to the previous year ended December 31, 2006. The discussion should be read in conjunction with the financial statements (unaudited) and related notes contained elsewhere in this report. The reader is assumed to have access to the Company’s Form 10-K for the previous year ended December 31, 2006, which contains additional statistics and explanations. All numbers, except per share data, are expressed in thousands of dollars.
In addition to historical information, this report contains ``forward-looking statements'' within the meaning of the Private Securities Litigation Reform Act of 1995 (``PSLRA''). Such forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected, including but not limited to the following: the concentration of loans of the company's banking subsidiary, particularly with respect to commercial and residential real estate lending; changes in the regulatory environment and increases in associated costs, particularly ongoing compliance expenses and resource allocation needs in response to the Sarbanes-Oxley Act and related rules and regulations; vendor quality and efficiency; employee recruitment and retention, specifically in the Bank's Portland and Seattle markets; the company's ability to control risks associated with rapidly changing technology both from an internal perspective as well as for external providers; increased competition among financial institutions; fluctuating interest rate environments; and similar matters. Readers are cautioned not to place undue reliance on the forward-looking statements. Pacific Continental Corporation undertakes no obligation to publicly revise or update the forward-looking statements to reflect events or circumstances that arise after the date of this filing. Readers should carefully review any risk factors described in Pacific Continental’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and other documents, including any Current Reports on Form 8-K furnished to or filed from time to time with the Securities & Exchange Commission. This statement is included for the express purpose of invoking PSLRA's safe harbor provisions.
SUMMARY OF CRITICAL ACCOUNTING POLICIES
The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements for the year ended December 31, 2006 as filed on the Form 10-K. Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements should be considered critical under the SEC definition:
Allowance for Loan Losses and Reserve for Unfunded Commitments
The allowance for outstanding loans is classified as a contra-asset account offsetting outstanding loans, and the allowance for unfunded commitments is classified as an other liability on the balance sheet. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balances of the allowance for loan losses for outstanding loans and unfunded commitments are maintained at amounts management believes will be adequate to absorb known and inherent losses in the loan portfolio and commitments to loan funds. The appropriate balance of the allowance for loan losses is determined by applying loss factors to the credit exposure from outstanding loans and unfunded loan commitments. Estimated loss factors are based on subjective measurements including management’s assessment of the internal risk classifications, changes in the nature of the loan portfolios, industry concentrations, and the impact of current local, regional, and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are possible and may have a material impact on the Company’s consolidated financial statements, results of operations, or liquidity.
13
Goodwill and Intangible Assets
At June 30, 2007, the Company had $23,238 in goodwill and other intangible assets consisting of $22,030 in goodwill and $1,208 in core deposit intangible from the 2005 acquisition of Northwest Business Financial Corporation (NWBF). During the second quarter 2007, the Bank sold its Consumer Finance Division and eliminated the $275 of goodwill related to this division. The core deposit intangible is currently being amortized to expense over seven years at approximately $223 per year. In accordance with Financial Accounting Standard 142, Goodwill and Other Intangible Assets, which was effective January 1, 2002, assets with indefinite lives are no longer amortized, but instead are periodically tested for impairment. Management performs an impairment analysis for the intangible assets with indefinite lives quarterly and has determined that there was no impairment as of June 30, 2007.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 157, “Fair Value Measurement”, defining fair value, establishing a framework for measuring fair value in generally accepted accounting principles, and expanding disclosures about fair value measurements. SFAS 157 is effective for the Company beginning in 2008. Implementation of SFAS 157 is not expected to have a material impact on our financial statements.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans”, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). This standard requires employers to recognize the under or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. The new reporting requirements and related new footnote disclosure rules of SFAS 158 are effective for fiscal years ending after December 15, 2006, and are not expected to have a material impact on our financial statements as the Company does not currently offer a defined benefit plan for its employees.
On February 15, 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115”. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in Statement 159 are elective; however, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. The FASB's stated objective is "to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions."
The fair value option established by Statement 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments.
14
Although early adoption of this standard is allowed, the Company has elected to adopt Statement 159 effective January 1, 2008 as that is the beginning of our next fiscal year after November 15, 2007. Implementation of SFAS 159 is not expected to have a material impact on our financial statements.
HIGHLIGHTS
| For the three months ended Jun. 30, | For the six months ended Jun. 30, | |||||||||||||||||||||||
| 2007 | 2006 | % Change | 2007 | 2006 | % Change | |||||||||||||||||||
| Net income | $ | 3,211 | $ | 3,188 | 0.72 | % | $ | 6,206 | $ | 6,120 | 1.41 | % | ||||||||||||
| Earnings per share | ||||||||||||||||||||||||
| Basic (1) | $ | 0.27 | $ | 0.28 | -3.57 | % | $ | 0.53 | $ | 0.53 | 0.00 | % | ||||||||||||
| Diluted (1) | $ | 0.27 | $ | 0.27 | 0.00 | % | $ | 0.52 | $ | 0.52 | 0.00 | % | ||||||||||||
| Assets, period-end | $ | 906,665 | $ | 832,337 | 8.93 | % | ||||||||||||||||||
| Loans, period-end | $ | 795,746 | $ | 726,728 | 9.50 | % | ||||||||||||||||||
| Core Deposits, period end (2) (3) | $ | 626,809 | $ | 544,517 | 15.11 | % | ||||||||||||||||||
| Deposits, period-end | $ | 699,402 | $ | 616,110 | 13.52 | % | ||||||||||||||||||
| Return on avg. assets (4) | 1.42 | % | 1.57 | % | 1.40 | % | 1.53 | % | ||||||||||||||||
| Return on avg. equity (4) | 12.66 | % | 14.44 | % | 12.47 | % | 14.22 | % | ||||||||||||||||
| Return on avg. tangible equity (5) | 16.48 | % | 19.85 | % | 16.30 | % | 19.70 | % | ||||||||||||||||
| (1) | All per share data has been retroactively adjusted to reflect 10% stock dividend declared and paid during the second quarter 2007. |
| (2) | Defined by the Company as demand, interest checking, money market, savings, and local time deposits, including local time deposits in excess of $100 thousand. |
| (3) | Included a temporary deposit of $25,000, which subsequently was withdrawn from the Bank after the end of the quarter. |
| (4) | Amounts annualized. |
| (5) | Tangible equity excludes goodwill and core deposit intangibles related to acquisitions. |
The Company earned $3,211 in the second quarter 2007, a 1% increase over net income of $3,188 for the same quarter last year. The improvement in income was primarily the result of loan and deposit growth, which resulted in a $1,042 or 11% increase in net interest income.
During the second quarter 2007, the Bank sold the assets of its Consumer Finance Division, which consisted primarily of $10,800 in consumer and real estate loans.
The net interest margin for the second quarter 2006 was 5.24%, down 7 basis points from last year for the same quarter, but up 1 basis point from the 5.23% net interest margin reported for first quarter 2007. The sale of Consumer Finance Division loans during the quarter accelerated the recognition of approximately $124 in deferred loan fees, which increased the second quarter net interest margin by 6 basis points.
Noninterest expenses for second quarter 2007 were $6,513, up 14% from the $5,704 reported for second quarter 2006, reflecting investments made throughout 2006 in additional personnel in the Bank’s Seattle and Portland operations. On a linked-quarter basis, second quarter noninterest income was up $155 over first quarter 2007, and down $77 from fourth quarter noninterest expense of $6,590.
For the first six months of 2007, the Company earned $6,206, a 1% increase over the $6,120 reported for the first six months of 2006. As was the improvement in quarterly results, the improvement in year-to-date net income resulted from increased loans and deposits, which increased net interest income by $2,000 or 10% over last year.
Through June 30, 2007, the Company’s net interest margin was 5.24%, down 4 basis points from last year’s net interest margin of 5.28% for the same period. While the net interest margin continued to be under pressure in a challenging and highly competitive operating environment, the Company has been able to mitigate the margin compression through its ability to generate core deposit growth.
15
Loans and deposits at June 30, 2007 showed growth rates of 10% and 14%, respectively, over June 30, 2006. Core deposits, which are defined as demand deposits, interest checking, money market account, and local time deposits (including local time deposits in excess of $100 thousand), constitute 90% of June 30, 2007 outstanding deposits compared to 88% at June 30, 2006. Outstanding core deposits at June 30, 2007 were $626,809, and up $82,292 or 15% over outstanding core deposits at June 30, 2006. Outstanding core deposits at June 30, 2007 contain a temporary deposit of approximately $25,000, which as expected, was withdrawn subsequent to the end of the second quarter 2007. Excluding the $25,000 temporary deposit included in outstanding core deposits at June 30, 2007, core deposits were up $57,292 or 11% over last year. Noninterest-bearing demand deposits at June 30, 2007 were $172,145 or 25% of total deposits.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the primary source of the Company’s revenue. Net interest income is the difference between interest income derived from earnings assets, principally loans, and interest expense associated with interest-bearing liabilities, principally deposits. The volume and mix of earnings assets and funding sources, market rates of interest, demand for loans, and the availability of deposits affect net interest income.
The net interest margin as a percentage of earning assets for the second quarter 2007 was 5.24%, a 7 basis point decline from the 5.31% net interest margin reported for second quarter 2006. However, the second quarter 2007 net interest margin of 5.24% was up 1 basis point from the first quarter 2007 net interest margin of 5.23%. The sale of loans during the second quarter 2007 accelerated the recognition of approximately $124 in deferred loan fees, which added 6 basis points to the Bank’s net interest margin in the quarter. The monthly net interest margins during the second quarter (with the month of June 2007 adjusted for the effect of the sale of loans) were 5.19%, 5.14%, and 5.22% for the months of April, May, and June 2007, respectively. This monthly pattern is typical of past year’s experience as core deposits seasonally decline during the month of May, thus increasing the cost of funds and compressing the margin, followed by strong core deposit growth in the month of June, which effectively lowers the cost of funds and increases the net interest margin. This is evidenced by the decline of $5,008 in average core deposit during May 2007 when compared to April 2007 and the $16,338 increase in average core deposits in June 2007 over May 2007.
The Bank’s net interest margin continued to be under pressure due to the intense competition for loans and deposits by all financial institutions and the current flat and sometimes inverted yield curve. Both competition and the current interest rate environment continued to put pressure on the net interest margin as the spreads between the Bank’s new and existing fixed rate loans and the cost of alternative or wholesale funding continued to be very narrow, in the range of 200 to 300 basis points.
Looking forward to third quarter 2007, management expects little or no change in the current competitive and market interest rate environment. During the second quarter 2007, the Bank’s core deposit base grew by more than $30,000, when the temporary $25,000 is excluded from June 30, 2007 core deposit total, providing a strong base at the beginning of the third quarter. The Bank’s deposit pipeline for booking new deposit relationships also appears strong. In addition, during the third and fourth quarter, historically the core deposit growth rate for existing clients also accelerates. As a result of the expected growth in core deposits during the third and fourth quarters, management expects, core deposit growth to fund all or a substantial portion of loan growth, thus lowering or stabilizing the Bank’s cost of funds. Based on these projections, management expects the third quarter 2007 net interest margin to be at the same level or down slightly from the reported second quarter 2007 net interest margin of 5.24%. However, based on the current market interest rate environment, this expectation is highly dependent upon acceleration in core deposit growth, and that this growth in core deposits will be with the anticipated projected mix.
16
The following table presents the condensed balance sheet information, together with interest income and yields on year-to-date average interest-earning assets, and interest expense and rates on interest-bearing liabilities for the six months ended June 30, 2007 compared to June 30, 2006:
17
Table I
(dollars in thousands)
Average Balance Analysis of Net Interest Earnings Six Months Ended | Six Months Ended | |||||||||
June 30, 2007 | June 30, 2006 | |||||||||
Interest | Average | Interest | Average | |||||||
Average | Income or | Yields or | Average | Income or | Yields or | |||||
Balance | Expense | Rates | Balance | Expense | Rates | |||||
Interest-Earning Assets | ||||||||||
| Federal funds sold and interest- | ||||||||||
| bearing deposits in banks | $ 1,196 | $ 29 | 4.83% | $ 946 | $ 20 | 4.35% | ||||
| Securities available for sale: | ||||||||||
| Taxable (1) | 37,693 | 781 | 4.18% | 38,767 | 748 | 3.89% | ||||
| Tax-exempt | 3,740 | 66 | 3.56% | 3,149 | 59 | 3.77% | ||||
| Loans, net of allowance | ||||||||||
| for loan losses (2) (3) (4) | 775,659 | 33,522 | 8.72% | 692,506 | 28,340 | 8.25% | ||||
| Total interest-earning assets | 818,288 | 34,398 | 8.48% | 735,368 | 29,167 | 8.00% | ||||
Nonearning Assets | ||||||||||
| Cash and due from banks | 23,204 | 23,629 | ||||||||
| Premises and equipment | 19,275 | 17,252 | ||||||||
| Goodwill & other intangibles | 23,569 | 24,141 | ||||||||
| Interest receivable and other | 6,681 | 4,386 | ||||||||
| Total non interest assets | 72,729 | 69,408 | ||||||||
| Total assets | $ 891,017 | $ 804,776 | ||||||||
Interest-Bearing Liabilities | ||||||||||
| Money market and NOW accounts | $ 349,680 | 6,705 | 3.87% | $ 293,434 | 4,597 | 3.16% | ||||
| Savings deposits | 25,728 | 272 | 2.14% | 23,018 | 152 | 1.33% | ||||
| Time deposits | 100,518 | 2,426 | 4.87% | 120,837 | 2,486 | 4.15% | ||||
| Federal funds purchased | 3,713 | 98 | 5.33% | 7,873 | 194 | 4.96% | ||||
| FHLB borrowings | 133,358 | 3,389 | 5.12% | 99,751 | 2,229 | 4.51% | ||||
| Trust preferred | 8,248 | 252 | 6.16% | 8,248 | 253 | 6.20% | ||||
| Total interest-bearing liabilities | 621,245 | 13,142 | 4.27% | 553,161 | 9,911 | 3.61% | ||||
Noninterest-Bearing Liabilities | ||||||||||
| Demand deposits | 165,345 | 158,145 | ||||||||
| Interest payable and other | 4,061 | 6,694 | ||||||||
| Total noninterest liabilities | 169,406 | 164,839 | ||||||||
| Total liabilities | 790,651 | 718,000 | ||||||||
| Stockholders' equity | 100,366 | 86,776 | ||||||||
| Total liabilities and stockholders' equity | $ 891,017 | $ 804,776 | ||||||||
Net Interest Income | $ 21,255 | $ 19,256 | ||||||||
Net Interest Income | ||||||||||
as a Percentage of Earning Assets | 5.24% | 5.28% | ||||||||
| (1) Federal Home Loan Bank stock is included in securities available for sale. | ||||||||||
| (2) Nonaccrual loans have been included in average balance totals. | ||||||||||
| (3) Interest income includes recognized loan origination fees of $1,097 and $903 for the six months ended | ||||||||||
| June 30, 2007 and 2006, respectively. | ||||||||||
| (4) Total includes loans held for sale. | ||||||||||
18
Table I shows that earning asset yields improved by 48 basis points in through June 30, 2007 over June 30, 2006 from 8.00% to 8.48%. Table I shows that deposit growth came through certain core deposits, primarily in money market and NOW account volumes, which were up $56,246. Table I also illustrates the change in the mix of alternative or wholesale funding use. Time deposits, primarily brokered time deposits, declined by approximately $20,000, while there was a corresponding increase of approximately $29,000 in FHLB and overnight borrowings. The table illustrates the difference in the cost of alternative funding sources compared to the cost of certain core deposits. For example, FHLB borrowings average cost of 5.12% for the first six months of 2007 compared to 3.87% for money market and interest checking accounts.
The following table sets forth a summary of changes in net interest income due to changes in year-to-date average asset and liability balances (volume) and changes in average rates (rate) for the six month period ended June 30, 2007 and June 30, 2006:
Table II
Analysis of Changes in Interest Income and Interest Expense
(dollars in thousands)
Six Months Ended | ||||||||||||
Jun. 30, 2007 compared to Jun. 30, 2006 | ||||||||||||
Increase (decrease) due to | ||||||||||||
Volume | Rate | Net | ||||||||||
Interest earned on: | ||||||||||||
| Federal funds sold and interest | ||||||||||||
| bearing deposits in banks | $ | 5 | $ | 3 | $ | 8 | ||||||
| Securities available-for-sale: | ||||||||||||
| Taxable | (20 | ) | 53 | 33 | ||||||||
| Tax-exempt | 11 | (4 | ) | 7 | ||||||||
| Loans, net of allowance for loan losses | 3,403 | 1,780 | 5,183 | |||||||||
| Total interest income | 3,399 | 1,832 | 5,231 | |||||||||
Interest paid on: | ||||||||||||
| Money market and NOW accounts | (1,078 | ) | (1,030 | ) | (2,108 | ) | ||||||
| Savings deposits | (28 | ) | (92 | ) | (120 | ) | ||||||
| Time deposits | 490 | (430 | ) | 60 | ||||||||
| Federal funds purchased | 109 | (14 | ) | 95 | ||||||||
| Term borrowings | (854 | ) | (305 | ) | (1,159 | ) | ||||||
| Trust preferred | - | 1 | 1 | |||||||||
| Total interest expense | (1,361 | ) | (1,870 | ) | (3,231 | ) | ||||||
| Net interest income | $ | 2,038 | $ | (38 | ) | $ | 2,000 | |||||
The year-to-date June 30, 2007 rate/volume analysis in Table II above shows that interest income including loan fees improved by $5,231 over the same period last year. Higher volumes of earning assets increased interest income by $3,399, and higher yields on loans increased interest income by $1,832. The rate/volume analysis shows that interest expense through June 30, 2007 increased by $3,231 over last year, as higher volumes on all deposit and other funding categories caused interest expense to increase by $1,361, combined with changes in rates, which increased interest expense by $1,870.
19
Loan Loss Provision and Allowance
Below is a summary of the Company’s allowance for loan losses for the first six months of:
2007 | 2006 | |||||||
| Balance, December 31 | $ | 8,284 | $ | 7,792 | ||||
| Provision charged to income | 325 | 450 | ||||||
| Loans charged against allowance | (43 | ) | (59 | ) | ||||
| Recoveries credited to allowance | 29 | 67 | ||||||
| Balance, June 30 | $ | 8,595 | $ | 8,250 | ||||
The year-to-date June 30, 2007 provision for loan losses was $325, compared to $450 for the same period last year. The lower provision in 2007 reflects loan growth during the current year and continued stability in the overall credit quality of the Bank’s loan portfolio. The loan loss provision for third and fourth quarter 2007 is expected to be dependent upon loan growth as there is very limited additional benefit available from further improvement in the overall credit quality of the portfolio.
Year-to-date June 30, 2007 net loan charge offs were $14, compared to $8 in net loan recoveries reported for the same period in 2006. The allowance for loan losses at June 30, 2007 was 1.08% of period end loans compared to 1.08% and 1.14% at December 31, 2006 and June 30, 2006, respectively. At June 30, 2007, the allowance for loan losses as a percentage of net nonperforming loans was 8,321% or 83 times the level of net nonperforming loans. The allowance at June 30, 2007 includes $27 in specific allowance (included in the ending allowance above) for impaired loans, which total $581. Impaired loans include $103 of nonaccrual loans and two loans to a single borrower totaling $478 that are performing under revised terms. At December 31, 2006, the Company had $495 of impaired loans with a specific allowance of $109 assigned.
The following table shows a summary of nonaccrual loans, loans past due 90 days or more and still accruing interest, and other real estate owned for the periods covered in this report:
Jun. 30, 2007 | Dec. 31, 2006 | Jun. 30, 2006 | ||||||||||
| Nonaccrual loans | $ | 103 | $ | - | $ | 20 | ||||||
| 90 days past due and accruing interest | - | - | - | |||||||||
| Total nonperforming loans | 103 | - | 20 | |||||||||
| Nonperforming loans guaranteed by government | - | - | - | |||||||||
| Net nonperforming loans | 103 | - | 20 | |||||||||
| Foreclosed assets | - | - | - | |||||||||
| Total nonperforming assets, net of guaranteed loans | $ | 103 | $ | - | $ | 20 | ||||||
At June 30, 2007, net nonperforming assets as a percentage of total assets was 0.01%. That compares to total net nonperforming assets to total assets of 0.00% and 0.00% at December 31, 2006 and June 30, 2006, respectively.
Noninterest Income
Noninterest income through June 30, 2007 was $1,897, a decrease of $116 or 6% from the same period in 2006. The decline in current year-to-date noninterest income was almost entirely due to a $196 drop in revenues related to the origination and sale of residential mortgages, and reflects staff changes in this area combined with a slowing level of new originations. The decline in mortgage related noninterest income was partially offset by an increase of $18 in service charges on deposit accounts, a $47 increase in merchant bankcard fees, and a $25 increase in the other noninterest income category. The increase in service charges was due to a decrease in the 91-day Treasury bill rate, which lowered the earnings credit on analyzed business accounts and, correspondingly, increased fee income received by the Bank. Merchant bankcard fees are up due to increased sales volume and higher penetration in the Bank’s Portland and Seattle markets. The increase in other income is primarily due to lockbox and loan referral fees.
20
On a linked quarter basis, noninterest income in second quarter 2007 of $949 was virtually unchanged from first quarter 2007 noninterest income of $948. Looking forward to third quarter, the Company expects noninterest income to be up slightly from second quarter 2007. On a linked quarter basis, the Bank expects improvement in merchant bankcard fees, an increase in account service charges due to new clients and price changes, and higher revenues from the origination and sale of residential mortgages as new personnel in this division have gained traction and created a reasonable pipeline of new business.
Noninterest Expense
Noninterest expense through June 30, 2007 was $12,871, an increase of $1,778 or 16% over the same period in 2006. Virtually all categories of noninterest expense showed an increase over last year. Personnel expense was up $1,087 or 16% in the first six months of 2007 over the same period last year and accounted for 61% of the total increase in noninterest expense on a year-over-year basis. This increase can be attributed to salary increases and equity-pay adjustments made during the first half of 2007 combined with the full year effect of staff additions made during 2006, primarily in the Seattle and Portland markets. The other noninterest expense category is also showing an increase of $572 or 31% over last year through June 30, 2007 and is primarily attributable to increased third party processing expenses of $145 due to new contracts, a $49 increase in on-line banking processing due to enhanced systems provided by an outside party, and a $217 increase in the other expenses category. The increase in the other expense category is related to the write-down of goodwill on the sale of Consumer Finance Division assets and increased expense due to additions to the Bank’s liability for unfunded loan commitments.
Beginning in late 2006, the Bank undertook a number of expense control initiatives and, on a linked quarter basis, second quarter 2007 noninterest expense of $6,513 was up $155 or 2.4% from first quarter 2007 noninterest expense of $6,358, and down $77 from fourth quarter 2006 noninterest expense of $6,590. When two unusual expense items totaling $48 are excluded from second quarter noninterest expense, noninterest expense in the quarter was up only $107 or 1.7% over first quarter 2007. Total personnel expense for second quarter 2007 was $3,819, down $196 from first quarter 2007 and was due to increased loan origination costs, which lowered net salary expense. The decrease in second quarter 2007 personnel expense from first quarter 2007 was more than offset by seasonal increases in marketing related expenses.
Looking forward to the third quarter, noninterest expense is expected to be down from second quarter 2007. This expected decline is the continued result of expense control initiatives combined with the effect of the sale of the Consumer Finance Division. The sale of the Consumer Finance Division is expected to reduce noninterest expense by $75, while planned reductions in occupancy and marketing expenses should also reduce third quarter noninterest expense.
BALANCE SHEET
Loans
At June 30, 2007, outstanding loans, net of deferred loan fees, and including loans held for sale, were $795,746, up $69,018 or 9.5% over outstanding loans of $726,728 at June 30, 2006 and up $26,506 from December 31, 2006 outstanding loans of $769,240. The sale of Consumer Finance Division loans during the second quarter reduced outstanding loans at June 30, 2007 by approximately $10,800. A summary of loan growth for the first six months of 2007 by market follows:
21
Balance | Balance | Balance | ||||||||||
Jun. 30, 2007 | Dec. 31, 2006 | Jun. 30, 2006 | ||||||||||
| Lane County Market | $ | 217,148 | $ | 234,118 | $ | 240,953 | ||||||
| Portland Market | 389,804 | 378,904 | 344,194 | |||||||||
| Seattle Market | 188,794 | 156,218 | 141,581 | |||||||||
| Total | $ | 795,746 | $ | 769,240 | $ | 726,728 | ||||||
The Seattle and Portland markets are accounting for the Bank’s loan growth. The decline in the Lane County market loans is attributable to the sale of $10,800 of Consumer Finance Division loans and normal seasonal changes and payoffs. Loan growth in this market is expected to accelerate during the last six months of the year. The prospects for increased loan activity in the third quarter 2007 is good as the Bank’s new business opportunity pipelines are increasing in all three of the Bank’s principal markets.
Securities
The Bank presently has $39,049 in securities classified as available-for-sale. At June 30, 2007, $11,689 of these securities were pledged as collateral for public deposits in Oregon and Washington and to the Federal Reserve Bank of San Francisco to support balances in its Treasury, Tax and Loan deposit account.
Goodwill and Intangible Assets
At June 30, 2007, the Company had a recorded balance of $22,030 in goodwill attributable to the November 30, 2005 acquisition of NWBF. In addition, at June 30, 2007, the Company had $1,208 in core deposit intangible assets resulting from the acquisition of NWBF. During the second quarter 2007, the goodwill associated with the Consumer Finance Division of $275 was eliminated as a result of the sale of this division’s loans. In accordance with Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, the Company does not amortize goodwill or other intangible assets with indefinite lives, but instead periodically tests these assets for impairment. Management is required to perform an impairment analysis for the intangible assets (goodwill) with indefinite lives at least annually. Management did perform an impairment analysis at June 30, 2007 and determined there was no indication of impairment of goodwill at that time. The core deposit intangible was determined to have an expected life of approximately seven and one-half years and will be amortized through mid-year 2013.
Deposits
Outstanding deposits at June 30, 2007 were $699,402, an increase of $83,292 over outstanding deposits of $616,110 at June 30, 2006. Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and local time deposits, including local time deposits in excess of $100 thousand, were $626,809, up $82,292 or 15% over last year and represented 90% of total deposits at June 30, 2007. Outstanding core deposits at June 30, 2007 included a temporary deposit of $25,000 in the Portland market core deposit base, which, as expected, was withdrawn from the Bank subsequent to the end of the quarter. A summary of both core deposit growth by market and other deposits classified as alternative funding for the six month period ending June 30, 2007 follows:
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Balance | Balance | Balance | ||||||||||
Jun. 30, 2007 | Dec. 31, 2006 | Jun. 30, 2006 | ||||||||||
| Lane County Market core deposits | $ | 382,873 | $ | 392,903 | $ | 378,188 | ||||||
| Portland Market core deposits | 156,806 | 124,273 | 99,019 | |||||||||
| Seattle Market core deposits | 87,130 | 63,034 | 67,310 | |||||||||
| Total core deposits | 626,809 | 580,210 | 544,517 | |||||||||
| Other deposits | 72,593 | 61,062 | 71,593 | |||||||||
| Total | $ | 699,402 | $ | 641,272 | $ | 616,110 | ||||||
The Portland and Seattle markets are accounting for the majority of year-over-year growth in core deposits and the growth of core deposits during the first six months of 2007. The Portland market had outstanding core deposits of $131,806 (excluding the temporary $25,000 deposit), up $32,787 or 33% over last year and up $7,533 or 6% since December 31, 2006. The Seattle market accounted for $19,820 of the year-over- year growth in the Bank’s core deposits, and $24,096 of growth in core deposits during the first six months of 2007. The Lane County market has experienced a small increase of over $4,000 in its year-over-year core deposit base, but has lost approximately $10,000 in core deposits during the first six months of the year. Although competition for core deposits is extremely high in all markets, the Bank expects core deposit growth to increase during the third quarter 2006 as the pipeline for new deposit relationships is strong in all three markets, and historically, there is a resurgence of core deposits during the third quarter. Management expects all three markets to increase their core deposit base during the third quarter.
Junior Subordinated Debentures
The Company had $8,248 in junior subordinated debentures at June 30, 2007, which were issued in conjunction with the acquisition of NWBF. At June 30, 2007, the entire $8,248 in junior subordinated debenture had an interest rate of 6.265% that is fixed for a five year period. As of June 30, 2007, the entire balance of the junior subordinated debentures qualified as Tier 1 capital under regulatory capital guidelines. Additional information regarding the terms of the junior subordinated debentures, including maturity/repricing dates and interest rate, is included in Note 12 of the Notes to Consolidated Financial Statements in the Company’s 2006 annual Form 10-K.
Capital Resources
Capital is the shareholders’ investment in the Company. Capital grows through the retention of earnings and the issuance of new stock through the exercise of stock options and decreases through the payment of dividends and share repurchase programs. Capital formation allows the Company to grow assets and provides flexibility in times of adversity.
Below is a summary of changes in the Company’s capital accounts from December 31, 2006 through June 30, 2007:
| Beginning capital December 31, 2006 | $ | 95,735 | ||
| Net income for six months ended Jun. 30, 2007 | 6,206 | |||
| Additions from exercise of stock options | 1,156 | |||
| Share based payments | 284 | |||
| Tax benefit from options exercised | 194 | |||
| Change in comprehensive income | (105 | ) | ||
| Cash dividends paid to shareholders | (2,035 | ) | ||
| Ending capital June 30, 2007 | $ | 101,435 |
Banking regulations require the Company to maintain minimum levels of capital. The Company manages its capital to maintain a “well capitalized” designation (the FDIC’s highest rating). A “well-capitalized” rating from the FDIC requires that the Bank maintain risk-based capital levels of 10% of total risk-based assets. At June 30, 2007, the Company’s total capital to risk weighted assets was 10.84%, compared to 10.77% at June 30, 2006.
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The Company’s Board of Directors reviews its dividend considerations so that cash dividends, when and if declared by the Company, would typically be paid in mid-March, June, September, and December of each year. During the first two quarters of 2007, the Company declared quarterly dividends of $0.09 per share paid on March 15, 2007 and June 15, 2007. The Company also declared and paid a 10% stock dividend during the second quarter of 2007 and maintained its $0.09 per share cash dividend. The Company expects to continue the $0.09 per share dividend amount for each quarter remaining in 2007, which would result in an annual dividend of $0.35 per share, and would equate to a 21% increase over the prior year, retroactively adjusting last year’s outstanding shares and cash dividends paid.
The Company projects that earnings retention and existing capital will be sufficient to fund anticipated asset growth and shareholder dividends, while maintaining a well-capitalized designation from the FDIC.
OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS
In the normal course of business, the Bank commits to extensions of credit and issues letters of credit. The Bank uses the same credit policies in making commitments to lend funds and conditional obligations as it does for other credit products. In the event of nonperformance by the customer, the Bank’s exposure to credit loss is represented by the contractual amount of the instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established by the contract. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At June 30, 2007, the Bank had $243,216 in commitments to extend credit.
Letters of credit written are conditional commitments issued by the Bank to guarantee performance of a customer to a third party. The credit risk involved is essentially the same as that involved in extending loan facilities to customers. At June 30, 2007, the Bank had $5,498 in letters of credit and financial guarantees written.
The Bank also has internal guidance lines of credit established for certain borrowers, primarily in the residential construction industry. These guidance lines are not contractual commitments to extend credit, and may be terminated by the Bank for any reason without any obligation to the borrower. These lines provide the Bank’s lenders limits on future extensions of credit to certain borrowers. The Bank uses the same credit policies in establishing internal guidance lines as it does for other credit products. At June 30, 2007, the Bank had unused and uncommitted guidance lines totaling approximately $38,797.
LIQUIDITY
Liquidity is the term used to define the Company’s ability to meet its financial commitments. The Company maintains sufficient liquidity to ensure funds are available for both lending needs and the withdrawal of deposit funds. The Company derives liquidity primarily through core deposit growth, the maturity of investment securities, and loan payments. Core deposits include demand, interest checking, money market, savings and local time deposits, including local time deposits in excess of $100. Additional liquidity is provided through sales of loans, sales of securities, and access to alternative funding sources. National time deposits, public deposits, Federal Home Loan Bank borrowings, and unsecured overnight fed funds borrowings are referred to as alternative funding sources.
Core deposits represented 90% of total deposits at June 30, 2007 compared to 88% at June 30, 2006. Historically, due to seasonal construction and economic activity and client payment of various tax obligations, the Company experiences a decline or slower growth of core deposits during the first quarter of each year as was the case during the first quarter 2007, as core deposits at the end of the first quarter showed a decline of $8,935 from year end December 31, 2006. The Company grew core deposits, net of the $25,000 in temporary deposits, by $30,534 during the second quarter 2007. The Company grew outstanding loans by $26,500 during the first six months of 2007. Growth in core deposits during the second quarter funded all of the loan growth experienced during the first half of 2007. At June 30, 2007, alternative funding sources were funding 18% of total Company assets compared to 19% of total assets at December 31, 2006. Core deposit growth is expected to fund all or a substantial portion of loan growth during the third quarter. Management expects as a result of this growth to lower the percentage of alternative funding as a percentage of total assets.
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The Bank has a borrowing limit with the Federal Home Loan Bank of Seattle (the “FHLB”) equal to 30% of total assets. At June 30, 2007, the borrowing line was approximately $270,000. However, two factors limit the availability of the FHLB line: value of collateral pledged and amount of FHLB stock owned. At
June 30, 2007, the Company had collateral pledged valued at approximately $172,000 and had stock on hand that would permit total borrowings of approximately $220,000, thus total borrowings at June 30, 2007 were limited to approximately $172,000. At June 30, 2007, $94,054 was advanced on the FHLB line. At
June 30, 2007, the Bank has established unsecured overnight lines totaling $118,000 with various correspondent banks none of which was being used at quarter end. In addition, at June 30, 2007, the Bank has commercial real estate loans pledged to the Federal Reserve Bank of San Francisco, which permits it to borrow up to approximately $6,400. Other sources of liquidity available to the Bank at June 30, 2007 included approximately $4,000 in funding available through the State of Washington time deposit program, $27,360 of unpledged securities available-for-sale, and approximately $27,500 of marketable government guaranteed loans included in the Bank’s loan portfolio.
There has been no material change in the Bank’s exposure to market risk. Readers are referred to the Bank’s Form 10-K and the Annual Report to Shareholders for the period ending December 31, 2006, for specific discussion.
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 240.13a-14(c) and 15d-14(c)) as of June 30, 2007, the date of this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective and timely, providing them with material information relating to the Company required to be disclosed in the reports we file or submit under the Exchange Act.
Changes in Internal Controls
There have not been any significant changes in our internal controls or in other factors during the first six months 2007 that could significantly affect these controls subsequent to the date of their evaluation. We are not aware of any significant deficiencies or material weaknesses in our internal controls, therefore no corrective actions were taken.
Our business exposes us to certain risks. The following is a discussion of the most significant risks and uncertainties that may affect our business, financial condition and future results.
Fluctuating interest rates and availability of low cost deposits can adversely affect our profitability
Our profitability is dependent to a large extent upon net interest income, which is the difference (or “spread”) between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates, as well as a very competitive environment for low cost deposits, could adversely affect our interest rate spread, and, in turn, our profitability. We seek to manage our interest rate risk within established guidelines. Generally, the Company seeks an asset and liability structure that insulates net interest income from large deviations attributable to changes in market rates.
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Our allowance for loan losses may not be adequate to cover actual loan losses, which could adversely affect our earnings
We maintain an allowance for loan losses in an amount that we believe is adequate to provide for losses inherent in the portfolio. While we strive to carefully manage and monitor credit quality and to identify loans that may become nonperforming, at any time there are loans included in the portfolio that will result in losses, but that have not been identified as nonperforming or potential problem loans. By managing our credit quality, we attempt to identify deteriorating loans before they become nonperforming assets and adjust the loan loss reserve accordingly. However, because future events are uncertain, there may be loans that deteriorate to a nonperforming status in a relatively short time frame. As a result of these types of situations, future additions to the allowance may be necessary. Because the loan portfolio contains a significant number of commercial and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans may cause a significant increase in nonperforming loans, requiring an increase to the loan loss allowance. Additionally, future additions to the allowance may be required based on changes in the loans comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions or as a result of incorrect assumptions by management in determining the allowance. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses could have a negative effect on our financial condition and results of operation.
An economic downturn in the market areas we serve may cause us to have lower earnings and could increase our credit risk associated with our loan portfolio
The inability of borrowers to repay loans can erode our earnings. Substantially all of our loans are to businesses and individuals in Oregon and Washington, and any decline in the economy of these market areas could impact us adversely. As a lender, we are exposed to the risk that our customers will be unable to repay their loans in accordance with their terms, and that any collateral securing the payment of their loans may not be sufficient to assure repayment.
| (a) | Pacific Continental Corporation’s Annual Shareholders’ Meeting was held on April 24, 2007 |
| (b) | Not Applicable |
| (c) | A brief description of each matter voted upon at the Annual Meeting and number of votes cast for or withheld, including a separate tabulation with respect to each nominee to serve on the Board is presented below: |
| (1) | Election of (3) three Directors (Hal M. Brown, Larry G. Campbell, Michael D. Holzgang) for three-year terms expiring in 2010. Election of (1) one Director (Cathi Hatch) for a two-year term expiring in 2009. Election of (1 ) one Director (R. Jay Tejera) for a one-year term expiring in 2008. |
Directors:
Hal M. Brown
| Votes Cast For: | 8,091,868 | ||
| Votes Withheld: | 51,583 | ||
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Larry G. Campbell
| Votes Cast For: | 8,044,941 | ||
| Votes Withheld: | 54,249 | ||
Michael D. Holzgang
| Votes Cast For: | 8,069,306 | ||
| Votes Withheld: | 29,884 | ||
Cathi Hatch
| Votes Cast For: | 7,932,482 | ||
| Votes Withheld: | 166,708 | ||
R. Jay Tejera
| Votes Cast For: | 8,042,157 | ||
| Votes Withheld: | 57,033 | ||
| (2) | Amend the Company’s Articles of Incorporation, Article IX to eliminate the staggered board provision and allow for the annual election of all Directors. |
| Votes Cast For: | 7,578,226 | ||
| Votes Cast Against: | 481,460 | ||
| Votes Abstained: | 39,504 |
| (a) | Exhibits |
| 3 | Amended Articles of Incorporation |
| 31.1 | 302 Certification, Hal Brown, President and Chief Executive Officer |
| 31.2 | 302 Certification, Michael A. Reynolds, Executive Vice President and |
| Chief Financial Officer | |
| 32 | Certifications Pursuant to 18 U.S.C. Section 1350 |
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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 CONTINENTAL CORPORATION
(Registrant)
| Dated August 6, 2007 | /s/ Hal Brown | |
| Hal Brown | ||
| President and Chief Executive Officer | ||
| Dated August 6, 2007 | /s/ Michael A. Reynolds | |
| Michael A. Reynolds | ||
| Executive Vice President and Chief Financial Officer |
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