Pacific Continental 10-Q 2014 Q3 Quarterly report

UNITED STATES

SECURITIES & EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended September 30, 2014.

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: 0-30106

PACIFIC CONTINENTAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

OREGON	93-1269184
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No)

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 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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Act. (Check one)

Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨	Smaller Reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares of common stock outstanding as of November 1, 2014 was 17,717,214

PACIFIC CONTINENTAL CORPORATION

FORM 10-Q

QUARTERLY REPORT

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION	3
ITEM 1	Financial Statements	3
	Consolidated Balance Sheets	3
	Consolidated Statements of Income	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Changes in Shareholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Consolidated Financial Statements	8
ITEM 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	45
ITEM 3	Quantitative and Qualitative Disclosures about Market Risk	67
ITEM 4	Controls and Procedures	67
PART II	OTHER INFORMATION	68
ITEM 1	Legal Proceedings	68
ITEM1A	Risk Factors	68
ITEM 2	Unregistered Sales of Equity Securities and Use of Proceeds	71
ITEM 6	Exhibits	71

2

PART I FINANCIAL INFORMATION

ITEM 1 Financial Statements

Pacific Continental Corporation and Subsidiary

Consolidated Balance Sheets

(In thousands)

(Unaudited)

	September 30,		December 31,		September 30,
	2014		2013		2013
ASSETS
Cash and due from banks	$	18,671	$	19,410	$	26,568
Interest-bearing deposits with banks		5,841		1,698		16,041
Total cash and cash equivalents		24,512		21,108		42,609
Securities available-for-sale		348,052		347,386		347,506
Loans, less allowance for loan losses and net deferred fees		1,019,127		977,928		960,916
Interest receivable		4,759		4,703		4,608
Federal Home Loan Bank stock		10,125		10,425		10,523
Property and equipment, net of accumulated depreciation		18,040		18,836		19,116
Goodwill and intangible assets		23,525		23,616		23,710
Deferred tax asset		7,247		9,598		9,438
Other real estate owned		13,177		16,355		16,602
Bank-owned life insurance		16,488		16,136		16,008
Other assets		4,667		3,635		3,842
Total assets	$	1,489,719	$	1,449,726	$	1,454,878
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing demand	$	390,790	$	366,891	$	379,598
Savings and interest-bearing checking		598,776		559,632		565,204
Core time deposits		57,645		63,792		70,850
Total core deposits		1,047,211		990,315		1,015,652
Other deposits		98,024		100,666		101,877
Total deposits		1,145,235		1,090,981		1,117,529
Federal funds and overnight funds purchased		670		5,150		—
Federal Home Loan Bank borrowings		145,000		160,000		145,000
Junior subordinated debentures		8,248		8,248		8,248
Accrued interest and other payables		8,028		6,163		4,423
Total liabilities		1,307,181		1,270,542		1,275,200
Shareholders’ equity
Common stock, shares authorized: 50,000,000; shares issued and outstanding: 17,716,776 at September 30, 2014, 17,891,687 at December 31, 2013, and 17,888,251 at September 30, 2013		131,057		133,835		133,597
Retained earnings		48,011		45,250		45,533
Accumulated other comprehensive income		3,470		99		548
		182,538		179,184		179,678
Total liabilities and shareholders’ equity	$	1,489,719	$	1,449,726	$	1,454,878

See accompanying notes.

3

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Income

(In thousands, except share and per share amounts)

(Unaudited)

	Three months ended				Nine months ended
	September 30,				September 30,
	2014		2013		2014			2013
Interest and dividend income
Loans	$	13,703	$	14,028	$	40,391		$	39,793
Taxable securities		1,547		1,489		4,693			4,164
Tax-exempt securities		500		488		1,471			1,430
Federal funds sold & interest-bearing deposits with banks		3		2		7			7
		15,753		16,007		46,562			45,394
Interest expense
Deposits		843		801		2,469			2,586
Federal Home Loan Bank & Federal Reserve borrowings		278		292		838			905
Junior subordinated debentures		57		51		169			140
Federal funds purchased		3		5		12			12
		1,181		1,149		3,488			3,643
Net interest income		14,572		14,858		43,074			41,751
Provision for loan losses		—		—		—			250
Net interest income after provision for loan losses		14,572		14,858		43,074			41,501
Noninterest income
Service charges on deposit accounts		524		487		1,582			1,436
Other fee income, principally bankcard		211		432		657			1,217
Bank-owned life insurance income		118		131		352			387
Net gain (loss) on sale of investment securities		3		—		(34	)		(8	)
Impairment losses on investment securities (OTTI)		—		—		—			(16	)
Other noninterest income		341		397		1,119			1,248
		1,197		1,447		3,676			4,264
Noninterest expense
Salaries and employee benefits		5,939		5,541		17,851			16,344
Property and equipment		958		919		2,825			2,746
Data processing		657		659		2,019			1,954
Legal and professional services		148		421		889			1,460
Business development		344		421		1,059			1,375
FDIC insurance assessment		209		231		647			674
Bankcard processing		1		150		6			418
Other real estate expense		100		1,185		338			1,762
Merger related expense		—		—		—			1,246
Other noninterest expense		793		879		2,296			2,708
		9,149		10,406		27,930			30,687
Income before provision for income taxes		6,620		5,899		18,820			15,078
Provision for income taxes		2,189		1,959		6,409			4,963
Net income	$	4,431	$	3,940	$	12,411		$	10,115
Earnings per share
Basic	$	0.25	$	0.22	$	0.70		$	0.57
Diluted	$	0.25	$	0.22	$	0.69		$	0.56
Weighted average shares outstanding
Basic		17,749,217		17,888,182		17,844,914			17,865,582
Common stock equivalents attributable to stock-based awards		221,241		221,100		229,687			191,046
Diluted		17,970,458		18,109,282		18,074,601			18,056,628

See accompanying notes.

4

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(Unaudited)

	Three months ended						Nine months ended
	September 30,						September 30,
	2014			2013			2014			2013
Net income	$	4,431		$	3,940		$	12,411		$	10,115
Other comprehensive income:
Available-for-sale securities:
Unrealized (loss) gain arising during the period		(460	)		528			5,622			(8,998	)
Reclassification adjustment for (losses) gains realized in net income		(3	)		—			34			24
Income tax benefit (expense)		180			(206	)		(2,206	)		3,500
Derivative agreements—cash flow hedge
Unrealized gain (loss) arising during the period		57			(38	)		(130	)		313
Income tax (expense) benefit		(22	)		15			51			(122	)
Total other comprehensive (loss) income, net of tax		(248	)		299			3,371			(5,283	)
Total comprehensive income	$	4,183		$	4,239		$	15,782		$	4,832

See accompanying notes.

5

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

(In thousands, except share amounts)

(Unaudited)

										Accumulated
										Other
	Number			Common			Retained			Comprehensive
	of Shares			Stock			Earnings			Income			Total
Balance, December 31, 2012		17,835,088		$	133,017		$	44,533		$	5,831		$	183,381
Net income								13,767						13,767
Other comprehensive loss, net of tax											(5,732	)		(5,732	)
Comprehensive income														8,035
Stock issuance		56,599
Share-based compensation expense					1,102									1,102
Vested employee RSUs and SARs surrendered to cover tax consequences					(284	)								(284	)
Cash dividends								(13,050	)					(13,050	)
Balance, December 31, 2013		17,891,687		$	133,835		$	45,250		$	99		$	179,184
Net income								12,411						12,411
Other comprehensive income, net of tax											3,371			3,371
Comprehensive income														15,782
Stock issuance and related tax benefit		92,169			203									203
Stock repurchased		(267,080	)		(3,600	)								(3,600	)
Share-based compensation expense					1,127									1,127
Vested employee RSUs and SARs surrendered to cover tax consequences					(508	)								(508	)
Cash dividends								(9,650	)					(9,650	)
Balance, September 30, 2014		17,716,776		$	131,057		$	48,011		$	3,470		$	182,538

See accompanying notes.

6

Pacific Continental Corporation and Subsidiary

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Nine months ended
	September 30,
	2014			2013
Cash flows from operating activities:
Net income	$	12,411		$	10,115
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization, net of accretion		5,155			6,798
Valuation adjustment on foreclosed assets		82			1,436
Provision for loan losses		—			250
Deferred income taxes		197			620
BOLI income		(352	)		(387	)
Share-based compensation		1,202			877
Loss on sale of investment securities		34			8
Other than temporary impairment on investment securities		—			16
Gain on sale from foreclosed assets		(7	)		—
Excess tax benefit of stock options exercised		14			—
Change in:
Interest receivable		(56	)		162
Deferred loan fees		102			114
Accrued interest payable and other liabilities		1,803			(1,758	)
Income taxes receivable		80			1,415
Other assets		(1,242	)		(462	)
Net cash provided by operating activities		19,423			19,204
Cash flows from investing activities:
Proceeds from maturities and sales of available-for-sale investment securities		60,621			84,788
Purchase of available-for-sale investment securities		(59,612	)		(56,908	)
Net loan principal originations		(43,029	)		(44,425	)
Net purchase of property and equipment		(322	)		(835	)
Proceeds on sale of foreclosed assets		4,831			489
Redemption of Federal Home Loan Bank stock		300			293
Cash consideration paid, net of cash acquired in merger		—			(2,891	)
Net cash used by investing activities		(37,211	)		(19,489	)
Cash flows from financing activities:
Change in deposits		54,255			8,165
Change in federal funds purchased and Federal Home Loan Bank short-term borrowings		(19,480	)		17,430
Proceeds from Federal Home Loan Bank term advances originated		—			(2,000	)
Proceeds from stock options exercised		189			—
Excess tax benefit from stock options exercised		(14	)		—
Dividends paid		(9,650	)		(9,115	)
Repurcahse of common stock		(3,600	)		—
Vested SARs and RSUs surrendered by employee to cover tax consequence		(508	)		(287	)
Net cash provided by financing activities		21,192			14,193
Net change in cash and cash equivalents		3,404			13,908
Cash and cash equivalents, beginning of period		21,108			28,701
Cash and cash equivalents, end of period	$	24,512		$	42,609
Supplemental information:
Noncash investing and financing activities:
Transfers of loans to foreclosed assets	$	1,728		$	555
Change in fair value of securities, net of deferred income taxes	$	3,371		$	(5,283	)
Cash paid during the period for:
Income taxes	$	6,258		$	3,550
Interest	$	3,430		$	3,544

See accompanying notes.

7

Pacific Continental Corporation and Subsidiary

Notes to Consolidated Financial Statements

(Unaudited)

A complete set of Notes to Consolidated Financial Statements is a part of the Company’s 2013 Form 10-K filed March 14, 2014. The notes below are included due to material changes in the consolidated financial statements or to provide the reader with additional information not otherwise available. In preparing these consolidated financial statements, the Company has evaluated subsequent events and transactions for potential recognition or disclosure in the consolidated financial statements. All dollar amounts in the following notes are expressed in thousands, except share and per share amounts or where otherwise indicated.

Certain amounts contained in the prior period consolidated financial statements have been reclassified where appropriate to conform to the financial statement presentation used in the current period. These reclassifications had no effect on previously reported net income, earnings per share or retained earnings.

NOTE 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 consolidated 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, 2013, was derived from audited consolidated financial statements, but does not include all disclosures contained in the Company’s 2013 Form 10-K. The interim consolidated financial statements should be read in conjunction with the December 31, 2013, consolidated financial statements, including the notes thereto, included in the Company’s 2013 Form 10-K.

8

NOTE 2 – SECURITIES AVAILABLE-FOR-SALE

The amortized cost and estimated fair values of securities available-for-sale at September 30, 2014, were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Unrealized Loss Positions
Obligations of U.S. government agencies	$	8,080	$	—	$	(77	)	$	8,003
Obligations of states and political subdivisions		15,349		—		(281	)		15,068
Private-label mortgage-backed securities		877		—		(55	)		822
Mortgage-backed securities		65,356		—		(758	)		64,598
SBA variable rate pools		10,390		—		(139	)		10,251
	$	100,052	$	—	$	(1,310	)	$	98,742
Unrealized Gain Positions
Obligations of U.S. government agencies	$	30,562	$	383	$	—		$	30,945
Obligations of states and political subdivisions		64,816		3,104		—			67,920
Private-label mortgage-backed securities		3,178		127		—			3,305
Mortgage-backed securities		138,247		3,076		—			141,323
SBA variable rate pools		5,783		34		—			5,817
	$	242,586	$	6,724	$	—		$	249,310
	$	342,638	$	6,724	$	(1,310	)	$	348,052

At September 30, 2014, of the 399 investment securities held, there were 77 in unrealized loss positions. Unrealized losses existed on certain securities classified as obligations of U.S. government agencies, obligations of state and political subdivisions, private-label mortgage-backed securities, mortgage-backed securities and SBA variable rate pools. The unrealized losses on mortgage-backed securities, securities that are obligations of U.S. government agencies, obligations of state and political subdivisions, and SBA variable rate pools were deemed to be temporary, as these securities retain strong credit ratings, continue to perform adequately, and are backed by various government-sponsored enterprises. These decreases in fair value are associated with the changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and are not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal is expected.

The following table presents a summary of securities in a continuous unrealized loss position at September 30, 2014:

	Securities in Continuous Unrealized Loss Position for Less Than 12 Months		Gross Unrealized Loss on Securities in Loss Position for Less Than 12 Months		Securities in Continuous Unrealized Loss Position for 12 Months or Longer		Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
Obligations of U.S. government agencies	$	5,061	$	20	$	2,941	$	57
Obligations of states and political subdivisions		295		1		14,772		280
Private-label mortgage-backed securities		320		1		503		54
Mortgage-backed securities		32,898		151		31,701		607
SBA variable rate pools		10,251		139		—		—
	$	48,825	$	312	$	49,917	$	998

9

During the third quarter 2014, management reviewed all private label mortgage backed securities for the presence of other-than-temporary impairment (“OTTI”) and determined no additional OTTI was required. Management’s OTTI evaluation included the use of independently generated third-party credit surveillance reports that analyze the loans underlying each security. These reports include estimates of default rates and severities, life collateral loss rates, and static voluntary prepayment assumptions to generate estimated cash flows at the individual security level. Additionally, management considered factors such as downgraded credit ratings, severity and duration of the impairments, the stability of the issuers, and any discounts paid when the securities were purchased. Management has considered all available information related to the collectability of the impaired investment securities and believes that the estimated credit loss is appropriate.

Following is a tabular roll-forward of the amount of credit-related OTTI recognized in earnings during the three and nine months ended September 30, 2014, and 2013:

	Three months ended September 30,				Nine months ended September 30,
	2014		2013		2014		2013
Balance, beginning of period:	$	227	$	220	$	227	$	220
Additions:
Initial OTTI credit loss		—		—		—		—
Balance, end of period:	$	227	$	220	$	227	$	220

At September 30, 2014, six of the Company’s private-label mortgage-backed securities with an amortized cost of $1,950 were classified as substandard as their underlying credit was considered impaired. Securities with an amortized cost of $2,593 and $2,721 were classified as substandard at December 31, 2013, and September 30, 2013, respectively.

At September 30, 2014, the projected average life of the securities portfolio was 4.15 years.

The amortized cost and estimated fair values of securities available-for-sale at December 31, 2013, were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Unrealized Loss Positions
Obligations of U.S. government agencies	$	17,268	$	—	$	(276	)	$	16,992
Obligations of states and political subdivisions		40,408		—		(2,180	)		38,228
Private-label mortgage-backed securities		2,679		—		(245	)		2,434
Mortgage-backed securities		103,851		—		(1,928	)		101,923
SBA variable rate pools		3,722		—		(44	)		3,678
	$	167,928	$	—	$	(4,673	)	$	163,255
Unrealized Gain Positions
Obligations of U.S. government agencies	$	13,515	$	340	$	—		$	13,855
Obligations of states and political subdivisions		39,210		1,357		—			40,567
Private-label mortgage-backed securities		2,790		90		—			2,880
Mortgage-backed securities		119,181		2,616		—			121,797
SBA variable rate pools		5,004		28		—			5,032
	$	179,700	$	4,431	$	—		$	184,131
	$	347,628	$	4,431	$	(4,673	)	$	347,386

10

At December 31, 2013, of the 445 investment securities held, there were 187 in unrealized loss positions. The following table presents a summary of securities in a continuous unrealized loss position at December 31, 2013:

	Securities in Continuous Unrealized Loss Position for Less Than 12 Months		Gross Unrealized Loss on Securities in Loss Position for Less Than 12 Months		Securities in Continuous Unrealized Loss Position for 12 Months or Longer		Gross Unrealized Loss on Securities in Loss Position for 12 Months or Longer
Obligations of U.S. government agencies	$	16,992	$	276	$	—	$	—
Obligations of states and political subdivisions		36,873		2,053		1,356		127
Private-label mortgage-backed securities		1,256		44		1,178		201
Mortgage-backed securities		68,647		1,309		33,275		619
SBA variable rate pools		3,678		44		—		—
	$	127,446	$	3,726	$	35,809	$	947

The amortized cost and estimated fair values of securities available-for-sale at September 30, 2013, were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Unrealized Loss Positions
Obligations of U.S. government agencies	$	8,109	$	—	$	(119	)	$	7,990
Obligations of states and political subdivisions		39,036		—		(2,230	)		36,806
Private-label mortgage-backed securities		2,987		—		(238	)		2,749
Mortgage-backed securities		104,093		—		(1,799	)		102,294
	$	154,225	$	—	$	(4,386	)	$	149,839
Unrealized Gain Positions
Obligations of U.S. government agencies	$	18,523	$	387	$	—		$	18,910
Obligations of states and political subdivisions		41,056		1,503		—			42,559
Private-label mortgage-backed securities		3,300		107		—			3,407
Mortgage-backed securities		129,817		2,974		—			132,791
	$	192,696	$	4,971	$	—		$	197,667
	$	346,921	$	4,971	$	(4,386	)	$	347,506

11

At September 30, 2013, of the 447 investments held, there were 184 investment securities in unrealized loss positions. The following table presents a summary of securities in a continuous unrealized loss position at September 30, 2013:

	Securities in		Gross		Securities in		Gross
	Continuous		Unrealized Loss		Continuous		Unrealized Loss
	Unrealized		on Securities		Unrealized		on Securities
	Loss		in Loss		Loss		in Loss
	Position for		Position for		Position for		Position for
	Less Than		Less Than		12 Months		12 Months
	12 Months		12 Months		or Longer		or Longer
Obligations of U.S. government agencies	$	7,990	$	119	$	—	$	—
Obligations of states and political subdivisions		35,831		2,166		975		64
Private-label mortgage-backed securities		1,496		39		1,253		199
Mortgage-backed securities		76,814		1,254		25,480		545
	$	122,131	$	3,578	$	27,708	$	808

The amortized cost and estimated fair value of securities at September 30, 2014, December 31, 2013, and September 30, 2013, by maturity are shown below. Obligations of U.S. government agencies and states and political subdivisions are shown by contractual maturity. Mortgage-backed securities and SBA variable pools are shown by projected average life.

	September 30, 2014				December 31, 2013				September 30, 2013
			Estimated				Estimated				Estimated
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
Due in one year or less	$	12,824	$	13,060	$	18,707	$	18,870	$	17,285	$	17,388
Due after one year through 5 years		214,577		217,088		217,713		219,375		179,366		181,527
Due after 5 years through 10 years		76,484		78,143		66,103		65,432		140,288		139,523
Due after 10 years		38,753		39,761		45,105		43,709		9,982		9,068
	$	342,638	$	348,052	$	347,628	$	347,386	$	346,921	$	347,506

No securities were sold during the third quarter 2014. However, a gain of $3 was recorded as a result of an adjustment in proceeds on a security sold during the prior quarter.

At September 30, 2014, securities with an aggregate amortized cost of $22,859 (estimated aggregate market value of $23,278) were pledged to secure certain public deposits as required by law. At September 30, 2014, securities with an aggregate amortized cost of $3,975 (estimated aggregate market value of $4,031) were pledged for repurchase accounts. At September 30, 2014, there was a balance of $1,067 for repurchase agreements.

12

NOTE 3 – LOANS, ALLOWANCE FOR LOAN LOSSES, AND CREDIT QUALITY INDICATORS

Loans are stated at the amount of unpaid principal net of loan premiums or discounts for purchased loans, net deferred loan origination fees, discounts associated with retained portions of loans sold, and an allowance for loan losses. Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding. Loan origination fees, net of origination costs and discounts, are amortized over the lives of the loans as adjustments to yield.

Major classifications of period-end loans are as follows:

	September 30,			% of Gross			December 31,			% of Gross			September 30,			% of Gross
	2014			Loans			2013			Loans			2013			Loans
Real estate loans
Multi-family residential	$	50,563			4.88	%	$	46,217			4.65	%	$	47,795			4.88	%
Residential 1-4 family		44,610			4.31	%		46,438			4.67	%		49,206			5.03	%
Owner-occupied commercial		249,657			24.10	%		249,311			25.06	%		244,828			25.02	%
Nonowner-occupied commercial		180,648			17.44	%		158,786			15.96	%		164,708			16.83	%
Total permanent real estate loans		525,478			50.73	%		500,752			50.34	%		506,537			51.76	%
Construction loans
Multi-family residential		19,178			1.85	%		23,419			2.35	%		22,929			2.34	%
Residential 1-4 family		35,421			3.42	%		26,512			2.67	%		29,880			3.05	%
Commercial real estate		32,946			3.18	%		30,516			3.07	%		24,106			2.46	%
Commercial bare land and acquisition & development		12,264			1.18	%		11,473			1.15	%		11,191			1.14	%
Residential bare land and acquisition & development		6,736			0.65	%		6,990			0.70	%		7,053			0.72	%
Total construction real estate loans		106,545			10.28	%		98,910			9.94	%		95,159			9.71	%
Total real estate loans		632,023			61.01	%		599,662			60.28	%		601,696			61.47	%
Commercial loans		398,702			38.49	%		390,301			39.24	%		372,129			38.02	%
Consumer loans		3,348			0.32	%		3,878			0.39	%		3,660			0.38	%
Other loans		1,802			0.18	%		928			0.09	%		1,188			0.13	%
Gross loans		1,035,875			100.00	%		994,769			100.00	%		978,673			100.00	%
Deferred loan origination fees		(1,026	)					(924	)					(955	)
		1,034,849						993,845						977,718
Allowance for loan losses		(15,722	)					(15,917	)					(16,802	)
Total loans, net of allowance for loan losses and net deferred fees	$	1,019,127					$	977,928					$	960,916

At September 30, 2014, outstanding loans to dental professionals totaled $307,088 and represented 29.65% of total outstanding loans, compared to dental professional loans of $307,268 or 30.89% of total outstanding loans at December 31, 2013, and $303,911 or 31.05% of total outstanding loans at September 30, 2013. See Note 4 for additional information on the dental loan portfolio. There are no other industry concentrations in excess of 10% of the total loan portfolio. However, as of September 30, 2014, 61.01% of the Company’s loan portfolio was collateralized by real estate and is, therefore, susceptible to changes in real estate market conditions.

13

Allowance for Loan Losses

A summary of activity in the allowance for loan losses for the three and nine months ended September 30, 2014, and 2013 is as follows:

	Three months ended						Nine months ended
	September 30,						September 30,
	2014			2013			2014			2013
Balance, beginning of period	$	15,675		$	16,303		$	15,917		$	16,346
Provision charged to income		—			—			—			250
Loans charged against allowance		(23	)		(221	)		(654	)		(1,049	)
Recoveries credited to allowance		70			720			459			1,255
Balance, end of period	$	15,722		$	16,802		$	15,722		$	16,802

The allowance for loan losses is established as an amount that management considers adequate to absorb possible losses on existing loans within the portfolio. The allowance consists of general, specific, and unallocated components. The general component is based upon all loans collectively evaluated for impairment. The specific component is based upon all loans individually evaluated for impairment. The unallocated component represents credit losses inherent in the loan portfolio that may not have been contemplated in the general risk factors or the specific allowance analysis. Loans are charged against the allowance when management believes the collection of principal or interest is unlikely.

The Company performs regular credit reviews of the loan portfolio to determine the credit quality and adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process and on an ongoing basis by management. The Company’s internal risk rating methodology assigns risk ratings ranging from one to ten, where a higher rating represents higher risk. The ten-point risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan losses.

Estimated credit losses reflect consideration of all significant factors that affect the collectability of the loan portfolio. The historical loss rate for each group of loans with similar risk characteristics is determined based on the Company’s own loss experience in that group. Historical loss experience and recent trends in losses provide a reasonable starting point for analysis, however they do not by themselves form a sufficient basis to determine the appropriate level for the allowance for loan losses. Qualitative or environmental factors that are likely to cause estimated credit losses to differ from historical losses are also considered, including but not limited to:

• Changes in international, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments,

• Changes in the nature and volume of the portfolio and in the terms of loans,

• Changes in the experience, ability, and depth of lending management and other relevant staff,

• Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans,

• Changes in the quality of the institution’s loan review system,

• Changes in the value of underlying collateral for collateral-dependent loans,

• The existence and effect of any concentrations of credit, and changes in the level of such concentrations,

• The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio,

• Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses, and

• Changes in the current and future US political environment, including debt ceiling negotiations, government shutdown and healthcare reform, that may affect national, regional and local economic conditions, taxation, or disruption of national or global financial markets.

14

The adequacy of the allowance for loan losses and the reserve for unfunded commitments is determined using a systematic methodology and is monitored regularly based on management’s evaluation of numerous factors. For each portfolio segment, these factors include:

• The quality of the current loan portfolio,

• The trend in the migration of the loan portfolio’s risk ratings,

• The velocity of migration of losses and potential losses,

• Current economic conditions,

• Loan concentrations,

• Loan growth rates,

• Past-due and nonperforming trends,

• Evaluation of specific loss estimates for all significant problem loans,

• Recovery experience, and

• Peer comparison loss rates.

A summary of the activity in the allowance for loan losses by major loan classification follows:

	For the three months ended September 30, 2014
	Commercial and Other			Real Estate			Construction		Consumer			Unallocated		Total
Beginning balance	$	5,596		$	7,429		$	1,340	$	59		$	1,251	$	15,675
Charge-offs		—			(19	)		—		(4	)		—		(23	)
Recoveries		67			—			3		—			—		70
Provision (reclassification)		(159	)		(151	)		82		(8	)		236		—
Ending balance	$	5,504		$	7,259		$	1,425	$	47		$	1,487	$	15,722

	For the nine months ended September 30, 2014
	Commercial and Other			Real Estate			Construction			Consumer			Unallocated			Total
Beginning balance	$	5,113		$	7,668		$	1,493		$	68		$	1,575		$	15,917
Charge-offs		(442	)		(49	)		(155	)		(8	)		—			(654	)
Recoveries		282			162			11			4			—			459
Provision (reclassification)		551			(522	)		76			(17	)		(88	)		—
Ending balance	$	5,504		$	7,259		$	1,425		$	47		$	1,487		$	15,722

At September 30, 2014, the allowance for loan losses on dental loans was $4,084 compared to $3,730 at December 31, 2013 and $2,688 at September 30, 2013. See Note 4 for additional information on the dental loan portfolio.

15

	Balances as of September 30, 2014
	Commercial and Other		Real Estate		Construction		Consumer		Unallocated		Total
Ending allowance: collectively evaluated for impairment	$	5,490	$	7,255	$	1,302	$	47	$	1,487	$	15,581
Ending allowance: individually evaluated for impairment		14		4		123		—		—		141
Total ending allowance	$	5,504	$	7,259	$	1,425	$	47	$	1,487	$	15,722
Ending loan balance: collectively evaluated for impairment	$	397,609	$	519,768	$	106,184	$	3,348	$	—	$	1,026,909
Ending loan balance: individually evaluated for impairment		2,895		5,710		361		—		—		8,966
Total ending loan balance	$	400,504	$	525,478	$	106,545	$	3,348	$	—	$	1,035,875
	Balances as of December 31, 2013
	Commercial and Other		Real Estate		Construction		Consumer		Unallocated		Total
Ending allowance: collectively evaluated for impairment	$	5,095	$	7,667	$	1,455	$	68	$	1,575	$	15,860
Ending allowance: individually evaluated for impairment		18		1		38		—		—		57
Total ending allowance	$	5,113	$	7,668	$	1,493	$	68	$	1,575	$	15,917
Ending loan balance: collectively evaluated for impairment	$	386,332	$	495,924	$	98,627	$	3,878	$	—	$	984,761
Ending loan balance: individually evaluated for impairment		4,897		4,828		283		—		—		10,008
Total ending loan balance	$	391,229	$	500,752	$	98,910	$	3,878	$	—	$	994,769
	Balances as of September 30, 2013
	Commercial and Other		Real Estate		Construction		Consumer		Unallocated		Total
Ending allowance: collectively evaluated for impairment	$	5,490	$	8,043	$	1,635	$	70	$	1,541	$	16,779
Ending allowance: individually evaluated for impairment		21		2		—		—		—		23
Total ending allowance	$	5,511	$	8,045	$	1,635	$	70	$	1,541	$	16,802
Ending loan balance: collectively evaluated for impairment	$	368,944	$	500,493	$	94,876	$	3,660	$	—	$	967,973
Ending loan balance: individually evaluated for impairment		4,373		6,044		283		—		—		10,700
Total ending loan balance	$	373,317	$	506,537	$	95,159	$	3,660	$	—	$	978,673

Management believes that the allowance for loan losses was adequate as of September 30, 2014. However, future loan losses may exceed the levels provided for in the allowance for loan losses and could possibly result in additional charges to the provision for loan losses.

16

Credit Quality Indicators

The Company uses the following loan grades, which are also often used by regulators when assessing the credit quality of a loan portfolio.

Pass – Credit exposure in this category ranges between the highest credit quality to average credit quality. Primary repayment sources generate satisfactory debt service coverage under normal conditions. Cash flow from recurring sources is expected to continue to produce adequate debt service capacity. There are many levels of credit quality contained in the Pass definition, but none of the loans contained in this category rise to the level of Special Mention. This category includes loans with an internal risk rating of 1-6.

Special Mention – A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. The Bank strictly and carefully employs the FDIC definition in assessing assets that may apply to this category. It is apparent that in many cases asset weaknesses relevant to this definition either (1) better fit a definition of a “well-defined weakness,” or (2) in management’s experience ultimately migrate to worse risk grade categories, such as Substandard and Doubtful. Consequently, management elects to downgrade most potential Special Mention credits to Substandard or Doubtful, and therefore adopts a conservative risk grade process in the use of the Special Mention risk grade. This category includes loans with an internal risk rating of 7.

Substandard – A Substandard asset is inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans in this category are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified Substandard. This category includes loans with an internal risk rating of 8.

Doubtful – An asset classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values, highly questionable and improbable. This category includes loans with an internal risk rating of 9.

Management strives to consistently apply these definitions when allocating its loans by loan grade. The loan portfolio is continuously monitored for changes in credit quality and management takes appropriate action to update the loan risk ratings accordingly. Management has not changed the Company’s policy towards its use of credit quality indicators during the periods reported.

17

The following tables present the Company’s loan portfolio information by loan type and credit grade at September 30, 2014, December 31, 2013, and September 30, 2013:

Credit Quality Indicators

As of September 30, 2014

	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Real estate loans
Multi-family residential	$	49,044	$	—	$	1,519	$	—	$	50,563
Residential 1-4 family		36,819		—		7,791		—		44,610
Owner-occupied commercial		239,662		4,210		5,785		—		249,657
Nonowner-occupied commercial		176,696		—		3,952		—		180,648
Total real estate loans		502,221		4,210		19,047		—		525,478
Construction
Multi-family residential		19,178		—		—		—		19,178
Residential 1-4 family		35,421		—		—		—		35,421
Commercial real estate		32,946		—		—		—		32,946
Commercial bare land and acquisition & development		12,028		—		236		—		12,264
Residential bare land and acquisition & development		5,993		—		743		—		6,736
Total construction loans		105,566		—		979		—		106,545
Commercial and other		388,470		—		12,034		—		400,504
Consumer		3,338		—		10		—		3,348
Totals	$	999,595	$	4,210	$	32,070	$	—	$	1,035,875

Credit Quality Indicators

As of December 31, 2013

	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Real estate loans
Multi-family residential	$	44,677	$	—	$	1,540	$	—	$	46,217
Residential 1-4 family		37,831		—		8,607		—		46,438
Owner-occupied commercial		239,539		4,278		5,494		—		249,311
Nonowner-occupied commercial		153,055		—		5,731		—		158,786
Total real estate loans		475,102		4,278		21,372		—		500,752
Construction
Multi-family residential		23,419		—		—		—		23,419
Residential 1-4 family		26,145		—		367		—		26,512
Commercial real estate		28,978		—		1,538		—		30,516
Commercial bare land and acquisition & development		11,223		—		250		—		11,473
Residential bare land and acquisition & development		4,346		—		2,644		—		6,990
Total construction loans		94,111		—		4,799		—		98,910
Commercial and other		378,828		—		12,401		—		391,229
Consumer		3,856		—		22		—		3,878
Totals	$	951,897	$	4,278	$	38,594	$	—	$	994,769

18

Credit Quality Indicators

As of September 30, 2013

	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Real estate loans
Multi-family residential	$	46,487	$	—	$	1,308	$	—	$	47,795
Residential 1-4 family		40,181		—		9,025		—		49,206
Owner-occupied commercial		234,794		4,297		5,737		—		244,828
Nonowner-occupied commercial		158,944		—		5,764		—		164,708
Total real estate loans		480,406		4,297		21,834		—		506,537
Construction
Multi-family residential		22,929		—		—		—		22,929
Residential 1-4 family		29,683		—		197		—		29,880
Commercial real estate		22,548		—		1,558		—		24,106
Commercial bare land and acquisition & development		10,980		—		211		—		11,191
Residential bare land and acquisition & development		4,475		—		2,578		—		7,053
Total construction loans		90,615		—		4,544		—		95,159
Commercial and other		360,749		—		12,551		17		373,317
Consumer		3,630		—		30		—		3,660
Totals	$	935,400	$	4,297	$	38,959	$	17	$	978,673

At September 30, 2014, December 31, 2013, and September 30, 2013, the Company had $534, $532 and $668, respectively, in unfunded commitments on its classified loans, which is included in the calculation of our classified asset ratio.

19

Past Due and Nonaccrual Loans

The Company uses the terms “past due” and “delinquent” interchangeably. Amortizing loans are considered past due or delinquent based upon the number of contractually required payments not made. Delinquency status for all contractually matured loans, commercial and commercial real estate loans with non-monthly amortization, and all other extensions of credit is determined based upon the number of calendar months past due.

The following tables present an aging analysis of past due and nonaccrual loans at September 30, 2014, December 31, 2013, and September 30, 2013:

Age Analysis of Loans Receivable

As of September 30, 2014

					Greater
	30-59 Days		60-89 Days		Than 90 days				Total Past
	Past Due		Past Due		Past Due				Due and		Total		Total Loans
	Still Accruing		Still Accruing		Still Accruing		Nonaccrual		Nonaccrual		Current		Receivable
Real estate loans
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	50,563	$	50,563
Residential 1-4 family		187		—		—		459		646		43,964		44,610
Owner-occupied commercial		184		—		—		787		971		248,686		249,657
Nonowner-occupied commercial		—		—		—		1,245		1,245		179,403		180,648
Total real estate loans		371		—		—		2,491		2,862		522,616		525,478
Construction
Multi-family residential		—		—		—		—		—		19,178		19,178
Residential 1-4 family		—		—		—		—		—		35,421		35,421
Commercial real estate		—		—		—		—		—		32,946		32,946
Commercial bare land and acquisition & development		—		—		—		—		—		12,264		12,264
Residential bare land and acquisition & development		—		—		—		—		—		6,736		6,736
Total construction loans		—		—		—		—		—		106,545		106,545
Commercial and other		1,269		—		—		762		2,031		398,473		400,504
Consumer		12		—		—		—		12		3,336		3,348
Total	$	1,652	$	—	$	—	$	3,253	$	4,905	$	1,030,970	$	1,035,875

Age Analysis of Loans Receivable

As of December 31, 2013

					Greater
	30-59 Days		60-89 Days		Than 90 days				Total Past
	Past Due		Past Due		Past Due				Due and		Total		Total Loans
	Still Accruing		Still Accruing		Still Accruing		Nonaccrual		Nonaccrual		Current		Receivable
Real estate loans
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	46,217	$	46,217
Residential 1-4 family		137		—		—		636		773		45,665		46,438
Owner-occupied commercial		488		—		—		1,685		2,173		247,138		249,311
Nonowner-occupied commercial		1,188		—		—		136		1,324		157,462		158,786
Total real estate loans		1,813		—		—		2,457		4,270		496,482		500,752
Construction
Multi-family residential		—		—		—		—		—		23,419		23,419
Residential 1-4 family		—		—		—		—		—		26,512		26,512
Commercial real estate		—		—		—		—		—		30,516		30,516
Commercial bare land and acquisition & development		—		—		—		—		—		11,473		11,473
Residential bare land and acquisition & development		—		—		—		—		—		6,990		6,990
Total construction loans		—		—		—		—		—		98,910		98,910
Commercial and other		436		—		—		2,886		3,322		387,907		391,229
Consumer		5		1		—		—		6		3,872		3,878
Total	$	2,254	$	1	$	—	$	5,343	$	7,598	$	987,171	$	994,769

20

Age Analysis of Loans Receivable

As of September 30, 2013

					Greater
	30-59 Days		60-89 Days		Than 90 days				Total Past
	Past Due		Past Due		Past Due				Due and		Total		Total Loans
	Still Accruing		Still Accruing		Still Accruing		Nonaccrual		Nonaccrual		Current		Receivable
Real estate loans
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	47,795	$	47,795
Residential 1-4 family		—		—		—		1,206		1,206		48,000		49,206
Owner-occupied commercial		166		166		—		2,235		2,567		242,261		244,828
Nonowner-occupied commercial		1,096		559		—		139		1,794		162,914		164,708
									��
Total real estate loans		1,262		725		—		3,580		5,567		500,970		506,537
Construction
Multi-family residential		—		—		—		—		—		22,929		22,929
Residential 1-4 family		—		—		—		—		—		29,880		29,880
Commercial real estate		—		—		—		—		—		24,106		24,106
Commercial bare land and acquisition & development		—		—		—		—		—		11,191		11,191
Residential bare land and acquisition & development		—		—		—		—		—		7,053		7,053
Total construction loans		—		—		—		—		—		95,159		95,159
Commercial and other		1,292		325		—		2,361		3,978		369,339		373,317
Consumer		5		—		—		—		5		3,655		3,660
Total	$	2,559	$	1,050	$	—	$	5,941	$	9,550	$	969,123	$	978,673

Impaired Loans

Regular credit reviews of the portfolio are performed to identify loans that are considered potentially impaired. A loan is considered impaired when, based on current information and events, the Company is unlikely to collect all principal and interest due according to the terms of the loan agreement. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. Impaired loans are often reported net of government guarantees to the extent that the guarantees are expected to be collected. Impaired loans generally include all loans classified as nonaccrual and troubled debt restructurings. Impaired loans are included in the specific calculation of allowance for loan losses.

Accrual of interest is discontinued on impaired loans when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal or interest is doubtful. Accrued but uncollected interest is generally reversed when loans are placed on nonaccrual status. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized. Interest income may be recognized on impaired loans that are not on nonaccrual status.

21

The following tables display an analysis of the Company’s impaired loans at September 30, 2014, December 31, 2013, and September 30, 2013:

Impaired Loan Analysis

As of September 30, 2014

	Recorded		Recorded
	Investment		Investment								Related
	With No Specific		With Specific				Unpaid		Average		Specific
	Allowance		Allowance		Recorded		Principal		Recorded		Allowance
	Valuation		Valuation		Investment		Balance		Investment		Valuation
Real estate
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	—
Residential 1-4 family		709		315		1,024		1,350		1,183		4
Owner-occupied commercial		1,843		—		1,843		2,076		2,636		—
Nonowner-occupied commercial		2,843		—		2,843		2,862		1,685		—
Total real estate loans		5,395		315		5,710		6,288		5,504		4
Construction
Multi-family residential		—		—		—		—		—		—
Residential 1-4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—		—		—
Residential bare land and acquisition & development		—		361		361		361		370		123
Total construction loans		—		361		361		361		370		123
Commercial and other		2,377		518		2,895		3,200		4,405		14
Consumer		—		—		—		—		—		—
Total impaired loans	$	7,772	$	1,194	$	8,966	$	9,849	$	10,279	$	141

Impaired Loan Analysis

As of December 31, 2013

	Recorded		Recorded
	Investment		Investment								Related
	With No Specific		With Specific				Unpaid		Average		Specific
	Allowance		Allowance		Recorded		Principal		Recorded		Allowance
	Valuation		Valuation		Investment		Balance		Investment		Valuation
Real estate
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	—
Residential 1-4 family		912		317		1,229		1,633		2,229		1
Owner-occupied commercial		2,767		—		2,767		3,000		3,359		—
Nonowner-occupied commercial		832		—		832		835		799		—
Total real estate loans		4,511		317		4,828		5,468		6,387		1
Construction
Multi-family residential		—		—		—		—		—		—
Residential 1-4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—		133		—
Residential bare land and acquisition & development		—		283		283		373		413		38
Total construction loans		—		283		283		373		546		38
Commercial and other		4,368		529		4,897		10,627		4,100		18
Consumer		—		—		—		—		—		—
Total impaired loans	$	8,879	$	1,129	$	10,008	$	16,468	$	11,033	$	57

22

Impaired Loan Analysis

As of September 30, 2013

	Recorded Investment With No Specific Allowance Valuation		Recorded Investment With Specific Allowance Valuation		Recorded Investment		Unpaid Principal Balance		Average Recorded Investment		Related Specific Allowance Valuation
Real estate
Multi-family residential	$	—	$	—	$	—	$	—	$	—	$	—
Residential 1-4 family		1,489		318		1,807		2,158		2,491		2
Owner-occupied commercial		3,329		—		3,329		3,800		3,551		—
Nonowner-occupied commercial		908		—		908		908		786		—
Total real estate loans		5,726		318		6,044		6,866		6,828		2
Construction
Multi-family residential		—		—		—		—		—		—
Residential 1-4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—		178		—
Residential bare land and acquisition & development		283		—		283		283		457		—
Total construction loans		283		—		283		283		635		—
Commercial and other		3,839		534		4,373		9,475		3,616		21
Consumer		—		—		—		—		—		—
Total impaired loans	$	9,848	$	852	$	10,700	$	16,624	$	11,079	$	23

The impaired balances reported above are not adjusted for government guarantees of $1,129, $1,532, and $1,354 at September 30, 2014, December 31, 2013, and September 30, 2013, respectively. The recorded investment in impaired loans, net of government guarantees, totaled $7,837, $8,476 and $9,346 at September 30, 2014, December 31, 2013, and September 30, 2013, respectively.

23

Troubled Debt Restructurings

In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties.

The following table displays the Company’s TDRs by class at September 30, 2014, December 31, 2013, and September 30, 2013:

	Troubled Debt Restructurings as of
	September 30, 2014				December 31, 2013				September 30, 2013
	Number of Contracts		Post-Modification Outstanding Recorded Investment		Number of Contracts		Post-Modification Outstanding Recorded Investment		Number of Contracts		Post-Modification Outstanding Recorded Investment
Real estate
Multifamily residential		—	$	—		—	$	—		—	$	—
Residential 1-4 family		7		781		7		819		8		1,108
Owner-occupied commercial		4		1,244		5		1,949		5		1,973
Non owner-occupied commercial		6		2,843		2		714		2		698
Total real estate loans		17		4,868		14		3,482		15		3,779
Construction
Multifamily residential		—		—		—		—		—		—
Residential 1-4 family		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—		—		—
Residential bare land and acquisition & development		—		—		—		—		—		—
Total construction loans		—		—		—		—		—		—
Commercial and other		11		2,527		10		2,379		11		2,406
Consumer		—		—		—		—		—		—
Total		28	$	7,395		24	$	5,861		26	$	6,185

The recorded investment in TDRs on nonaccrual status totaled $2,044, $1,597, and $1,911 at September 30, 2014, December 31, 2013, and September 30, 2013, respectively. The Company’s policy is that loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Company’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

For the nine months ended September 30, 2014, the Company identified seven TDRs that were newly considered impaired for which impairment was previously measured under the Company’s general loan loss allowance methodology. At September 30, 2014, the total recorded investment in such receivables was $2,992 with no associated allowance.

The types of modifications offered can generally be described in the following categories:

Rate Modification -A modification in which the interest rate is modified.

Term Modification -A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest-only Modification -A modification in which the loan is converted to interest-only payments for a period of time.

Combination Modification -Any other type of modification, including the use of multiple types of modifications.

24

The following tables present newly restructured loans that occurred during the nine months ended September 30, 2014, and 2013, respectively:

	Troubled Debt Restructurings Identified During the Nine Months ended September 30, 2014
	Rate Modification		Term Modification		Interest-only Modification		Combination Modification
Real estate
Multi-family residential	$	—	$	—	$	—	$	—
Residential 1-4 family		—		—		—		—
Owner-occupied commercial		—		—		—		—
Nonowner-occupied commercial		—		1,598		548		—
Total real estate loans		—		1,598		548		—
Construction
Multi-family residential		—		—		—		—
Residential 1-4 family		—		—		—		—
Commercial real estate		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—
Residential bare land and acquisition & development		—		—		—		—
Total construction loans		—		—		—		—
Commercial and other		—		276		570		—
Consumer		—		—		—		—
Total	$	—	$	1,874	$	1,118	$	—

	Troubled Debt Restructurings Identified During the Nine Months ended September 30, 2013
	Rate Modification		Term Modification		Interest-only Modification		Combination Modification
Real estate
Multi-family residential	$	—	$	—	$	—	$	—
Residential 1-4 family		318		—		—		274
Owner-occupied commercial		—		—		—		—
Nonowner-occupied commercial		559		—		—		—
Total real estate loans		877		—		—		274
Construction
Multi-family residential		—		—		—		—
Residential 1-4 family		—		—		—		—
Commercial real estate		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—
Residential bare land and acquisition & development		—		—		—		—
Total construction loans		—		—		—		—
Commercial and other		—		778		524		680
Consumer		—		—		—		—
Total	$	877	$	778	$	524	$	954

25

Subsequent to a loan being classified as a TDR, a borrower may become unwilling or unable to abide by the terms of the modified agreement. In such cases of default, the Company takes appropriate action to recover principal and interest payments including the use of foreclosure proceedings. The following table presents loans receivable modified as TDRs that subsequently defaulted within the first twelve months of restructure during the period:

	Troubled Debt Restructurings that Subsequently Defaulted During the Nine Months ended September 30,
	2014				2013
	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
Real estate
Multi-family residential		—	$	—		—	$	—
Residential 1-4 family		—		—		1		274
Owner-occupied commercial		—		—		1		303
Nonowner-occupied commercial		—		—		1		559
Total real estate loans		—		—		3		1,136
Construction
Multi-family residential		—		—		—		—
Residential 1-4 family		—		—		—		—
Commercial real estate		—		—		—		—
Commercial bare land and acquisition & development		—		—		—		—
Residential bare land and acquisition & development		—		—		—		—
Total construction loans		—		—		—		—
Commercial and other		—		—		4		289
Consumer		—		—		—		—
Total		—	$	—		7	$	1,425

At September 30, 2014, December 31, 2013, and September 30, 2013, the Company had no commitments to lend additional funds on loans restructured as TDRs.

NOTE 4 – DENTAL LOAN PORTFOLIO

Dental lending is not operated as a business segment, and dental loans are made in the normal course of commercial lending activities throughout the Company. However, to assist in understanding the concentrations and risks associated with the Company’s loan portfolio, the following Note has been included to provide additional information relating to the Company’s dental loan portfolio. At September 30, 2014, December 31, 2013, and September 30, 2013, loans to dental professionals totaled $307,088, $307,268, and $303,911, respectively, and represented 29.65%, 30.89% and 31.05% in principal amount of total outstanding loans, respectively. As of September 30, 2014, December 31, 2013, and September 30, 2013, the dental loans were supported by government guarantees totaling $13,196, $16,470 and $17,491, respectively. These guarantees represented 4.30%, 5.36% and 5.76% in principal amount of the outstanding dental loan balances as of such respective dates. The Company defines a “dental loan” as a loan to dental professionals for the purpose of practice expansion, acquisition or other purpose supported by the cash flows of a dental practice.

26

Loan Classification

Major classifications of dental loans at September 30, 2014, December 31, 2013, and September 30, 2013, were as follows:

	September 30, 2014		December 31, 2013		September 30, 2013
Real estate secured loans:
Owner-occupied commercial	$	60,871	$	59,279	$	59,868
Other dental real estate loans		2,600		1,967		2,021
Total permanent real estate loans		63,471		61,246		61,889
Dental construction loans		416		5,810		5,186
Total real estate loans		63,887		67,056		67,075
Commercial loans		243,201		240,212		236,836
Gross loans	$	307,088	$	307,268	$	303,911

Market Area

The Bank’s defined “local market area” is within the states of Oregon and Washington, west of the Cascade Mountain Range. This area is serviced by branch locations in Eugene, Oregon; Portland, Oregon; and Seattle, Washington. The Company also makes national dental loans throughout the United States. National loan relationships are maintained and serviced by Bank personnel primarily located in Portland. The following table summarizes the Company’s dental lending by borrower location:

	September 30,		December 31,		September 30,
	2014		2013		2013
Local	$	164,271	$	178,673	$	181,396
National		142,817		128,595		122,515
Total	$	307,088	$	307,268	$	303,911

Allowance

The allowance for loan losses identified for the dental loan portfolio is established as an amount that management considers adequate to absorb possible losses on existing loans within the dental loan portfolio. The allowance related to the dental loan portfolio consists of general and specific components. The general component is based upon all dental loans collectively evaluated for impairment, including qualitative conditions associated with loan type, national location, start-up financing, practice acquisition financing, and specialty practice financing. The specific component is based upon dental loans individually evaluated for impairment.

	Three months ended September 30,						Nine months ended September 30,
	2014			2013			2014			2013
Balance, beginning of period	$	4,136		$	3,522		$	3,730		$	2,683
Provision (reclassification)		(82	)		(854	)		713			382
Loans charged against allowance		(19	)		—			(466	)		(444	)
Recoveries credited to allowance		49			20			107			67
Balance, end of period	$	4,084		$	2,688		$	4,084		$	2,688

27

Credit Quality

Please refer to Note 3 for additional information on the definitions of the credit quality indicators.

The following tables present the Company’s dental loan portfolio by market and credit grade at September 30, 2014, December 31, 2013, and September 30, 2013:

As of September 30, 2014
	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Local	$	160,184	$	—	$	4,087	$	—	$	164,271
National		141,634		—		1,183		—		142,817
Total	$	301,818	$	—	$	5,270	$	—	$	307,088
As of December 31, 2013
	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Local	$	172,708	$	—	$	5,965	$	—	$	178,673
National		127,842		—		753		—		128,595
Total	$	300,550	$	—	$	6,718	$	—	$	307,268
As of September 30, 2013
	Loan Grade
	Pass		Special Mention		Substandard		Doubtful		Totals
Local	$	175,602	$	—	$	5,794	$	—	$	181,396
National		121,757		—		758		—		122,515
Total	$	297,359	$	—	$	6,552	$	—	$	303,911

28

Past Due and Nonaccrual Loans

The following tables present an aged analysis of the dental loan portfolio by market, including nonaccrual loans, as of September 30, 2014, December 31, 2013, and September 30, 2013:

As of September 30, 2014
					Greater
	30-59 Days		60-89 Days		Than 90 Days				Total Past
	Past Due		Past Due		Past Due				Due and		Total		Total Loans
	Still Accruing		Still Accruing		Still Accruing		Nonaccrual		Nonaccrual		Current		Receivable
Local	$	601	$	—	$	—	$	119	$	720	$	163,551	$	164,271
National		—		—		—		222		222		142,595		142,817
Total	$	601	$	—	$	—	$	341	$	942	$	306,146	$	307,088
As of December 31, 2013
					Greater
	30-59 Days		60-89 Days		Than 90 Days				Total Past
	Past Due		Past Due		Past Due				Due and		Total		Total Loans
	Still Accruing		Still Accruing		Still Accruing		Nonaccrual		Nonaccrual		Current		Receivable
Local	$	—	$	—	$	—	$	2,176	$	2,176	$	176,497	$	178,673
National		—		—		—		224		224		128,371		128,595
Total	$	—	$	—	$	—	$	2,400	$	2,400	$	304,868	$	307,268
As of September 30, 2013
					Greater
	30-59 Days		60-89 Days		Than 90 Days				Total Past
	Past Due		Past Due		Past Due				Due and		Total		Total Loans
	Still Accruing		Still Accruing		Still Accruing		Nonaccrual		Nonaccrual		Current		Receivable
Local	$	1,292	$	346	$	—	$	1,225	$	2,863	$	178,533	$	181,396
National		—		—		—		224		224		122,291		122,515
Total	$	1,292	$	346	$	—	$	1,449	$	3,087	$	300,824	$	303,911

29

NOTE 5 – FEDERAL FUNDS AND OVERNIGHT FUNDS PURCHASED

At September 30, 2014, the Company had unsecured federal funds borrowing lines with various correspondent banks totaling $129,000. At September 30, 2014, and December 31, 2013 there was $670, and $5,150 outstanding on these lines, respectively. There were no borrowings outstanding on these lines at September 30, 2013.

The Company also has a secured overnight borrowing line available from the Federal Reserve Bank of San Francisco (“FRB”) that totaled $71,557, $92,579 and $92,712 at September 30, 2014, December 31, 2013, and September 30, 2013, respectively. At September 30, 2014, the FRB borrowing line was secured by the pledge of approximately $143,550 of commercial loans under the Company’s Borrower-In-Custody program. At September 30, 2014, December 31, 2013, and September 30, 2013, there were no outstanding borrowings on this line.

NOTE 6 – FEDERAL HOME LOAN BANK BORROWINGS

The Company has a borrowing limit with the Federal Home Loan Bank (“FHLB”) equal to 30% of total assets, subject to the value of discounted collateral pledged. The Company does have the ability to access the FHLB excess stock pool, thus borrowing is not limited by FHLB stock held. At September 30, 2014, the maximum borrowing line was $446,916; however, the FHLB borrowing line was limited by the discounted value of collateral pledged. The Company had pledged $453,792 in real estate loans to the FHLB that had a discounted value of $299,083. There was $145,000 borrowed on this line at September 30, 2014.

At December 31, 2013, the maximum FHLB borrowing line was $434,963, and the Company had pledged real estate loans and securities to the FHLB with a discounted value of $229,547. There was $160,000 borrowed on this line at December 31, 2013.

At September 30, 2013, the maximum FHLB borrowing line was $436,463, and the Company had pledged real estate loans and securities to the FHLB with a discounted collateral value of $225,546. There was $145,000 borrowed on this line at September 30, 2013.

	Current	September 30,		December 31,		September 30,
	Rates	2014		2013		2013
Cash management advance	NA	$	—	$	—	$	—
2013	—		—		—		104,000
2014	0.21% - 0.30%		104,000		119,000		—
2015	0.60% - 1.60%		13,500		13,500		13,500
2016	1.84% - 2.36%		22,500		22,500		22,500
2017	2.28%		3,000		3,000		3,000
2018	—		—		—		—
Thereafter	3.85%		2,000		2,000		2,000
		$	145,000	$	160,000	$	145,000

30

NOTE 7 – SHARE-BASED COMPENSATION

The Company’s 2006 Stock Option and Equity Compensation Plan (the “2006 SOEC Plan”) authorizes the award of up to 1,550,000 shares in share-based awards. The awards granted under this plan are performance-based and are subject to vesting. The Compensation Committee of the Board of Directors may impose any terms or conditions on the vesting of an award that it determines to be appropriate. Awards granted generally vest over four years and have a maximum life of ten years. Awards may be granted at exercise prices of not less than 100% of the fair market value of the Company’s common stock at the grant date.

Pursuant to the 2006 SOEC Plan, incentive stock options (“ISOs”), nonqualified stock options, restricted stock, restricted stock units (“RSUs”), or stock appreciation rights (“SARs”) may be awarded to attract and retain the best available personnel to the Company and its subsidiaries. SARs may be settled in common stock or cash as determined at the date of issuance. Liability-based awards (including all cash-settled SARs) have no impact on the number of shares available to be issued within the plan. Additionally, non-qualified option awards and restricted stock awards may be granted to directors under the terms of this plan.

Prior to April 2006, ISO and non-qualified option awards were granted to employees and directors under the Company’s 1999 Employees’ Stock Option Plan and the Company’s 1999 Directors’ Stock Option Plan. The Company has stock options outstanding under both of these plans. Subsequent to the annual shareholders’ meeting in April 2006, all shares available under these plans were deregistered and are no longer available for future grants.

For the nine months ended September 30, 2014, 14,996 restricted shares were granted and issued to directors with no restrictions imposed. Additionally, 127,051 RSUs were granted to employees during the first nine months of 2014. Of the 127,051 RSUs granted, 116,771 vest over four years, 9,902 vest over two years, and 378 vested immediately. Shares of common stock will be issued as soon as practicable upon vesting. For the nine months ended September 30, 2013, 10,179 restricted shares were granted and issued to directors with no restrictions imposed. Additionally, 145,420 RSUs were granted to employees during the first nine months of 2013, all of which vest over four years. No other awards were granted during the nine months ended September 30, 2014, and 2013.

The following table summarizes the shares and the grant-date fair market values of the equity-based awards granted during the nine months ended September 30, 2014, and 2013:

	Nine months ended
	September 30,
	2014				2013
	Shares		Fair Market Value		Shares		Fair Market Value
Equity-based awards:
Director restricted stock		14,996	$	200		10,179	$	110
Employee stock options		—		—		—		—
Employee stock SARs		—		—		—		—
Employee RSUs		127,051		1,679		145,420		1,366
		142,047	$	1,879		155,599	$	1,476

31

The following table provides a summary of the Company’s RSU activity, including the weighted average grant date fair value, for the six months ended September 30, 2014:

	Nine months ended
	September 30, 2014
	Non-Vested Restricted Stock Units			Weighted Average Grant Date Fair Value
Balance, beginning of period		299,696		$	9.79
Granted		127,051			13.21
Vested shares issued		(58,518	)		9.65
Vested shares surrendered for taxes		(36,384	)		9.65
Forfeited or expired		(17,682	)		10.49
Balance, end of period		314,163		$	11.18

The following table identifies the compensation expense recorded and tax benefits received by the Company on its share-based compensation plans for the three and nine months ended September 30, 2014, and 2013:

	Three months ended
	September 30,
	2014				2013
	Compensation Expense		Tax Benefit		Compensation Expense		Tax Benefit
Equity-based awards:
Director restricted stock	$	—	$	—	$	—	$	—
Employee stock options		—		—		13		—
Employee stock SARs		—		—		27		10
Employee RSUs		327		124		229		87
Liability-based awards:
Employee cash SARs		5		2		10		4
	$	332	$	126	$	279	$	101
	Nine months ended
	September 30,
	2014				2013
	Compensation Expense		Tax Benefit		Compensation Expense		Tax Benefit
Equity-based awards:
Director restricted stock	$	200	$	76	$	110	$	39
Employee stock options		13		—		56		—
Employee stock SARs		26		10		100		38
Employee RSUs		888		337		601		228
Liability-based awards:
Employee cash SARs		75		29		10		4
	$	1,202	$	452	$	877	$	309

32

The following table identifies stock options, employee stock SARs, and employee cash SARs exercised during the three and nine months ended September 30, 2014:

	Three months ended
	September 30, 2014
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		—	$	—	$	—		—		NA
Employee stock SARs		2,901	$	11.72	$	3		234		NA
Employee cash SARs		1,417	$	12.07		NA		NA	$	1
	Nine months ended
	September 30, 2014
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		16,779	$	11	$	57		—		NA
Employee stock SARs		17,151	$	11.84	$	28		1,876		NA
Employee cash SARs		8,055	$	12.18		NA		NA	$	10

No liability-based or equity-based awards vested during the three and nine months ended September 30, 2014.

33

The following table identifies stock options, employee stock SARs, and employee cash SARs exercised during the three and nine months ended September 30, 2013:

	Three months ended
	September 30, 2013
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		—	$	—	$	—		—		NA
Employee stock SARs		4,664	$	11.78	$	4		306		NA
Employee cash SARs		845	$	12.07		NA		NA	$	1
	Nine months ended
	September 30, 2013
	Number Exercised		Weighted Average Exercise Price		Intrinsic Value		Number of Shares Issued		Net Cash Payment to Employees
Stock options		—	$	—	$	—		—		NA
Employee stock SARs		4,664	$	11.78	$	4		306		NA
Employee cash SARs		845	$	12.07		NA		NA	$	1

No liability-based or equity-based awards vested during the three and nine months ended September 30, 2013.

At September 30, 2014, the Company had estimated unrecognized compensation expense of approximately $2,714 for unvested RSUs. These amounts are based on historical forfeiture rates of 13.00% for all RSUs granted to employees. The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested RSUs was approximately 2.72 years as of September 30, 2014.

34

NOTE 8 – FAIR VALUE

The following table presents estimated fair values of the Company’s financial instruments as of September 30, 2014, December 31, 2013, and September 30, 2013, in accordance with the provisions of FASB ASC 825 “Financial Instruments.” The use of different assumptions and estimation methods could have a significant effect on the reported fair value amounts. Accordingly, the estimates of fair value herein are not necessarily indicative of the amounts that might be realized in a current market exchange.

	September 30, 2014				December 31, 2013				September 30, 2013
	Carrying				Carrying				Carrying
	Amount		Fair Value		Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	24,512	$	24,512	$	21,108	$	21,108	$	42,609	$	42,609
Securities available-for-sale		348,052		348,052		347,386		347,386		347,506		347,506
Loans		1,034,849		1,019,916		993,845		980,334		977,718		967,188
Federal Home Loan Bank stock		10,125		10,125		10,425		10,425		10,523		10,523
Interest receivable		4,759		4,759		4,703		4,703		4,608		4,608
Bank-owned life insurance		16,488		16,488		16,136		16,136		16,008		16,008
Swap derivative		275		275		405		405		313		313
Financial liabilities:
Deposits	$	1,145,235	$	1,145,558	$	1,090,981	$	1,091,355	$	1,117,529	$	1,117,840
Federal funds and overnight funds purchased		670		670		5,150		5,150		—		—
Federal Home Loan Bank borrowings		145,000		145,818		160,000		160,984		145,000		146,032
Junior subordinated debentures		8,248		2,365		8,248		2,265		8,248		2,235
Accrued interest payable		194		194		193		193		195		195

Cash and cash equivalents – The carrying amount approximates fair value.

Securities available-for-sale – Fair value is based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans – For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying values. Fair value of fixed rate loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable, and consider credit risk.

Federal Home Loan Bank stock – The carrying amount approximates fair value.

Interest receivable and payable – The carrying amounts of accrued interest receivable and payable approximate their fair value.

Bank-owned life insurance – The carrying amount is based on cash surrender value which approximates fair value.

Swap derivative – Fair value is based on quoted market prices.

Deposits – Fair value of demand, interest bearing demand and savings deposits is the amount payable on demand at the reporting date. Fair value of time deposits is estimated using the interest rates currently offered for deposits of similar remaining maturities. The Company uses an independent third-party to establish the fair value of time deposits.

Federal funds and overnight funds purchased – The carrying amount is a reasonable estimate of fair value because of the short-term nature of these borrowings.

Federal Home Loan Bank borrowings – Fair value of Federal Home Loan Bank borrowings is estimated by discounting future cash flows at rates currently available for debt with similar terms and remaining maturities.

35

Junior subordinated debentures – Fair value of junior subordinated debentures is estimated by discounting future cash flows at rates currently available for debt with similar credit risk, terms and remaining maturities.

Off-balance sheet financial instruments – The carrying amount and fair value are based on fees charged for similar commitments and are not material.

The Company also adheres to the FASB guidance with regards to ASC 820, “Fair Value Measures.” This guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The statement requires fair value measurement disclosure of all assets and liabilities that are carried at fair value on either a recurring or nonrecurring basis. The Company determines fair value based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available. The valuation techniques used are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:

• Level 1 – Quoted prices for identical instruments in active markets.

• Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active or model-derived valuations whose inputs are observable or whose significant value drivers are observable.

• Level 3 – Unobservable inputs are used to measure fair value to the extent that observable inputs are not available. The Company’s own data used to develop unobservable inputs is adjusted for market consideration when reasonably available.

Financial instruments, measured at fair value, are broken down in the tables below by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.

The following table presents information about the level in the fair value hierarchy for the Company’s assets and liabilities not measured and carried at fair value as of September 30, 2014, December 31, 2013, and September 30, 2013:

	Carrying Amount		Fair Value at September 30, 2014
			Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	24,512	$	24,512	$	—	$	—
Loans		1,034,849		—		—		1,019,916
Federal Home Loan Bank stock		10,125		10,125		—		—
Accrued interest receivable		4,759		4,759		—		—
Bank-owned life insurance		16,488		16,488		—		—
Financial liabilities:
Deposits	$	1,145,235	$	—	$	1,145,558	$	—
Federal funds and overnight funds purchased		670		670		—		—
Federal Home Loan Bank borrowings		145,000		—		145,818		—
Junior subordinated debentures		8,248		—		2,365		—
Accrued interest payable		194		194		—		—

36

	Carrying Amount		Fair Value at December 31, 2013
			Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	21,108	$	21,108	$	—	$	—
Loans		993,845		—		—		980,334
Federal Home Loan Bank stock		10,425		10,425		—		—
Accrued interest receivable		4,703		4,703		—		—
Bank-owned life insurance		16,136		16,136		—		—
Financial liabilities:
Deposits	$	1,090,981	$	—	$	1,091,355	$	—
Federal funds and overnight funds purchased		5,150		5,150		—		—
Federal Home Loan Bank borrowings		160,000		—		160,984		—
Junior subordinated debentures		8,248		—		2,265		—
Accrued interest payable		193		193		—		—

	Carrying Amount		Fair Value at September 30, 2013
			Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	42,609	$	42,609	$	—	$	—
Loans		977,718		—		—		967,188
Federal Home Loan Bank stock		10,523		10,523		—		—
Accrued interest receivable		4,608		4,608		—		—
Bank-owned life insurance		16,008		16,008		—		—
Financial liabilities:
Deposits	$	1,117,529	$	—	$	1,117,840	$	—
Federal funds and overnight funds purchased		—		—		—		—
Federal Home Loan Bank borrowings		145,000		—		146,032		—
Junior subordinated debentures		8,248		—		2,235		—
Accrued interest payable		4,423		4,423		—		—

37

The tables below show assets measured at fair value on a recurring basis as of September 30, 2014, December 31, 2013, and September 30, 2013:

	Carrying		Fair Value at September 30, 2014
September 30, 2014	Value		Level 1		Level 2		Level 3
Available-for-sale securities
Obligations of U.S. government agencies	$	38,948	$	—	$	38,948	$	—
Obligations of states and political subdivisions		82,988		—		82,988		—
Mortgage-backed securities		205,921		—		205,921		—
Private-label mortgage-backed securities		4,127		—		2,488		1,639
SBA variable rate pools		16,068		—		16,068		—
Swap derivative		275		—		275		—
Total assets measured on a recurring basis	$	348,327	$	—	$	346,688	$	1,639
	Carrying		Fair Value at December 31, 2013
December 31, 2013	Value		Level 1		Level 2		Level 3
Available-for-sale securities
Obligations of U.S. government agencies	$	30,847	$	—	$	30,847	$	—
Obligations of states and political subdivisions		78,795		—		78,795		—
Mortgage-backed securities		223,720		—		223,720		—
Private-label mortgage-backed securities		5,314		—		3,528		1,786
SBA variable rate pools		8,710		—		8,710		—
Swap derivative		405		—		405		—
Total assets measured on a recurring basis	$	347,791	$	—	$	346,005	$	1,786
			Fair Value at September 30, 2013
September 30, 2013	Value		Level 1		Level 2		Level 3
Available-for-sale securities
Obligations of U.S. government agencies	$	26,900	$	—	$	26,900	$	—
Obligations of states and political subdivisions		79,365		—		79,365		—
Mortgage-backed securities		235,085		—		235,085		—
Private-label mortgage-backed securities		6,156		—		4,624		1,532
Swap derivative		313		—		313		—
Total assets measured on a recurring basis	$	347,819	$	—	$	346,287	$	1,532

No transfers to or from Levels 1 and 2 occurred on assets measured at fair value on a recurring basis during the nine months ended September 30, 2014, and 2013, or during the year ended December 31, 2013.

38

The following is a description of the inputs and valuation methodologies used for assets recorded at fair value on a recurring basis. Fair value for all classes of available-for-sale securities is estimated by obtaining quoted market prices for identical assets, where available. If such prices are not available, fair value is based on independent asset pricing services and models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, prepayments, defaults, cumulative loss projections, and cash flows. Fair value of the swap derivative is determined by FTN Financial, and represents an active price quote which they would pay or the Bank would be charged to leave the swap early. There have been no significant changes in the valuation techniques during the periods reported.

The following table provides a reconciliation of assets measured at fair value on a recurring basis using unobservable inputs (Level 3) for the three and nine months ended September 30, 2014, and 2013:

	Three months ended						Nine months ended
	September 30,						September 30,
	2014			2013			2014			2013
Beginning balance	$	1,693		$	1,589		$	1,786		$	1,682
Transfers to Level 3		—			—			—			—
Transfers out of Level 3		—			—			—			—
Total gains or losses		—						—
Included in earnings		—			—			—			—
Included in other comprehensive income		(19	)		31			(30	)		98
Paydowns		(35	)		(88	)		(117	)		(248	)
Purchases, issuances, sales and settlements		—						—
Purchases		—			—			—			—
Issuances		—			—			—			—
Sales		—			—			—			—
Settlements		—			—			—			—
Ending balance	$	1,639		$	1,532		$	1,639		$	1,532

The Company utilizes FTN Financial as a third-party pricing service to estimate fair value on all of its available-for-sale securities. The inputs used to value all securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data, including market research, market indicators, and industry and economic trends. Additional inputs specific to each asset type are as follows:

• Obligations of U.S. government agencies – TRACE reported trades.

• Obligations of states and political subdivisions – MSRB reported trades, material event notices, and Municipal Market Data (MMD) benchmark yields.

• Private-label mortgage-backed securities – new issue data, monthly payment information, and collateral performance (whole loan collateral).

• Mortgage-backed securities – TBA prices and monthly payment information.

• SBA variable pools – TBA prices and monthly payment information.

Inputs may be prioritized differently on any given day for any security and not all inputs listed are available for use in the evaluation process on any given day for each security evaluation.

39

The valuation methodology used by asset type includes:

• Obligations of U.S. government agencies – security characteristics, defined sector break-down, benchmark yields, applied base spread, yield to maturity (bullet structures), corporate action adjustment, and evaluations based on T+3 settlement.

• Obligations of states and political subdivisions – security characteristics, benchmark yields, applied base spread, yield to worst or market convention, ratings updates, prepayment schedules (housing bonds), material event notice adjustments, and evaluations based on T+3 settlement.

• Private-label mortgage-backed securities – security characteristics, prepayment speeds, cash flows, TBA, Treasury and swap curves, IO/PO strips or floating indexes, applied base spread, spread adjustments, yield to worst or market convention, ratings updates (whole-loan collateral), and evaluations based on T+0 settlement.

• Mortgage-backed securities – security characteristics, TBA, Treasury, or floating index benchmarks, spread to TBA levels, prepayment speeds, applied spreads, and evaluations based on T+0 settlement.

• SBA variable pools – security characteristics, TBA, Treasury, or floating index benchmarks, spread to TBA levels, prepayment speeds, applied spreads, and evaluations based on T+0 settlement.

The third-party pricing service follows multiple review processes to assess the available market, credit and deal-level information to support its valuation estimates. If sufficient objectively verifiable information is not available to support a security’s valuation, an alternate independent evaluation source will be used.

The Company’s securities portfolio was valued through its independent third-party pricing service using evaluated pricing models and quoted prices based on market data. For further assurance, the Company’s estimate of fair value was compared to an additional independent third-party estimate at September 30, 2014, and the Company obtained key inputs for a sample of securities across sectors and evaluated those inputs for reasonableness. This analysis was performed at the individual security level and no material variances were noted.

There have been no significant changes in the valuation techniques during the periods reported.

40

The tables below show assets measured at fair value on a nonrecurring basis as of September 30, 2014, December 31, 2013, and September 30, 2013:

	Carrying		Fair Value
September 30, 2014	Value		Level 1		Level 2		Level 3
Loans measured for impairment (net of government guarantees and specific reserves)	$	3,254	$	—	$	—	$	3,254
Other real estate owned		13,177		—		—		13,177
Total	$	16,431	$	—	$	—	$	16,431
	Carrying		Fair Value
December 31, 2013	Value		Level 1		Level 2		Level 3
Loans measured for impairment (net of government guarantees and specific reserves)	$	5,749	$	—	$	—	$	5,749
Other real estate owned		16,355		—		—		16,355
Total	$	22,104	$	—	$	—	$	22,104
	Carrying		Fair Value
September 30, 2013	Value		Level 1		Level 2		Level 3
Loans measured for impairment (net of government guarantees and specific reserves)	$	6,948	$	—	$	—	$	6,948
Other real estate owned		16,602		—		—		16,602
Total	$	23,550	$	—	$	—	$	23,550

41

The following is a description of the inputs and valuation methodologies used for assets recorded at fair value on a nonrecurring basis.

Loans measured for impairment (net of government guarantees and specific reserves) include the estimated fair value of collateral-dependent loans, less collectible government guarantees, as well as certain noncollateral-dependent loans measured for impairment with an allocated specific reserve. When a collateral-dependent loan is identified as impaired, the value of the loan is measured using the current fair value of the collateral less selling costs. The fair value of collateral is generally estimated by obtaining external appraisals which are usually updated every 6 to 12 months based on the nature of the impaired loans. Certain noncollateral-dependent loans measured for impairment with an allocated specific reserve are valued based upon the estimated net realizable value of the loan. If the estimated fair value of the impaired loan, less collectible government guarantees, is less than the recorded investment in the loan, impairment is recognized as a charge-off through the allowance for loan losses. The carrying value of the loan is adjusted to the estimated fair value. The carrying value of loans fully charged off is zero.

Other real estate owned represents real estate which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically orders appraisals or performs valuations to ensure that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Appraisals are generally updated every 6 to 12 months on other real estate owned. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on other real estate owned for fair value adjustments based on the fair value of the real estate.

There have been no significant changes in the valuation techniques during the periods reported.

NOTE 9 – DERIVATIVE INSTRUMENTS

Derivative instruments are entered into primarily as a risk management tool of the Company to help manage its interest rate risk position. Financial derivatives are recorded at fair value as other assets and other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability are recognized currently in earnings. For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, are recorded in accumulated other comprehensive income and subsequently reclassified to earnings as the hedged transaction impacts net income. Any ineffective portion of a cash flow hedge is recognized currently in earnings.

During the second quarter 2013, the Company entered into an interest rate swap agreement with an $8,000 notional amount to convert its variable-rate Junior Subordinated Debenture debt into a fixed rate for a term of seven years at a rate of 2.73%. The derivative is designated as a cash flow hedge. The hedge meets the definition of highly effective and the Company expects the hedge to be highly effective throughout the remaining term of the swap. The fair value of the derivative instrument at September 30, 2014, was a $275 unrealized gain, which is recorded in the other asset section of the consolidated balance sheet, net of the tax effect. No gain or loss was recognized in earnings for the nine months ended September 30, 2014, related to interest rate swaps.

The Company maintains written documentation for the hedge. This documentation identifies the hedging objective and strategy, the hedging instrument, the instrument being hedged, the reasoning behind the assertion that the hedge is highly effective and the methodology for measuring ongoing hedge effectiveness and ineffectiveness. The Company pledged $400 under collateral arrangements to satisfy collateral requirements associated with the interest rate swap contract.

42

NOTE 10 – REGULATORY MATTERS

The Company and the Bank are subject to the regulations of certain federal and state agencies and receive periodic examinations by those regulatory authorities. In addition, they are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to leverage assets. Management believes that, as of September 30, 2014, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of September 30, 2014, and according to Federal Reserve and FDIC guidelines, the Bank was considered to be well-capitalized. To be categorized as well-capitalized, the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table.

43

											To Be Well
											Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2014:
Total capital (to risk weighted assets)
Bank:	$	176,519		15.59	%	$	90,593		8.00	%	$	113,241		10.00	%
Company:	$	177,718		15.69	%		NA					NA
Tier I capital (to risk weighted assets)
Bank:	$	162,342		14.34	%	$	45,297		4.00	%	$	67,945		6.00	%
Company:	$	163,541		14.44	%		NA					NA
Tier I capital (to leverage assets)
Bank:	$	162,342		11.12	%	$	58,385		4.00	%	$	72,981		5.00	%
Company:	$	163,541		11.20	%		NA					NA
As of December 31, 2013:
Total capital (to risk weighted assets)
Bank:	$	174,311		15.89	%	$	87,744		8.00	%	$	109,680		10.00	%
Company:	$	177,209		16.15	%		NA					NA
Tier I capital (to risk weighted assets)
Bank:	$	160,572		14.64	%	$	43,872		4.00	%	$	65,808		6.00	%
Company:	$	163,470		14.90	%		NA					NA
Tier I capital (to leverage assets)
Bank:	$	160,572		11.29	%	$	56,887		4.00	%	$	71,109		5.00	%
Company:	$	163,470		11.49	%		NA					NA
As of September 30, 2013:
Total capital (to risk weighted assets)
Bank:	$	174,025		16.16	%	$	86,172		8.00	%	$	107,715		10.00	%
Company:	$	176,929		16.42	%		NA					NA
Tier I capital (to risk weighted assets)
Bank:	$	160,517		14.90	%	$	43,086		4.00	%	$	64,629		6.00	%
Company:	$	163,421		15.16	%		NA					NA
Tier I capital (to leverage assets)
Bank:	$	160,517		11.36	%	$	56,520		4.00	%	$	70,650		5.00	%
Company:	$	163,421		11.56	%		NA					NA

44

ITEM 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition than can be obtained from reading the Consolidated Financial Statements alone. The discussion should be read in conjunction with the consolidated financial statements and the notes included in this report. Please refer also to our Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in the Company’s 2013 Form 10-K. All dollar amounts, except share and 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. These forward-looking statements include, but are not limited to, statements regarding projected results for fourth quarter 2014 and full year 2014, the expected interest rate environment and its impact on our business, loan yields and expected prepayments, net interest margin, expectations regarding nonperforming assets, loan growth, earning asset mix, expected cash flows from the securities portfolio, expectations regarding the Company’s securities portfolio and the sale of securities, their value and yields, core deposits and cost, capital levels, liquidity and dividends, expectations regarding certain large depositor relationships, the outcome of legal proceedings, the 2014 provision for loan losses, management’s plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations in the forward-looking statements, including those set forth in this report, and our other reports filed with the SEC:

• Local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets.

• The local housing or real estate market could decline.

• The risks presented by an economic recession, which could adversely affect credit quality, collateral values, including real estate collateral, investment values, liquidity and loan originations, and loan portfolio delinquency rates.

• Our concentration in loans to dental professionals exposes us to the risks affecting dental practices in general.

• Interest rate changes could significantly reduce net interest income and negatively affect funding sources.

• Projected business increases following any future strategic expansion or opening of new branches could be lower than expected.

• Competition among financial institutions could increase significantly.

• The goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings and capital.

• The reputation of the financial services industry could deteriorate, which could adversely affect our ability to access markets for funding and to acquire and retain customers.

• The efficiencies we may expect to receive from any investments in personnel, acquisitions, and infrastructure may not be realized.

• The level of nonperforming assets and charge-offs or changes in the estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements may increase.

• Changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, executive compensation, and insurance) could have a material adverse effect on our business, financial condition and results of operations.

• Acts of war or terrorism, or natural disasters, such as the effects of pandemic flu, may adversely impact our business.

• The timely development and acceptance of new banking products and services and perceived overall value of these products and services by users may adversely impact our ability to increase market share and control expenses.

• Changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters, may impact the results of our operations.

45

• The costs and effects of legal, regulatory and compliance developments, including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews, may adversely impact our ability to increase market share and control expenses, or may result in substantial uninsured liabilities, which could adversely affect our business, prospects, results of operations and financial condition.

• Our success at managing the risks involved in the foregoing items will have a significant impact on our results of operations and future prospects.

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Part I, Item 1A “Risk Factors” in the Company’s 2013 Form 10-K and Part II, Item 1A, “Risk Factors” in this report and elsewhere in this report or in our other reports with the SEC, include risks and uncertainties described or referred to in Part I, Item 1 “Business” under the captions “Competition” and “Supervision and Regulation” in the Company’s 2013 Form 10-K and Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. Please take into account that forward-looking statements speak only as of the date of this report or documents incorporated by reference. The Company does not undertake any obligation to publicly correct or update any forward-looking statement whether as a result of new information, future events or otherwise.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

We follow accounting standards set by the Financial Accounting Standards Board, commonly referred to as the “FASB.” The FASB sets generally accepted accounting principles (“GAAP”) that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in this report are to the “FASB Accounting Standards Codification,” sometimes referred to as the “Codification” or “ASC.”

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 theNotes to Consolidated Financial Statements in the Company’s 2013 Form 10-K. Management believes that the following policies and those disclosed in theNotes to Consolidated Financial Statements in the Company’s 2013 Form 10-K should be considered critical under the SEC definition:

Nonaccrual Loans

Accrual of interest is discontinued on contractually delinquent loans when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal or interest is doubtful. At a minimum, loans that are past due as to maturity or payment of principal or interest by 90 days or more are placed on nonaccrual status, unless such loans are well-secured and in the process of collection. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized.

Allowance for Loan Losses and Reserve for Unfunded Commitments

The allowance for loan losses on 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 an amount 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 reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

46

Troubled Debt Restructurings

In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties. Additional information regarding the Company’s TDRs can be found in Note 3 of theNotes to Consolidated Financial Statements in Item 1 of Part I of this report.

Goodwill and Intangible Assets

At September 30, 2014, the Company had $23,525 in goodwill and other intangible assets. In accordance with financial accounting standards, assets with indefinite lives are no longer amortized, but instead are periodically tested for impairment. Management performs an impairment analysis of its goodwill and intangible assets with indefinite lives at least annually and has determined that there was no impairment as of December 31, 2013, the date the most recent analysis was performed.

Share-based Compensation

In accordance with FASB ASC 718, Stock Compensation, we recognize expense in the income statement for the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period). The requisite service period may be subject to performance conditions. The fair value of each grant is estimated as of the grant date using the Black-Scholes option-pricing model. Management assumptions utilized at the time of grant impact the fair value of the option calculated under the Black-Scholes methodology, and ultimately, the expense that will be recognized over the expected service period. Additional information is included in Note 1 of theNotes to Consolidated Financial Statements.

Fair Value Measurements

GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820, “Fair Value Measurements,” establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources while unobservable inputs reflect our estimates about market data. In general, fair values determined by Level 1 inputs utilize quoted prices for identical assets or liabilities traded in active markets that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Additional information regarding the Company’s fair value measurements can be found in Note 8 of theNotes to Consolidated Financial Statements in Item 1 of Part I of this report.

Recent Accounting Pronouncements

In January 2014, the FASB issued ASU No. 2014-01,Accounting for Investments in Qualified Affordable Housing Projects.ASU 2014-01 permits an entity to make an accounting policy election to account for its investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014, and should be applied prospectively. The Company is currently reviewing the requirements of ASU No. 2014-01, but does not expect it to have a material impact on the Company’s consolidated financial statements.

47

In January 2014, the FASB issued ASU No. 2014-04,Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. ASU 2014-04 clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014, and can be applied with a modified retrospective transition method or prospectively. The adoption of ASU No. 2014-04 is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-11,Transfers and Servicing Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.ASU 2014-11 improves the financial reporting of repurchase agreements and other similar transactions by introducing two accounting changes: (1) repurchase-to-maturity transactions will be accounted for as secured borrowing transactions on the balance sheet; previously, they were accounted for as sales when certain conditions were met, and (2) for repurchase financing arrangements, an entity will account separately for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. It also requires enhanced disclosures about repurchase agreements and other similar transactions. The adoption of ASU No. 2014-11 is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12,Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.ASU 2014-12 was issued to clarify that a performance target in a share-based payment that affects vesting and that could be achieved after the requisite service period should be accounted for as a performance condition under Accounting Standards Codification (ASC) 718,Compensation — Stock Compensation. As a result, the target is not reflected in the estimation of the award’s grant date fair value. Compensation cost would be recognized over the required service period, if it is probable that the performance condition will be achieved. The adoption of ASU No. 2014-12 is not expected to have a material impact on the Company’s consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-14,Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. ASU 2014-14 requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The adoption of ASU No. 2014-14, is not expected to have a material impact on the Company’s consolidated financial statements.

48

FINANCIAL HIGHLIGHTS

	For the three months ended									For the nine months ended
	September 30,									September 30,
	2014			2013			% Change			2014			2013			% Change
Net income	$	4,431		$	3,940			12.46	%	$	12,411		$	10,115			22.70	%
Operating revenue(1)	$	15,769		$	16,305			-3.29	%	$	46,750		$	46,015			1.60	%
Earnings per share
Basic	$	0.25		$	0.22			13.64	%	$	0.70		$	0.57			22.81	%
Diluted	$	0.25		$	0.22			13.64	%	$	0.69		$	0.56			23.21	%
Assets, period-end	$	1,489,719		$	1,454,878			2.39	%
Gross loans, period-end	$	1,035,875		$	978,673			5.84	%
Core deposits, period end(2)	$	1,047,211		$	1,015,651			3.11	%
Deposits, period-end	$	1,145,235		$	1,117,529			2.48	%
Return on average assets(3)		1.18	%		1.09	%					1.13	%		0.95	%
Return on average equity(3)		9.69	%		8.77	%					9.16	%		7.46	%
Return on average tangible equity(3) (4)		11.13	%		10.12	%					10.53	%		8.58	%

⁽¹⁾  Operating revenue is defined as net interest income plus noninterest income.

⁽²⁾  Defined by the Company as demand, interest checking, money market, savings, and local nonpublic time deposits, including local nonpublic time deposits in excess of $100.

⁽³⁾  Amounts annualized.

⁽⁴⁾  Tangible equity excludes goodwill and core deposit intangibles related to acquisitions.

The Company earned $4,431 or $0.25 per diluted share in third quarter 2014, up $491 or 12.46% over third quarter 2013. The improvement in net income was primarily due to lower noninterest expense. Noninterest expense in third quarter 2014 was down $1,257 or 12.08% from third quarter 2013 primarily due to lower professional and legal fees and other real estate expense. During the third quarter 2014, the Company recovered $300 in legal fees that had been expensed in prior quarters, which resulted in an increase of $0.01 per diluted share in the quarter. The reduction in other real estate expense was due to significant valuation write downs recorded during the third quarter 2013. There were no valuation write downs in third quarter 2014. For the sixth consecutive quarter, the Company booked no provision for loan losses reflecting improvement in the credit quality of the loan portfolio.

During third quarter 2014, the Company continued to experience organic growth in outstanding loans. Outstanding loans at September 30, 2014, were $1,035,875 up $4,746 over June 30, 2014, outstanding loans. For the first nine months of the year, outstanding loans were up $41,106 over year-end December 31, 2013, which represents an annualized growth rate of 5.52%. Loan growth during the first nine months of 2014 was primarily in the permanent real estate and commercial and industrial loan categories.

Core deposit growth accelerated during the third quarter 2014, reflecting a typical seasonal pattern. Outstanding core deposits at September 30, 2014, were $1,047,211, up $20,669 over June 30, 2014. For the first nine months of 2014, outstanding core deposits increased by $56,896 or 5.75% over December 31, 2013.

Year-to-date September 30, 2014, net income was $12,411, an improvement of $2,296 or 22.70% over the same period last year. The improvement was primarily due to increased operating revenues (net interest income plus noninterest income) combined with lower expenses. Results for the year ended 2013 included $1,246 of merger expenses related to the Century Bank acquisition.

On May 6, 2014, the Company’s Board of Directors authorized the repurchase of up to 5% of the Company’s outstanding shares, or 892,500 shares, with the purchases to take place over a 12-month period. During the third quarter 2014, the Company repurchased 132,358 shares at a weighted average price of $13.60 per share. Since the inception of the share repurchase plan, the Company has repurchased 267,080 shares at a weighted average price of $13.48 per share.

49

Reconciliation of non-GAAP financial information

Management utilizes certain non-GAAP financial measures to monitor the Company’s performance. While we believe the presentation of non-GAAP financial measures provides additional insight into our operating performance, readers of this report are urged to review the GAAP results as presented in theFinancial Statementsin Item 1 of Part I of this report.

The Company presents a computation of tangible equity along with tangible book value and return on average tangible equity. The Company defines tangible equity as total shareholders’ equity before goodwill and core deposit intangible assets. Tangible book value is calculated as tangible equity divided by total shares outstanding. Return on average tangible equity is calculated as net income divided by average tangible equity. We believe that tangible equity and certain tangible equity ratios are meaningful measures of capital adequacy which may be used when making period-to-period and company-to-company comparisons. Tangible equity and tangible equity ratios are considered to be non-GAAP financial measures and should be viewed in conjunction with total shareholders’ equity, book value and return on average equity. The following table presents a reconciliation of total shareholders’ equity to tangible equity.

	September 30,			December 31,			September 30,
	2014			2013			2013
Total shareholders’ equity	$	182,538		$	179,184		$	179,678
Subtract:
Goodwill		(22,881	)		(22,881	)		(22,945	)
Core deposit intangible assets		(644	)		(735	)		(765	)
Tangible shareholders’ equity (non-GAAP)	$	159,013		$	155,568		$	155,968
Book value per share	$	10.30		$	10.01		$	10.40
Tangible book value per share (non-GAAP)	$	8.98		$	8.69		$	8.72
Year-to-date return on average equity		9.16	%		7.61	%		7.46	%
Year-to-date return on average tangible equity (non-GAAP)		10.53	%		8.75	%		8.58	%

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of a company, they have limitations as analytical tools, and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.

50

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 earning assets, principally loans, and interest expense associated with interest-bearing liabilities, principally deposits. The volume and mix of earning assets and funding sources, market rates of interest, demand for loans, and the availability of deposits affect net interest income.

Net interest margin as a percentage of average earning assets for third quarter 2014 was 4.28%, a decline of 6 basis points from the prior quarter and down 29 basis points from third quarter 2013. The linked-quarter decline in the net interest margin was due to a decrease of 6 basis points in the yield on earning assets resulting from lower loan and security portfolio yields. In addition, the cost of wholesale funding was up 9 basis points in third quarter 2014 over the prior quarter due to brokered deposits called during the quarter resulting in write off of remaining broker discount. The decline in year-over-year net interest margin of 29 basis points was primarily due to nonrecurring items, including interest recoveries, prepayment penalties, and accretion, which added 35 basis points to the third quarter 2013 net interest margin. However, when accretion of fair value marks and nonrecurring items are removed, the third quarter 2014 net interest margin was relatively stable with the previous three quarters. Below is a summary of the core net interest margin, which excludes nonrecurring items and accretion of fair value marks, for the last five quarters. This summary presents a reconciliation of the net interest margin to adjusted net interest margin for the period:

	Adjusted Net Interest Margin
	Q3 2013			Q4 2013			Q1 2014			Q2 2014			Q3 2014
QTD net interest margin		4.57	%		4.38	%		4.32	%		4.34	%		4.28	%
Century accretion adjustment		-0.05	%		-0.04	%		-0.07	%		-0.03	%		-0.03	%
Additional interest income adjustment		-0.30	%		-0.07	%		0.00	%		-0.04	%		-0.03	%
Adjusted QTD net interest margin (non-GAAP)		4.22	%		4.27	%		4.25	%		4.27	%		4.22	%

51

The following table presents condensed balance sheet information, together with interest income and yields on average interest earning assets, and interest expense and rates on interest-bearing liabilities, for the quarter ended September 30, 2014, compared to the quarter ended September 30, 2013:

Table I

Average Balance Analysis of Net Interest Income

(dollars in thousands)

	Three months ended								Three months ended
	September 30, 2014								September 30, 2013
	Average Balance		Interest Income or (Expense)			Average Yields or Rates			Average Balance		Interest Income or (Expense)			Average Yields or Rates
Interest earning assets
Federal funds sold and interest-bearing deposits	$	4,606	$	3			0.26	%	$	3,614	$	2			0.22	%
Securities available-for-sale:
Taxable		274,299		1,547			2.24	%		283,700		1,489			2.08	%
Tax-exempt(1)		72,790		769			4.19	%		67,745		751			4.40	%
Loans, net of deferred fees and allowance(2)		1,023,266		13,703			5.31	%		958,372		14,028			5.81	%
Total interest-earning assets(1)		1,374,961		16,022			4.62	%		1,313,431		16,270			4.91	%
Non earning assets
Cash and due from banks		18,376								17,866
Property and equipment		18,181								19,252
Goodwill & intangible assets		23,541								23,726
Interest receivable and other assets		53,688								60,982
Total nonearning assets		113,786								121,826
Total assets	$	1,488,747							$	1,435,257
Interest-bearing liabilities
Money market and NOW accounts	$	533,322	($	360	)		-0.27	%	$	513,059	$	(382	)		-0.30	%
Savings deposits		51,815		(16	)		-0.12	%		42,677		(13	)		-0.12	%
Time deposits—core (3)		60,462		(78	)		-0.51	%		70,059		(120	)		-0.68	%
Total interest-bearing core deposits		645,599		(454	)		-0.28	%		625,795		(515	)		-0.33	%
Time deposits—noncore		104,560		(389	)		-1.48	%		105,408		(286	)		-1.08	%
Federal funds purchased		1,768		(3	)		-0.67	%		4,355		(5	)		-0.46	%
FHLB & FRB borrowings		148,402		(278	)		-0.74	%		162,370		(292	)		-0.71	%
Junior subordinated debenture		8,248		(57	)		-2.74	%		8,248		(51	)		-2.45	%
Total interest-bearing wholesale funding		262,978		(727	)		-1.10	%		280,381		(634	)		-0.90	%
Total interest-bearing liabilities		908,577		(1,181	)		-0.52	%		906,176		(1,149	)		-0.50	%
Noninterest-bearing liabilities
Demand deposits		391,738								346,692
Interest payable and other		6,975								4,144
Total noninterest liabilities		398,713								350,836
Total liabilities		1,307,290								1,257,012
Shareholders’ equity		181,457								178,245
Total liabilities and shareholders’ equity	$	1,488,747							$	1,435,257
Net interest income			$	14,841							$	15,121
Net interest margin(1)				4.28	%							4.57	%

⁽¹⁾  Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $269 and $263 for the three months ended September 30, 2014, and September 30, 2013, respectively.

Net interest margin was positively impacted by 8 basis points for the three months ended

⁽²⁾ Interest income includes recognized loan origination fees of $157 and $84 for the three months ended September 30, 2014, and September 30, 2013, respectively.

⁽³⁾ Defined by the Company as interest checking, money market, savings and local non- public time deposits, including local non-public time deposits in excess of $100.

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Table I shows that earning asset yields in third quarter 2014 were 4.62%, down 29 basis points from the 4.91% recorded in third quarter 2013. However, third quarter 2013 results included $982 of interest recoveries, which added 30 basis points to earning asset yields. Excluding the interest recoveries in last year’s results, earning asset yields in third quarter 2014 were virtually unchanged from third quarter 2013. The stable earning asset yields (excluding nonrecurring items) was primarily due to higher yield on the taxable portion of the securities portfolio combined with changes in the mix of earning assets as higher yielding loans made up a greater portion of earning assets in third quarter 2014 when compared to third quarter 2013.

The cost of interest-bearing liabilities increased by 2 basis points from 0.50% in third quarter 2013 to 0.52% in third quarter 2014. The rate on interest-bearing core deposits declined by 5 basis points and was more than offset by an increase of 20 basis points in the cost of interest-bearing wholesale funding. The decrease in the cost of core deposits was primarily due to lower rates on money market accounts and core time deposits. Core time deposits showed the most significant decline, moving from 0.68% in third quarter 2013 to 0.51% in third quarter 2014. The higher cost of wholesale funding was primarily due to an increase on the rate of non-core time deposits of 40 basis points from 1.08% in the third quarter 2013 to 1.48% in the third quarter 2014. This category of wholesale funding consists primarily of long-term callable brokered time deposits. During the third quarter 2014, the Company called $10,500 in brokered CD’s with a weighted average rate of 1.86%, and refinanced them at lower rates, which will benefit the net interest margin in future quarters. However, the call of these CD’s required the write down of the remaining broker discount of $32 during the third quarter 2014.

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The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the three months ended September 30, 2014, compared to September 30, 2013.

Table II

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

	Three months ended
	September 30, 2014
	compared to September 30, 2013
	Increase (decrease) due to
	Volume			Rate			Net
Interest earned on:
Federal funds sold and interest-bearing deposits	$	1		$	—		$	1
Securities available-for-sale:
Taxable		(49	)		107			58
Tax-exempt(1)		55			(37	)		18
Loans, net of deferred fees and allowance		950			(1,275	)		(325	)
Total interest-earning assets(1)		957			(1,205	)		(248	)
Interest paid on:
Money market and NOW accounts		15			(37	)		(22	)
Savings deposits		3			—			3
Time deposits - core(2)		(16	)		(26	)		(42	)
Total interest-bearing core deposits		2			(63	)		(61	)
Time deposits - noncore		(2	)		105			103
Federal funds purchased		(3	)		1			(2	)
FHLB & FRB borrowings		(25	)		11			(14	)
Junior subordinated debenture		—			6			6
Total interest-bearing wholesale funding		(30	)		123			93
Total interest-bearing liabilities		(28	)		60			32
Net interest income(1)	$	985		$	(1,265	)	$	(280	)

(1) Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $269 and $263 for the three months ended September 30, 2014 and September 30, 2013, respectively.

(2) Interest income includes recognized loan origination fees of $157 and $84 for the three months ended September 30, 2014, and September 30, 2013, respectively.

The third quarter 2014 rate/volume analysis shows that net interest income declined by $280 over third quarter 2013. The decline in interest income was due to $982 of nonrecurring interest recoveries recorded in third quarter 2013. Excluding the interest recoveries, interest income for third quarter 2014 was up $702 over third quarter 2013. Also contributing to the decline in net interest income was an increase in interest expense of $32 in third quarter 2014 when compared to the same quarter last year. The increase in interest expense was related to higher rates on wholesale funding, primarily centered in non-core time deposits and was directly related to the $32 in broker discount written off during the quarter on called time deposits.

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The following table presents the condensed average balance sheet information, together with taxable equivalent interest income and yields on average interest-earning assets, and interest expense and rates paid on average interest-bearing liabilities for the nine months ended September 30, 2014, compared to the same period in the prior year:

Table III

Average Balance Analysis of Net Interest Income

(dollars in thousands)

	Nine months ended								Nine months ended
	September 30, 2014								September 30, 2013
			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	$	3,591	$	7			0.26	%	$	3,478	$	7			0.27	%
Securities available-for-sale:
Taxable		276,119		4,693			2.27	%		301,931		4,164			1.84	%
Tax-exempt(1)		70,778		2,263			4.27	%		69,337		2,200			4.24	%
Loans, net of deferred fees and allowance(2)		1,009,217		40,391			5.35	%		933,112		39,793			5.70	%
Total interest earning assets(1)		1,359,705		47,354			4.66	%		1,307,858		46,164			4.72	%
Non earning assets
Cash and due from banks		18,262								18,606
Property and equipment		18,464								19,308
Goodwill & intangible assets		23,571								23,540
Interest receivable and other assets		54,537								59,357
Total non earning assets		114,834								120,811
Total assets	$	1,474,539							$	1,428,669
Interest-bearing liabilities
Money market and NOW accounts	$	535,581	$	(1,104	)		-0.28	%	$	519,534	$	(1,197	)		-0.31	%
Savings deposits		49,696		(49	)		-0.13	%		40,679		(37	)		-0.12	%
Time deposits - core (3)		61,798		(255	)		-0.55	%		73,126		(410	)		-0.75	%
Total interest-bearing core deposits		647,075		(1,408	)		-0.29	%		633,339		(1,644	)		-0.35	%
Time deposits - non-core		103,749		(1,061	)		-1.37	%		108,363		(943	)		-1.16	%
Federal funds purchased		2,399		(12	)		-0.67	%		3,270		(12	)		-0.49	%
FHLB & FRB borrowings		159,664		(838	)		-0.70	%		162,699		(905	)		-0.74	%
Junior subordinated debenture		8,248		(169	)		-2.74	%		8,248		(139	)		-2.25	%
Total interest-bearing wholesale funding		274,060		(2,080	)		-1.01	%		282,580		(1,999	)		-0.95	%
Total interest-bearing liabilities		921,135		(3,488	)		-0.51	%		915,919		(3,643	)		-0.53	%
Noninterest-bearing liabilities
Demand deposits		366,607								327,643
Interest payable and other		5,605								3,910
Total noninterest liabilities		372,212								331,553
Total liabilities		1,293,347								1,247,472
Shareholders’ equity		181,192								181,197
Total liabilities and shareholders’ equity	$	1,474,539							$	1,428,669
Net interest income			$	43,866							$	42,521
Net interest margin(1)				4.31	%							4.35	%

⁽¹⁾  Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $792 and $770 for the nine months ended September 30, 2014, and 2013, respectively. Net interest margin was positively impacted by 7 and 8 basis points, respectively for the nine months ended September 30, 2014 and 2013, respectively.

⁽²⁾  Interest income includes recognized loan origination fees of $424 and $361 for the nine months ended September 30, 2014, and 2013, respectively.

⁽³⁾  Defined by the Company as interest checking, money market, savings and local non-public time deposits, including local non-public time deposits in excess of $100.

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The net interest margin for the nine months ended September 30, 2014, was 4.31%, a decrease of 4 basis points from the 4.35% net interest margin for the same period in 2013. Table III shows that earning asset yields dropped 6 basis points to 4.66% for the first nine months of 2014, when compared to 4.72% for the same period in 2013. The decline in earning asset yields was due to a 35 basis point drop in the yield on loans. However, nonrecurring interest recoveries of $982 included in 2013 results increased earning asset yields by 10 basis points. Excluding the nonrecurring items in 2013, earning asset yields improved by 4 basis points due to higher yields on the Company’s taxable securities portfolio, which increased 40 basis points for the nine months ended September 30, 2014, when compared to the same period last year. The improvement in the yield on the taxable securities portfolio was the result of slower prepayment speeds on mortgage-backed securities which reduced the amortization of premium, increasing the yield on this portion of the securities portfolio.

Table III also shows that the overall cost of interest-bearing liabilities were down 2 basis points from 0.53 % at September 30, 2013, to 0.51% at September 30, 2014. The cost of interest-bearing core deposits fell by 6 basis points in the same periods from 0.35% to 0.29% with the most significant decline coming in the core time deposit category. The cost of interest-bearing wholesale funding for the nine months ended September 30, 2014, was up 6 basis points over the prior year same period with the increase centered in non-core time deposits, where the write down of brokered discount on called CD’s increased the rate from 1.16% for the nine months ended September 30, 2013, to 1.37% for the same period this year.

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The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the nine months ended September 30, 2014, compared to the same period in the prior year.

Table IV

Analysis of Changes in Interest Income and Interest Expense

(dollars in thousands)

	Nine months ended September 30, 2014
	Compared to nine months ended September 30, 2013
	Increase (decrease) due to
	Volume			Rate			Net
Interest earned on:
Federal funds sold and interest-bearing deposits	$	—		$	—			—
Securities available-for-sale:
Taxable		(356	)		885			529
Tax-exempt(1)		46			19			65
Loans, net of deferred fees and allowance		3,246			(2,650	)		596
Total interest earning assets(1)		2,936			(1,746	)		1,190
Interest paid on:
Money market and NOW accounts		37			(130	)		(93	)
Savings deposits		8			4			12
Time deposits - core(2)		(64	)		(91	)		(155	)
Total interest-bearing core deposits		(19	)		(217	)		(236	)
Time deposits - non-core		(40	)		158			118
Federal funds purchased		(3	)		3			—
FHLB & FRB borrowings		(17	)		(50	)		(67	)
Junior subordinated debenture		—			30			30
Total interest-bearing wholesale funding		(60	)		141			81
Total interest-bearing liabilities		(79	)		(76	)		(155	)
Net interest income(1)	$	3,015		$	(1,670	)	$	1,345

(1) Tax-exempt income has been adjusted to a tax-equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $792 and $770 for the nine months ended September 30, 2014 and 2013, respectively. Net interest margin was positively impacted by 7 and 8 basis points for the nine months ended September 30, 2014 and 2013, respectively.

(2) Interest income includes recognized loan origination fees of $424 and $361 for the nine months ended September 30, 2014 and 2013, respectively.

The rate/volume analysis for the nine months ended September 30, 2014, in Table IV, shows that interest income including loan fees increased by $1,190 over the same period in 2013. The increase in interest income due to higher volumes of earning assets was $2,936 and was all centered in loans. The increase in interest income due to higher volumes was partially offset by a decline in interest income of $1,746 due to lower rates on earning assets. The decline in interest income due to lower rates on loans of $2,650 was partially offset by an increase in interest income of $904 due to improved yields on the securities portfolio. The rate/volume analysis shows that interest expense for the nine months ended September 30, 2014, decreased by $155 from the same period last year. Overall, lower rates on both interest-bearing core deposits and wholesale funding caused a $76 drop in interest expense, while a change in the volume mix of interest-bearing liabilities lowered interest expense by $79 for the nine months ended September 30, 2014.

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Loan Loss Provision and Allowance

Below is a summary of the Company’s allowance for loan losses for the three-month and nine-month periods ended September 30, 2014, and 2013:

	Three months ended						Nine months ended
	September 30,						September 30,
	2014			2013			2014			2013
Balance, beginning of period	$	15,675		$	16,303		$	15,917		$	16,346
Provision charged to income		—			—			—			250
Loans charged against allowance		(23	)		(221	)		(654	)		(1,049	)
Recoveries credited to allowance		70			720			459			1,255
Balance, end of period	$	15,722		$	16,802		$	15,722		$	16,802

The Company booked no provision for loan losses for the nine months ended September 30,2014, compared to a provision for loan losses of $250 for the same period last year. The Company has now booked no provision for loan losses for six consecutive quarters. The decrease in the provision was primarily the result of a reduction in the level of classified loans and nonperforming assets. The Company’s classified assets at September 30, 2014, were 24.27% of regulatory capital compared to 29.02% and 30.25% of regulatory capital at December 31, 2013, and September 30, 2013, respectively. Net loan charge offs through September 30, 2014, were $195 or annualized 0.03% of average loans, compared to net loan recoveries of $206 or -0.03% of average loans recorded for the same period in 2013. During the third quarter 2014, the Company recorded net recoveries of $47. The allowance for loan losses for outstanding loans at September 30, 2014, was $15,722 or 1.52% of outstanding loans compared to 1.60% and 1.72% of outstanding loans at December 31, 2013, and September 30, 2013, respectively. The decline in the allowance as a percentage of outstanding loans was also reflective of improved credit quality of the loan portfolio. In addition, the allowance as a percentage of net nonperforming loans was 536.22% at September 30, 2014, compared to 345.42% and 325.94% at December 31, 2013, and September 30, 2013, respectively. The improvement in the allowance coverage ratio over nonperforming loans was due to reductions in nonaccrual loans during the period, combined with a relatively stable allowance for loan losses.

At September 30, 2014, $7,837 of loans (net of government guarantees) were classified as impaired. A specific allowance of $141 (included in the ending allowance at September 30, 2014) was assigned to these loans. That compares to impaired loans of $8,476 and a specific allowance assigned of $57 at December 31, 2013.

Total nonperforming assets, net of government guarantees, were $16,109, or 1.08% of total assets, at September 30, 2014, relatively unchanged from the prior quarter, but down from nonperforming assets of $20,963 or 1.45% of total assets at December 31, 2013, and $21,757 or 1.50% of total assets at September 30, 2013. During the third quarter 2014, the Company transferred a nonaccrual loan collateralized by commercial real estate and valued at approximately $1,200 into other real estate owned. No additional loan charge off was required at the time of the transfer. At September 30, 2014, nonperforming assets consisted of $2,932 in nonaccrual loans (net of government guarantees), no loans were 90 days past due and still accruing interest, and there was $13,177 of other real estate owned.

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The following table shows a summary of nonaccrual loans, loans past due 90 days or more, and other real estate owned for the periods covered in this report:

Nonperforming Assets and Asset Quality Ratios

	September 30,			December 31,			September 30,
	2014			2013			2013
NONPERFORMING ASSETS
Nonaccrual loans
Real estate loans
Multi-family residential	$	—		$	—		$	—
Residential 1-4 family		459			636			1,206
Owner-occupied commercial		787			1,685			2,235
Nonowner-occupied commercial		1,245			136			139
Total permanent real estate loans		2,491			2,457			3,580
Construction loans
Multi-family residential		—			—			—
Residential 1-4 family		—			—			—
Commercial real estate		—			—			—
Commercial bare land and acquisition & development		—			—			—
Residential bare land and acquisition & development		—			—			—
Total construction real estate loans		—			—			—
Total real estate loans		2,491			2,457			3,580
Commercial loans		762			2,886			2,361
Total nonaccrual loans		3,253			5,343			5,941
90-days past due and accruing interest		—			—			—
Total nonperforming loans		3,253			5,343			5,941
Nonperforming loans guaranteed by government		(321	)		(735	)		(786	)
Net nonperforming loans		2,932			4,608			5,155
Other real estate owned		13,177			16,355			16,602
Total nonperforming assets, net of guaranteed loans	$	16,109		$	20,963		$	21,757
ASSET QUALITY RATIOS
Allowance for loan losses as a percentage of total loans outstanding, net of loans held for sale		1.52	%		1.60	%		1.72	%
Allowance for loan losses as a percentage of total nonperforming loans, net of government guarantees		536.22	%		345.42	%		325.94	%
Net loan charge offs as a percentage of average loans, annualized		0.03	%		0.35	%		-0.03	%
Net nonperforming loans as a percentage of total loans		0.28	%		0.46	%		0.53	%
Nonperforming assets as a percentage of total assets		1.08	%		1.45	%		1.50	%
Consolidated classified asset ratio(1)		24.27	%		29.02	%		30.25	%

⁽¹⁾  Classified asset ratio is defined as the sum of all loan-related contingent liabilities and loans internally graded substandard or worse (net of government guarantees), adversely classified securities, and other real estate owned, divided by total consolidated Tier 1 capital plus the allowance for loan losses.

Nonperforming assets at September 30, 2014, declined $5,648 from the same period last year, and declined $4,854 from December 31, 2013. The majority of the decline in nonperforming assets from year-end and one year ago occurred in other real estate owned and resulted from the sale of a commercial property during the first nine months of 2014, carried in other real estate owned and valued at approximately $3,500. Other real estate owned at September 30, 2014, consisted of seven properties, with two properties, a commercial land development project valued at $10,040 and a commercial real estate

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property valued at $1,244, comprised 85.63% of the total other real estate owned category. The Company did receive an appraisal during the third quarter 2014 on the commercial land development property valued at $10,040, and no further valuation write-down was required. The Company is actively marketing this property; however the location and nature of the property make it susceptible to possible future valuation write-downs as new appraisals become available.

Noninterest Income

Year-to-date September 30, 2014, noninterest income was $3,676, down $588 or 13.79% from the same period last year. The decline in noninterest income in the first nine months of 2014 when compared to the same period last year was primarily due to merchant bankcard processing fees as this service was outsourced during fourth quarter 2013 and resulted in a $560 drop in merchant fees in the first nine months of 2014. This outsourcing also resulted in the near elimination of bankcard processing expense. Improved service charge revenue of $146 partially offset the decline in merchant fees. The improvement in service charge revenue was the result of implementing new account analysis charges effective January 1, 2014. During the second quarter 2014, a classified private-label mortgage backed security was sold at a loss of $97. The loss in the second quarter 2014 more than offset the gain on sale of securities of $63 recorded during first quarter 2014.

Noninterest Expense

Year-to-date September 30, 2014, noninterest expense was $27,930, a decrease of $2,757 or 8.98% from the same period last year. When merger expenses related to the Century acquisition of $1,246 are excluded from 2013 noninterest expense, noninterest expense through September 30, 2014, was down $1,511 or 5.13% from last year. A $1,507 or 9.22% increase in personnel expense through September 30, 2014, was offset by declines in legal and professional fees of $571, business development of $316, other real estate expense of $1,424, bankcard processing expense of $412, and the other expense category of $412. The decline in legal and professional fees was primarily due to the recovery of $300 of legal fees expensed in prior periods recorded during the third quarter 2014. The decline in business development costs reflects timing of marketing expenditures in 2014 when compared to the prior year. The significant decline in other real estate expense was the result of large valuation write-downs totaling approximately $1,100 recorded during 2013 on two commercial properties. No significant valuation write-downs have been recorded to date during 2014. The decline in the other expense category was primarily due to lower travel costs and non-recurring expense of $100 recorded in 2013.

At the June 2014 board meeting, the Company’s board of directors approved a deferred compensation plan. The initial plan is a qualified unfunded plan, which contains no employer defined contribution or benefit. This plan is open to Senior Vice Presidents and above, and the board of directors. Deferrals began during August 2014. Deferred compensation expense is not expected to be material in amount during 2014.

BALANCE SHEET

Loans

At September 30, 2014, outstanding loans were $1,035,875, up $41,106 from December 31, 2013, and up $57,202 from September 30, 2013. Loan growth during the first nine months of 2014 was primarily centered in real estate and commercial and industrial loans. A summary of outstanding loans by market at September 30, 2014, December 31, 2013, and September 30, 2013, follows:

	Period Ended
	September 30,		December 31,		September 30,
	2014		2013		2013
Eugene market gross loans, period-end	$	361,599	$	334,511	$	324,320
Portland market gross loans, period-end		389,977		391,295		390,014
Seattle market gross loans, period-end		132,827		132,488		136,178
National healthcare gross loans, period-end		151,472		136,475		128,161
Total gross loans, period-end	$	1,035,875	$	994,769	$	978,673

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Growth in outstanding loans during 2014 has been centered in the Eugene and National healthcare lending, while outstanding loans in the Portland and Seattle markets have remained relatively flat in this period. Loan production, both new and renewed loans, has been strong in all markets; however the Portland and Seattle markets experienced high levels of prepayments on its loan portfolio, thus stemming net loan growth in these markets. Net loan growth is expected to continue during the remainder of 2014 due to the addition of experienced market lenders and solid pipelines in all markets, combined with a resurgent regional economy.

Outstanding loans to dental professionals, which are comprised of both local and national loans, at September 30, 2014, totaled $307,088 or 29.65% of the loan portfolio, compared to $307,268 or 30.89% of the loan portfolio at December 31, 2013. While the Company’s national dental loans increased by $14,222 since December 31, 2013 and are now represented in 31 states, local dental loans contracted due to amortization of the existing portfolio, early pay offs and intense pricing competition during the same period. At September 30, 2014, $13,196 or 4.30% of the outstanding dental loans were supported by government guarantees. Loans to dental professionals include loans for such purposes as starting up a practice, acquisition of a practice, equipment financing, owner-occupied facilities, and working capital. National dental loans are limited only to acquisition of a seasoned practice by experienced dental professionals, practice refinances and owner-occupied real estate loans.

In addition to loan growth in the dental industry, growth was also experienced in the wider healthcare field with loans to physicians, veterinarians, optometrists, and medical specialists. The healthcare portfolio, other than dental, experienced growth during the quarter. This segment grew 11.49% over year-end 2013 to $68,972 as of September 30, 2014. The majority of the expansion was in veterinary lending in both practice acquisition and owner-occupied real estate financing.

Additional data on the Company’s dental loan portfolio and the credit quality of this portfolio can be found in Note 4 of theNotes to Consolidated Financial Statementsin this report.

All loans to related parties were made in the ordinary course of business and on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable loans with persons not related to the Company.

Detailed credit quality data on the entire loan portfolio can be found in Note 3 of theNotes to Consolidated Financial Statements in this report.

Securities

At September 30, 2014, the balance of securities available-for-sale was $348,052, up $666 over December 31, 2013. The increase in the securities portfolio during the year was entirely due to improvement in the unrealized gain on the portfolio at September 30, 2014, when compared to December 31, 2013. At September 30, 2014, the portfolio had an unrealized pre-tax gain of $5,414 compared to an unrealized pre-tax loss of $242, at December 31, 2013. The improvement in the unrealized gain or market value of the securities portfolio during the first nine months of 2014 was due to a decline in longer-term interest rates and tightening of spreads. The average life and duration of the portfolio at September 30, 2014, was 4.2 years and 3.8 years respectively, both relatively unchanged from December 31, 2013. At September 30, 2014, $27,309 of the securities portfolio were pledged as collateral for public deposits in Oregon and Washington and for repurchase agreements.

The Company continued to structure the portfolio to provide consistent cash flow and reduce the market value volatility of the portfolio in a rising rate environment in light of the Company’s current liability sensitive position. The portfolio is structured to generate sufficient cash flow to allow reinvestment at higher rates should interest rates move up or to fund loan growth in future periods. In a stable rate environment, approximately $47,000 in cash flow is anticipated over the next twelve months. Going forward, purchases will be dependent upon core deposit growth, loan growth, and the Company’s interest rate risk position.

At September 30, 2014, $4,127, or 1.19% of the total securities portfolio was composed of private-label mortgage-backed securities. In previous reporting periods management has booked OTTI on this portion of the portfolio totaling approximately $227. During the second quarter 2014, a classified private-label mortgage-backed security was sold at a loss of $97. The loss in the second quarter 2014 more than offset the gain on sale of securities of $63 recorded during first quarter 2014. It was determined that an OTTI was required on this security. After further analysis, it was also determined that future impairment was possible and additional losses could result in future additional impairment charges. The sale at the loss limited the potential future losses.

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Management reviews monthly all available information, including current and projected default rates and current and projected loss severities, related to the collectability of its potentially impaired investment securities to determine if an additional OTTI is required. No additional OTTI was recorded during the first nine months of 2014. Recognition of additional OTTI on the private-label mortgage-backed portion of the portfolio is possible in future quarters depending upon economic conditions, default rates on home mortgages, loss severities on foreclosed homes, unemployment levels, and home values.

In management’s opinion, the remaining securities in the portfolio in an unrealized loss position are considered only temporarily impaired. The Company has no intent, nor is it more likely than not that it will be required, to sell its impaired securities before their recovery. The impairment is due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal is expected.

Goodwill and Intangible Assets

At September 30, 2014, the Company had a recorded balance of $22,881 in goodwill from the November 30, 2005, acquisition of Northwest Business Financial Corporation (“NWBF”) and the February 1, 2013, acquisition of Century Bank. In addition, at September 30, 2014, the Company had $644 of core deposit intangible assets resulting from the acquisition of Century Bank. The core deposit intangible was determined to have an expected life of seven years, and is being amortized over that period using the straight-line method and will be fully amortized in January 2020. In accordance with GAAP, the Company does not amortize goodwill or other intangible assets with indefinite lives, but instead periodically tests these assets for impairment. Management performs an impairment analysis of the intangible assets with indefinite lives at least annually, but more frequently if an impairment triggering event is deemed to have occurred. The last impairment test was performed at December 31, 2013, at which time no impairment was determined to exist.

Deposits

Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and nonpublic local time deposits, including nonpublic local time deposits in excess of $100, were $1,047,211 and represented 91.44% of total deposits at September 30, 2014. Core deposits at September 30, 2014, were up $56,896 over December 31, 2013, with growth occurring during the latter part of second quarter 2014 and during third quarter 2014. At the end of the first quarter 2014, core deposits were virtually flat when compared with December 31, 2013. Slow or little growth early in the year followed by acceleration of core deposit growth during the last three quarters of the year is a typical seasonal pattern.

A key component of core deposits is noninterest-bearing demand deposits, which totaled $390,790 and represented 37.32% of core deposits at September 30, 2014. The weighted average cost of funds, when factoring in non-interest bearing core deposits, for the nine months ended September 30, 2014, was 0.19%.

A summary of outstanding core deposits and average core deposits by market and other deposits classified as wholesale funding at September 30, 2014, December 31, 2013, and September 30, 2013, follows:

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	Period ended
	September 30,		December 31,		September 30,
	2014		2013		2013
Eugene market core deposits, period-end(1)	$	642,220	$	588,158	$	596,403
Portland market core deposits, period-end(1)		256,732		249,050		256,710
Seattle market core deposits, period-end(1)		148,259		153,107		162,538
Total core deposits, period-end(1)		1,047,211		990,315		1,015,651
Other deposits, period-end		98,024		100,666		101,878
Total deposits, period-end	$	1,145,235	$	1,090,981	$	1,117,529

	Three Months Ended
	September 30,		December 31,		September 30,
	2014		2013		2013
Eugene market core deposits, average(1)	$	634,412	$	592,179	$	589,123
Portland market core deposits, average(1)		250,029		242,855		240,612
Seattle market core deposits, average(1)		152,895		152,173		142,752
Total core deposits, average(1)		1,037,336		987,207		972,487
Other deposits, average		104,561		101,263		105,408
Total deposits, average	$	1,141,897	$	1,088,470	$	1,077,895

⁽¹⁾  Core deposits include all demand, savings, money market, interest checking accounts, plus all nonpublic local time deposits including local time deposits in excess of $100.

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Other Deposits

The Company uses public and brokered deposits to provide short-term and long-term funding sources. The Company defines short-term as having a contractual maturity of less than one year. The Company uses brokered deposits to help mitigate interest rate risk in a rising rate environment. All long-term brokered deposits have a call feature, which provides the Company the option to redeem the deposits on a quarterly basis and allows the Company to refinance long-term funding at lower rates should market rates fall. During the third quarter 2014, the Company called $10,500 in brokered time deposits with a weighted average rate of 1.86% and refinanced them at a lower rate. Below is a schedule detailing public and brokered deposits by type, including weighted average rate (“WAR”) and weighted average maturity (“WAM”).

Non-Core Deposit Summary

	Balance September 30, 2014		WAR			WAM
Short-Term Public Time Deposits	$	30,520		0.17	%		26 days
Long-Term Public Time Deposits		1,706		0.55	%		6.65 years
	$	32,226
Short-Term Brokered Time Deposits	$	17,500		0.24	%		157 days
Long-Term Brokered Time Deposits		48,719		2.03	%		5.98 years
	$	66,219

Borrowings

The Company has both secured and unsecured borrowing lines with the FHLB, FRB and various correspondent banks. The Federal Reserve and correspondent borrowings are generally short-term, with a maturity of less than 30 days. The FHLB borrowings can be either short-term or long-term in nature. See Note 6 of theNotes to Consolidated Financial Statements in Part I, Item I of this report for a full maturity and interest rate schedule for the FHLB borrowings.

Junior Subordinated Debentures

The Company had $8,248 in junior subordinated debentures outstanding at September 30, 2014, which were issued in conjunction with the 2005 acquisition of NWBF. The junior subordinated debentures had an interest rate of 6.27% that was fixed through January 2011. In January 2011, the rate on the junior subordinated debentures changed to three-month LIBOR plus 135 basis points. On April 22, 2013, the Bank entered into a cash flow hedge on $8,000 of the trust preferred payment, swapping the variable interest rate for a fixed rate of 2.73% for approximately seven years. At September 30, 2014, the fair value of the interest rate swap on the Company’s subordinated debentures was $275. At September 30, 2014, the $8,000 of junior subordinated debentures qualified as Tier 1 capital under regulatory capital guidelines.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances, such as the Company’s junior subordinated debentures, as Tier 1 capital. Under final rules adopted by the Federal Reserve and the other U.S. Federal banking agencies, our trust preferred securities would remain as Tier 1 capital since total assets of the Company are less than $15 billion. Additional information regarding these final capital rules is included in Part I, Item 2,“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” of this report and in Part II, Item 1A“Risk Factors” of our 2013 Form 10-K under the heading “We operate in a highly regulated environment and the effects of recent and pending federal legislation or of changes in, or supervisory enforcement of, banking or other laws and regulations could adversely affect us.”

Additional information regarding the terms of the cash flow hedge is included in Note 9 of theNotes to Consolidated Financial Statements in Part I, Item I of this report.

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Capital Resources

Capital is the shareholders’ investment in the Company. Capital grows through the retention of earnings and the issuance of new stock or other equity securities whether through stock offerings or through the exercise of equity awards. Capital formation allows the Company to grow assets and provides flexibility in times of adversity. Shareholders’ equity at September 30, 2014, was $182,538, up $3,354 from December 31, 2013. The increase in shareholders’ equity was due to the improvement in the market value of the Company’s securities available-for-sale, which positively impacted accumulated other comprehensive income.

On May 6, 2014, the Company’s Board of Directors authorized the repurchase of up to 5.00% of the Company’s outstanding shares, or 892,500 shares, with the purchases to take place over a 12-month period. During the third quarter 2014, the Company repurchased 132,358 shares at a weighted average price of $13.60 per share. Since the inception of the share repurchase plan, the Company has repurchased 267,080 shares at a weighted average price of $13.48 per share. Over the last ten quarters, the Company has used a combination of regular dividends, special dividends, and share repurchases to maintain capital levels comparable with year-end December 31, 2011, capital levels. For additional details regarding the changes in equity, review theConsolidated Statements of Changes in Shareholders’ Equity in Item 1 of Part I of this report.

The Federal Reserve and the FDIC have in place guidelines for risk-based capital requirements applicable to U.S. bank holding companies and banks. These risk-based capital guidelines take into consideration risk factors, as defined by regulation, associated with various categories of assets, both on and off-balance sheet. Under the guidelines, capital strength is measured in three ways, first by measuring Tier 1 capital to leverage assets, followed by capital measurement in two tiers, which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios. These guidelines require a minimum of 4.00% Tier 1 capital to leverage assets, 4.00% Tier 1 capital to risk-weighted assets, and 8.00% total capital to risk-weighted assets. In order to be classified as “well-capitalized,” the highest capital rating by the Federal Reserve and the FDIC, these three ratios must be in excess of 5.00%, 6.00%, and 10.00%, respectively. The Company’s leverage capital ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio were 11.20%, 14.44%, and 15.69%, respectively, at September 30, 2014, all capital ratios for the Company and Bank being well above the minimum designations.

In July 2013, the Federal Reserve Board and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the Basel Committee’s current international regulatory capital accord (Basel III). These rules, upon their effectiveness, will replace the federal banking agencies’ general risk-based capital rules, advanced approaches rule, market-risk rule, and leverage rules, in accordance with certain transition provisions. Banks, such as Pacific Continental Bank, will become subject to the new rules on January 1, 2015. The new rules establish more restrictive capital definitions, create additional categories and higher risk-weightings for certain asset classes and off-balance sheet exposures, higher leverage ratios and capital conservation buffers that will be added to the minimum capital requirements and must be met for banking organizations to avoid being subject to certain limitations on dividends and discretionary bonus payments to executive officers. The new rules also implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. When fully phased in, the final rules will provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.50%; (b) a Tier 1 capital ratio of 6.00% (which is an increase from 4.00%); (c) a total capital ratio of 8.00%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4.00%. While earlier proposals would have required that our trust preferred securities (TruPS) be phased out of Tier 1 capital, the new rules exempt depository institution holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, from this requirement. These capital instruments, if issued prior to May 19, 2010, and currently in Tier 1 capital, are grandfathered in Tier 1 capital, subject to certain limits. Under the new rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements (equal to 2.50% of total risk-weighted assets). The phase-in of the capital conservation buffer will begin January 1, 2016, and be completed by January 1, 2019. The new rules also provide for various adjustments and deductions to the definitions of regulatory capital that will phase in from January 1, 2014, to December 31, 2017. We are currently evaluating the impact of these changes on our regulatory capital.

On January 12, 2014, the Basel Committee issued its near final version of its leverage ratio and disclosure guidance (the “Basel III Leverage Ratio”). The Basel III Leverage Ratio will be subject to further calibration until 2017, with final implementation expected by January 18, 2018. The Basel III Leverage Ratio makes a number of significant changes to the Basel Committee’s June 2013 consultative paper (“Consultative Paper”) by easing the approach to measuring the exposures of off-balance sheet items. These changes address the financial services industry’s concern that the Consultative Paper’s definition of exposure was too expansive, i.e., that the leverage ratio’s denominator was too large. The changes eliminate many, but not all, differences between the Basel III Leverage Ratio and the U.S. supplemental leverage ratio, which is currently set at a minimum of 3.00% and applies to U.S. firms with over $250 billion in assets.

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For additional information regarding the Company’s regulatory capital levels, see Note 10 inNotes to Consolidated Financial Statements in Part I, Item I of this report.

The Company has regularly paid cash dividends on a quarterly basis, typically in February, May, August and November of each year. The Board of Directors considers the dividend amount quarterly and takes a broad perspective in its dividend deliberations including a review of recent operating performance, capital levels, and concentrations of loans as a percentage of capital, and growth projections. The Board also considers dividend payout ratios, dividend yield, and other financial metrics in setting the quarterly dividend. There can be no assurance that dividends will be paid in the future.

During the first nine months of 2014, the Company declared and paid a regular cash dividend of $0.10 in each of the first, second and third quarters and a special cash dividend of $0.10, $0.11 and $0.03 in the first, second and third quarters 2014, respectively. Subsequent to the end of third quarter 2014, the Company declared a regular quarterly cash dividend of $0.10 per share and a special cash dividend of $0.05 per share to be paid on November 13, 2014, to shareholders of record as of November 3, 2014.

OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

In the normal course of business, the Company commits to extensions of credit and issues letters of credit. The Company 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 Company’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 September 30, 2014, the Company had $173,091 in commitments to extend credit.

Letters of credit written are conditional commitments issued by the Company 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 September 30, 2014, the Company had $1,809 in letters of credit and financial guarantees outstanding.

For additional information regarding the Company’s regulatory capital levels, see Note 10 inNotes to Consolidated Financial Statements in Part I, Item I of this report.

LIQUIDITY AND CASH FLOWS

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 through core deposit growth, maturity of investment securities, and loan payments. Core deposits include demand, interest checking, money market, savings, and local time deposits, including local nonpublic time deposits in excess of $100. Additional liquidity and funding sources are provided through the sale of loans, sales of securities, access to national CD markets, and both secured and unsecured borrowings. The Company uses a number of measurements to monitor its liquidity position on a daily, weekly, and monthly basis, which includes its ability to meet both short-term and long-term obligations, and requires the Company to maintain a certain amount of liquidity on the asset side of its balance sheet. The Company also prepares quarterly projections of its liquidity position 30 days, 90 days, 180 days, and 1 year into the future. In addition, the Company prepares a Liquidity Contingency Plan at least semi-annually that is strategic in nature and forward-looking to test the ability of the Company to fund a liquidity shortfall arising from various escalating events. The Liquidity Contingency Plan is presented and reviewed by the Company’s Asset and Liability Committee.

Core deposits at September 30, 2014, were $1,047,211 and represented 91.44% of total deposits. Core deposits at September 30, 2014, were up $56,896 over December 31, 2013, with virtually all of the growth occurring in the second and third quarter 2014. The growth in these quarters reflects a typical seasonal pattern. The Company experienced an increase in outstanding loans of $41,106 during the first nine months of 2014, which was funded entirely by growth in core deposits. Core deposit growth not required to fund asset growth was used to pay down short-term borrowings. It is anticipated that core deposit growth and cash flows from the securities portfolio will provide a significant portion of the funding during the remainder of

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2014, as loans are expected to continue to increase. The securities portfolio represented 23.36% of total assets at September 30, 2014. At September 30, 2014, $27,309 of the securities portfolio was pledged to support public deposits and repurchase agreements, leaving $320,743 of the securities portfolio unencumbered and available-for-sale. In addition, at September 30, 2014, the Company had $34,230 of government guaranteed loans that could be sold in the secondary market to support the Company’s liquidity position.

Due to its strategic focus to market to specific segments, the Company has been successful in developing deposit relationships with several large clients, which are generally defined as deposit relationships of $1,000 or more, which are closely monitored by management and Company officers. At September 30, 2014, 56 large deposit relationships with the Company accounted for $438,102 or 41.84% of total outstanding core deposits. The single largest client represented 7.04% of outstanding core deposits at September 30, 2014. The loss of this deposit relationship or other large deposit relationships could cause an adverse effect on short-term liquidity. The Company uses a 10-point risk-rating system to evaluate each of its large depositors in order to assist management in its daily monitoring of the volatility of this portion of its core deposit base. The risk-rating system attempts to determine the stability of the deposits of each large depositor, evaluating among other things the length of time the depositor has been with the Company and the likelihood of loss of individual large depositor relationships. Risk ratings on large depositors are reviewed at least quarterly and adjusted if necessary. Company management and officers maintain close relationships and hold regular meetings with its large depositors to assist in management of these relationships. The Company expects to maintain these relationships, and believes it has sufficient sources of liquidity to mitigate the loss of one or more of these clients and regularly tests its ability to mitigate the loss of multiple large depositor relationships in its Liquidity Contingency Plan. There can be no assurance that these large depositor relationships will be maintained or that the loss of one or more of these clients will not adversely affect the Company’s liquidity.

At September 30, 2014, the Company had secured borrowing lines with the FHLB of Seattle and the FRB, along with unsecured borrowing lines with various correspondent banks totaling $499,640. The Company’s secured lines with the FHLB and FRB were limited by the amount of collateral pledged. At September 30, 2014, the Company had pledged $299,083 in discounted collateral value in commercial real estate loans, first and second lien single-family residential loans, multi-family loans, and securities to the FHLB. Additionally, certain commercial and commercial real estate loans with a discounted value of $71,557 were pledged to the FRB under the Company’s Borrower-In-Custody program. The Company’s unsecured correspondent bank lines totaled $129,000. At September 30, 2014, the Company had $145,000 in borrowings outstanding from the FHLB, no borrowings outstanding with the FRB, and $670 outstanding on its overnight correspondent bank lines, leaving a total of $353,970 available on its secured and unsecured borrowing lines as of such date.

Net cash provided by operating activities was $19,423 during the nine months ended September 30, 2014. Net cash of $37,211 was used in investing activities, consisting principally of a net loan principal increase of $43,029, which was partially offset by net proceeds from investment securities of $1,009. For the nine months ended September 30, 2014, cash provided by financing activities was $21,129 and primarily consisted of an increase in deposits.

ITEM 3 Quantitative and Qualitative Disclosures about Market Risk

There has been no material change in the Company’s exposure to market risk. Readers are referred to the Company’s 2013 Form 10-K and the Annual Report to Shareholders for the year ended December  31, 2013, for additional information.

ITEM 4 Controls and Procedures

Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

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Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the quarter ended September 30, 2014, that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1 Legal Proceedings

On August 23, 2013, a putative class action lawsuit was filed in the Circuit Court of the State of Oregon for the County of Multnomah on behalf of individuals who placed money with Berjac of Oregon and Berjac of Portland, both currently in Chapter 11 bankruptcy. The lawsuit, which alleges violations of state securities laws and aiding breach of fiduciary duty, names Pacific Continental Bank, along with Holcomb Family Limited Partnership, Fred “Jack” W. Holcomb, Holcomb Family Trust, Jones & Roth, P.C. and Umpqua Bank, as defendants. Claimants seek the return of the money placed with Berjac of Oregon and Berjac of Portland, plus interest, and costs and attorneys’ fees, which are claimed to be in excess of $10 million. On August 28, 2014, the court-appointed bankruptcy trustee for Berjac of Oregon (the surviving entity in the merger of Berjac of Oregon and Berjac of Portland) filed an adversary complaint in the U.S Bankruptcy Court for the District of Oregon alleging that Pacific Continental Bank, Pacific Continental Corporation, Umpqua Bank, Century Bank and Summit Bank provided lines of credit that enabled continuation of the Ponzi scheme operated by Berjac of Oregon and the two partners of the pre-existing Berjac general partnerships, Michael Holcomb and Gary Holcomb. In addition to seeking an award of punitive damages not to exceed $10 million, the trustee is seeking the recovery of payments associated with allegedly fraudulent transfers totaling up to approximately $55.3 million, including up to $23.0 million from Century Bank and up to $6.3 million from Pacific Continental Bank. The complaint also alleges that accounting firm Jones & Roth, P.C., is jointly and severally liable for the return of the allegedly fraudulent transfers to the bankruptcy estate. Among other claims for relief, the trustee is seeking the disgorgement of $300,000 advanced to the Holcomb Family Limited Partnership by Century Bank and returned to the estate by Court order following the post-petition cash collateral hearing, and of approximately $1.4 million received by Pacific Continental Bank from the proceeds of the sale of stock held by the Holcomb Family Limited Partnership and securing one of the lines of credit previously held by Century Bank.

We may from time to time be involved in claims, proceedings and litigation arising from our business and property ownership. We believe, based on currently available information, that the results of such proceedings, including the above-described proceeding, in the aggregate, will not have a material adverse effect on our financial condition.

ITEM 1A Risk Factors

For a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our 2013 Form 10-K, which is incorporated by reference herein, in addition to the following information:

Industry Factors

Fluctuating interest rates could adversely affect our profitability.

As is the case with many banks, our profitability is dependent to a large extent upon our net interest income, which is the difference 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 could adversely affect, and has in past years, impacted, our net interest margin, and, in turn, our profitability. This impact could result in a decrease in our interest income relative to interest expense. Increases in interest rates may also adversely impact the value of our securities investment portfolio. At September 30, 2014, our balance sheet was liability sensitive, and an

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increase in interest rates could cause our net interest margin and our net interest income to decline. For the past several years, the banking industry has operated in an extremely low interest rate environment relative to historical averages, and the Federal Reserve has pursued highly accommodative monetary policies (including a very low Federal funds rate and substantial purchases of long-term U.S. Treasury and agency securities) in an effort to facilitate growth in the U.S. economy and a reduction in levels of unemployment. This environment has placed downward pressure on the net interest margins of U.S. banks, including Pacific Continental Bank. During the first quarter of 2014, in light of improving conditions in the labor market, the Federal Reserve began to reduce the rate of its purchases of long-term U.S. Treasury and agency securities. In late October 2014, the Federal Reserve announced that, in view of the substantial improvement in the outlook for the labor market, it had determined to end its asset purchase program by the end of that month. It also indicated that it would continue its existing policy of reinvesting principal payments from its holdings of agency debt and mortgage-backed securities in agency mortgage-backed securities and of rolling over Treasury securities at auction in order to keep its holdings of longer-term securities at sizeable levels to help maintain accommodative financial conditions. The Federal Reserve further indicated that it expects to maintain the current very low target range for the federal funds rate for some time while it assesses progress toward its objectives of maximum employment and 2 percent inflation and that even after employment and inflation are near its objectives, economic conditions may warrant for some time keeping the target federal funds rate below longer-term normal levels. We cannot predict with any certainty the time during which, nor the extent to which, these Federal Reserve policies will continue. It is also unclear when the Federal Reserve will begin to unwind its asset holdings, as well as the pace at which it may do so. However, as the Federal Reserve unwinds its position, it is expected that excess reserves will be drained from the banking system, which will decrease the overall level of deposits in the system. This could lead to a decline in deposits at some institutions and to increased price competition for stable deposits, which could hamper the improvement in net interest margins that banks are anticipating from rising rates.

Company Factors

We have a significant concentration in loans to dental professionals, and loan concentrations within one industry may create additional risk.

Bank regulatory authorities and investors generally view significant loan concentrations within any particular industry as carrying higher inherent risk than a loan portfolio without any significant concentration in one industry. Dental lending is not operated as a business segment, and dental loans are made in the normal course of commercial lending activities throughout the Company. However, the Company has a significant concentration of loans to dental professionals, which represented 29.65% in principal amount of our total loan portfolio at September 30, 2014 (see Note 4 in theNotes to Consolidated Financial Statementsincluded in Item I, Note I of this Form 10-Q). While we apply credit practices which we believe to be prudent to these loans as well as all the other loans in our portfolio, due to our concentration in dental lending we are exposed to the general risks of industry concentration, which include adverse market factors impacting that industry alone or disproportionately to other industries. In addition, bank regulatory authorities may in the future require us to limit additional lending in the dental industry if they have concerns that our concentration in that industry creates significant risks, which in turn could limit our ability to pursue new loans in an area where we believe we currently have a competitive advantage.

Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.

At September 30, 2014, our nonperforming loans (which include all nonaccrual loans, net of government guarantees) were 0.28% of the loan portfolio. At September 30, 2014, our nonperforming assets (which include foreclosed real estate) were 1.08% of total assets. Nonperforming loans and assets adversely affect our net income in various ways. We generally do not record interest income on nonperforming loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, less estimated selling expenses, which may ultimately result in a loss. An increase in the level of nonperforming assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile. While we reduce problem assets through loan sales, workouts, and restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition, perhaps materially. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors which can be detrimental to the performance of their other responsibilities. Any significant future increase in nonperforming assets could have a material adverse effect on our business, financial condition and results of operations.

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We may not have the ability to continue paying dividends on our common stock at current or historic levels.

On July 23, 2014, we announced a quarterly cash dividend of $0.10 per share, payable to shareholders of record on August 15, 2014, and declared a special cash dividend of $0.03 per share. Subsequent to the end of third quarter 2014, the Company declared a regular quarterly cash dividend of $0.10 per share and a special cash dividend of $0.05 per share to be paid on November 13, 2014, to shareholders of record as of November 3, 2014. Our ability to pay dividends on our common stock depends on a variety of factors. It is possible in the future that we may not be able to continue paying quarterly dividends commensurate with historic levels, if at all. As a holding company, a substantial portion of our cash flow typically comes from dividends our bank subsidiary pays to us. Cash dividends will depend on sufficient earnings to support them and adherence to bank regulatory requirements. If the Bank is not able to pay dividends to the Company, the Company may not be able to pay dividends on its common stock. Consequently, the inability to receive dividends from the Bank could adversely affect the Company’s financial condition, results of operations and prospects.

We may be required, in the future, to recognize impairment with respect to investment securities, including the FHLB stock we hold.

Our securities portfolio contains whole loan private mortgage-backed securities and municipal securities and currently includes securities with unrecognized losses. We may continue to observe volatility in the fair market value of these securities. We evaluate the securities portfolio for any OTTI each reporting period, as required by GAAP. Future evaluations of the securities portfolio could require us to recognize impairment charges. The credit quality of securities issued by certain municipalities has deteriorated in recent quarters. Although management does not believe the credit quality of the Company’s municipal securities has similarly deteriorated, such deterioration could occur in the future. For example, it is possible that government-sponsored programs to allow mortgages to be refinanced to lower rates could materially adversely impact the yield on our portfolio of mortgage-backed securities, since a significant portion of our investment portfolio is composed of such securities.

In addition, as a condition to membership in the FHLB, we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. At September 30, 2014, we had stock in the FHLB totaling $10,125. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. As of September 30, 2014, we did not recognize an impairment charge related to our FHLB stock holdings. Beginning in 2013, the FHLB began repurchasing small amounts of excess FHLB capital stock. Future negative changes to the financial condition of the FHLB could require us to recognize an impairment charge with respect to such holdings.

If the goodwill we have recorded in connection with acquisitions becomes impaired, it could have an adverse impact on our reported earnings.

At September 30, 2014, we had $22,881 of goodwill on our balance sheet. In accordance with GAAP, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. Such evaluation is based on a variety of qualitative and quantitative factors, including macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, and other relevant entity-specific events. The last impairment test was performed at December 31, 2013. At December 31, 2013, we did not recognize an impairment charge related to our goodwill. Future evaluations of goodwill may result in findings of impairment and write downs, which would impact our operating results and could be material

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ITEM 2 Unregistered Sales of Equity Securities and Use of Proceeds

On May 6, 2014, the Company’s Board of Directors adopted a repurchase plan to repurchase up to 5.00% percent of the Company’s outstanding shares with the purchases to take place over a 12-month period. For the nine months ended September 30, 2014, the Company purchased a total of 267,080 shares of common stock at a weighted average price of $13.48.

Period	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan (1)		Maximum Number of Shares that May Yet Be Purchased Under the Plan
January 1-31, 2014		—		n/a		—		—
February 1-28, 2014		—		n/a		—		—
March 1-31, 2014		—		n/a		—		—
April 1-30, 2014		—	$	13.28		11,400		881,100
May 1-31, 2014		—	$	13.37		123,322		757,778
June 1-30, 2014		—		n/a		—		—
July 1-31, 2014		—	$	13.60		94,389		663,389
August 1-31, 2014		—	$	13.59		37,969		625,420
September 1-30, 2014		—		n/a		—		—

(1) On May 6, 2014, the Company announced in a press release the adoption of a plan to repurchase up to 892,500 shares of its common stock over a 12-month period.

ITEM 6 Exhibits

31.1	Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer of the Registrant
31.2	Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of the Registrant
32*	Furnished statements of the Chief Executive Officer and Chief Financial Officer under 18 U.S.C Section 1350
101	The following financial information from Pacific Continental Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, is formatted in XBRL: (i) the Unaudited Consolidated Balance Sheets, (ii) the Unaudited Consolidated Statements of Income, (iii) the Unaudited Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income, (iv) the Unaudited Consolidated Statements of Cash Flows, and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text.

* In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibit 32 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.

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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 CONTINENTAL CORPORATION
		(Registrant)
Dated	November 7, 2014	/s/ Hal Brown
		Hal Brown
		Chief Executive Officer
		(Duly Authorized Officer; Principal Executive Officer)
Dated	November 7, 2014	/s/ Michael A. Reynolds
		Michael A. Reynolds
		Executive Vice President and Chief Financial Officer (Duly Authorized Officer; Principal Financial Officer)

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