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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarter ended June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 000-29829
PACIFIC FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1815009
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
300 East Market Street
Aberdeen, Washington 98520-5244
(360) 533-8870
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No __
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Title of Class Outstanding at July 31, 2005
-------------- ----------------------------
Common Stock, par value $1.00 per share 6,422,916 shares
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-1-
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION 3
ITEM 1. FINANCIAL STATEMENTS 3
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2005 AND DECEMBER 31, 2004 3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2005 AND 2004 5
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS'
EQUITY SIX MONTH PERIODS ENDED JUNE 30, 2005 AND 2004 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 15
ITEM 4. CONTROLS AND PROCEDURES 15
PART II OTHER INFORMATION 16
ITEM 1. LEGAL PROCEEDINGS 16
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF 16
PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16
ITEM 5. OTHER INFORMATION 16
ITEM 6. EXHIBITS 16
SIGNATURES 17
-2-
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PACIFIC FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
(Dollars in thousands)
June 30, December 31,
2005 2004
(Unaudited)
Assets
Cash and due from banks $ 11,785 $ 10,213
Interest bearing balances with banks 8,008 5,460
Federal funds sold 7,000 6,034
Investment securities available for sale 32,260 35,780
Investment securities held-to-maturity 6,881 7,210
Federal Home Loan Bank stock, at cost 1,858 1,850
Loans held for sale 6,559 1,852
Loans 362,982 345,907
Allowance for credit losses 4,842 4,236
-------- --------
Loans, net 358,140 341,671
======== ========
Premises and equipment 7,719 6,833
Foreclosed real estate 40 40
Accrued interest receivable 1,911 1,873
Cash surrender value of life insurance 9,216 9,037
Goodwill 11,283 11,282
Other intangible assets 816 887
Other assets 2,197 1,769
-------- --------
Total assets $465,673 $441,791
======== ========
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing $ 75,741 $ 71,711
Interest bearing 309,945 291,790
-------- --------
Total deposits 385,686 363,501
======== ========
Accrued interest payable 430 385
Secured borrowings 5,675 3,733
Long-term borrowings 24,500 21,500
Other liabilities 1,470 7,369
Total liabilities 417,761 396,488
======== ========
Shareholders' Equity
Common Stock (par value $1); 25,000,000 shares authorized; 6,423 6,421
6,422,916 shares issued and outstanding at June 30, 2005
and 6,421,396 at December 31, 2004
Additional paid-in capital 25,020 25,003
Retained earnings 16,532 13,746
Accumulated other comprehensive income (loss) (63) 133
-------- --------
Total shareholders' equity 47,912 45,303
======== ========
Total liabilities and shareholders' equity $465,673 $441,791
======== ========
-3-
PACIFIC FINANCIAL CORPORATION
Condensed Consolidated Statements of Income
Three and six months ended June 30, 2005 and 2004
(Dollars in thousands, except per share)
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
====== ====== ======= ======
Interest and dividend income
Loans $6,852 $5,661 $12,976 $9,817
Investment securities and FHLB dividends 438 517 888 1,183
Deposits with banks and federal funds sold 107 2 179 17
------ ------ ------- ------
Total interest and dividend income 7,397 6,180 14,043 11,017
====== ====== ======= ======
Interest Expense
Deposits 1,510 904 2,814 1,652
Other borrowings 374 173 589 304
------ ------ ------- ------
Total interest expense 1,884 1,077 3,403 1,956
Net Interest Income 5,513 5,103 10,640 9,061
Provision for credit losses 300 300 600 370
------ ------ ------- ------
Net interest income after provision
for credit losses 5,213 4,803 10,040 8,691
====== ====== ======= ======
Non-interest Income
Service charges on deposits 384 337 705 625
Gain on sales of loans 455 320 734 389
Gain on sale of foreclosed real estate -- 16 -- 51
Gain (loss) on sale of investments available for sale (7) -- 2 3
Gain on sale of premises and equipment 10 -- 90 --
Other operating income 192 230 389 406
------ ------ ------- ------
Total non-interest income 1,034 903 1,920 1,474
====== ====== ======= ======
Non-interest Expense
Salaries and employee benefits 2,505 2,080 4,919 3,705
Occupancy and equipment 482 409 949 711
Other 1,114 1,110 2,111 1,789
------ ------ ------- ------
Total non-interest expense 4,101 3,599 7,979 6,205
====== ====== ======= ======
Income before income taxes 2,146 2,107 3,981 3,960
====== ====== ======= ======
Provision for income taxes 650 680 1,195 1,159
------ ------ ------- ------
Net Income $1,496 $1,427 $ 2,786 $2,801
====== ====== ======= ======
Comprehensive Income $1,395 $ 564 $ 2,590 $2,237
Earnings per common share:
Basic $ .23 $ .23 $ .43 $ .48
====== ====== ======= ======
Diluted .23 .22 .43 .46
Average shares outstanding:
Basic 6,421,951 6,346,678 6,421,675 5,912,814
Diluted 6,541,074 6,537,746 6,533,503 6,062,700
-4-
PACIFIC FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2005 and 2004
(Dollars in thousands)
(Unaudited)
2005 2004
OPERATING ACTIVITIES
Net income $ 2,786 $ 2,801
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for credit losses 600 370
Depreciation and amortization 521 288
Deferred income tax (benefit) -- (17)
Stock dividends received (8) (32)
Origination of loans held for sale (49,825) (30,578)
Proceeds of loans held for sale 45,852 29,623
Gain on sales of loans (734) (389)
Gain on sale of investment securities (2) (3)
Gain on sale of foreclosed real estate -- (51)
Gain on sale of premises and equipment (90) --
Increase in accrued interest receivable (38) (66)
Increase in accrued interest payable 45 21
Other (1,753) (756)
------- -------
Net cash provided by (used in) operating activities (2,646) 1,211
======= =======
INVESTING ACTIVITIES
Net (increase) decrease in federal funds (966) 5,000
(Increase) decrease in interest bearing deposits with banks (2,548) 15,574
Purchase of securities held to maturity -- (1,169)
Purchase of securities available for sale (4,321) (3,034)
Proceeds from maturities of investments held to maturity 321 869
Proceeds from sales of securities available for sale 3,645 19,060
Proceeds from maturities of securities available for sale 3,830 4,612
Net increase in loans (17,093) (20,320)
Proceeds from sales of foreclosed real estate -- 414
Additions to premises and equipment (1,274) (1,789)
Proceeds from sales of premises and equipment 114 --
Purchase of bank owned life insurance -- (2,500)
Acquisition, net of cash received -- 3,146
------- -------
Net cash provided by (used in) investing activities (18,292) 19,863
======= =======
FINANCING ACTIVITIES
Net increase (decrease) in deposits 22,185 (6,344)
Net decrease in short-term borrowings -- (11,577)
Net increase in secured borrowings 1,942 --
Proceeds from issuance of long-term borrowings 8,000 7,000
Repayments of long-term borrowings (5,000) (2,000)
Stock options exercised 7 206
Payment of cash dividends (4,624) (3,530)
------- -------
Net cash provided by (used in) financing activities 22,510 (16,245)
======= =======
Net increase in cash and due from banks 1,572 4,829
======= =======
CASH AND DUE FROM BANKS
Beginning of period 10,213 9,280
End of period $11,785 $14,109
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 3,358 $ 1,865
Income Taxes 1,635 1,070
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES
Foreclosed real estate acquired in settlement of loans $ -- $ (349)
Change in fair value of securities available
for sale, net of tax (196) 564
Common stock issued upon business combination -- 17,282
-5-
PACIFIC FINANCIAL CORPORATION
Condensed Consolidated Statements of Shareholders' Equity
Six months ended June 30, 2005 and 2004
(Dollars in thousands) ACCUMULATED
(Unaudited) OTHER
ADDITIONAL COMPREHENSIVE
COMMON PAID-IN RETAINED INCOME
STOCK CAPITAL EARNINGS (LOSS) TOTAL
Balance December 31, 2003 $5,043 $ 7,484 $12,663 $ 460 $25,650
====== ======= ======= ===== =======
Issuance of common stock 1,272 16,010 17,282
Stock options exercised 30 176 206
Stock option expense 24 24
Tax benefit from exercise of options 14 14
Other comprehensive income:
Net income 2,801 2,801
Change in fair value of
securities available for sale, net (564) (564)
Comprehensive income 2,237
=======
------ ------- ------- ----- -------
Balance June 30, 2004 $6,345 $23,708 $15,464 $(104) $45,413
====== ======= ======= ===== =======
Balance December 31, 2004 $6,421 $25,003 $13,746 $133 $45,303
====== ======= ======= ===== =======
Stock options exercised 2 5 7
Stock option expense 12 12
Other comprehensive income:
Net income 2,786 2,786
Change in fair value of
securities available for sale, net (196) (196)
Comprehensive income 2,590
------ ------- ------- ----- -------
Balance June 30, 2005 $6,423 $25,020 $16,532 ($63) $47,912
-6-
PACIFIC FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
Six months ended June 30, 2005 and 2004
(unaudited)
NOTE 1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
by Pacific Financial Corporation ("Pacific" or the "Company") in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six months ended June 30, 2005, are not
necessarily indicative of the results anticipated for the year ending December
31, 2005. Certain information and footnote disclosures included in the Company's
consolidated financial statements for the year ended December 31, 2004, have
been condensed or omitted from this report. Accordingly, these statements should
be read with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2004.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
All dollar amounts in tables, except per share information, are stated in
thousands.
NOTE 2. Investment Securities
Investment securities consist principally of short and intermediate term debt
instruments issued by the U.S. Treasury, other U.S. government agencies, state
and local government units, and other corporations.
SECURITIES HELD TO MATURITY AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
June 30, 2005
U.S. Government Securities $ 1,426 $ 12 $ -- $ 1,438
State and Municipal Securities 5,455 52 29 5,478
------- ---- ---- -------
TOTAL $ 6,881 $ 64 $ 29 $ 6,916
SECURITIES AVAILABLE FOR SALE AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
June 30, 2005
U.S. Government Securities $13,987 $ 76 $178 $13,885
State and Municipal Securities 12,745 163 58 12,850
Corporate Securities 2,583 21 26 2,578
Mutual Funds 3,039 -- 92 2,947
------- ---- ---- -------
TOTAL $32,354 $260 $354 $32,260
-7-
For all the above investment securities, the unrealized losses are generally due
to changes in interest rates and, as such, are considered to be temporary by
management. The Company has evaluated the securities shown above and anticipates
full recovery of amortized cost with respect to these securities at maturity or
sooner in the event of a more favorable market interest rate environment.
Additionally, the contractual cash flow of mortgage backed securities are
guaranteed by an agency of the United States Government.
NOTE 3. Allowance for Credit Losses
THREE MONTHS SIX MONTHS TWELVE MONTHS
ENDED ENDED ENDED
JUNE 30, JUNE 30, DECEMBER 31,
2005 2004 2005 2004 2004
====== ====== ====== ====== ======
Balance at beginning of period $4,544 $3,466 $4,236 $2,238 $2,238
BNW Bancorp, Inc. acquisition -- -- -- 1,172 1,172
Provision for possible credit
Losses 300 300 600 370 970
Charge-offs (7) (10) (7) (29) (275)
Recoveries 5 5 13 10 131
Net (charge-offs) recoveries (2) (5) 6 (19) (144)
Balance at end of period $4,842 $3,761 $4,842 $3,761 $4,236
Ratio of net charge-offs to
Average loans outstanding .00% .01% .00% .01% .05%
NOTE 4. Computation of Basic Earnings per Share:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
Net Income $1,496,000 $1,427,000 $2,786,000 $2,801,000
Average Shares Outstanding 6,421,951 6,346,678 6,421,675 5,912,814
Basic Earnings Per Share $ .23 $ .23 $ .43 $ .48
-8-
NOTE 5. Computation of Diluted Earnings Per Share:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
Net Income $1,496,000 $1,427,000 $2,786,000 $2,801,000
Average Shares Outstanding 6,421,951 6,346,678 6,421,675 5,912,814
Effect of dilutive securities 119,123 191,068 111,828 149,886
Average Shares Outstanding and
Assumed conversion of dilutive
Stock options 6,541,074 6,537,746 6,533,503 6,062,700
Diluted Earnings Per Share $ 0.23 $ 0.22 $ 0.43 $ .46
NOTE 6. Equity Compensation Plans
At June 30, 2005, the Company has a stock-based employee compensation plan. The
Company accounts for the plan under recognition and measurement principles of
APB Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under this plan had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share had
the Company applied the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
Net Income, as reported $1,496,000 $1,427,000 $2,786,000 $2,801,000
Add stock compensation expense 12,000 24,000 12,000 24,000
Less total stock-based compensation
expense determined under fair value
method for all qualifying awards, 54,000 39,000 108,000 79,000
net of tax
Pro forma net income 1,454,000 1,412,000 2,690,000 2,746,000
Earnings per Share
Basic:
As reported $ .23 $ .23 $ .43 $ .48
Pro forma .23 .22 .42 .47
Diluted:
As reported .23 .22 .43 .46
Pro forma .22 .22 .41 .46
-9-
NOTE 7. Acquisition
On February 27, 2004, the Company completed the acquisition of BNW Bancorp, Inc.
("BNW Bancorp"). Each share of BNW Bancorp was exchanged for 0.85 shares of the
Company's common stock resulting in the issuance of 1,271,904 new shares. The
acquisition was accounted for using the purchase method of accounting and,
accordingly, the assets and liabilities of BNW Bancorp were recorded at their
respective fair value. Goodwill, the excess of the purchase price over the net
fair value of the assets and liabilities acquired, was recorded at $11,283,000.
As part of the accounting for the acquisition, the Company recorded a core
deposit identifiable intangible asset of $993,000.
NOTE 8. Subsequent Event
In July 2005, the Company purchased a building in Anacortes, Washington to
operate as a full service branch. Total cost of the building and adjacent land
is $1,028,000.
-10-
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
A Warning About Forward-Looking Information
This document contains forward-looking statements that are subject to
risks and uncertainties. These statements are based on the beliefs and
assumptions of our management, and on information currently available to them.
Forward-looking statements include the information concerning our possible
future results of operations set forth under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and statements
preceded by, followed by or that include the words "believes," "expects,"
"anticipates," "intends," "plans," "estimates" or similar expressions.
Any forward-looking statements in this document are subject to risks
relating to, among other things, the following:
1. competitive pressures among depository and other financial
institutions may impede our ability to attract and retain borrowers,
depositors and other customers, retain key employees, and maintain our
interest margins and fee income;
2. changes in the interest rate environment may reduce margins or
decrease the value of our securities;
3. our growth strategy, particularly if accomplished through
acquisitions, may not be successful if we fail to accurately assess market
opportunities, asset quality, anticipated cost savings, and transaction
costs, or experience significant difficulty integrating acquired
businesses or assets;
4. general economic or business conditions, either nationally or in
the regions in which we do business, may be less favorable than expected,
resulting in, among other things, a deterioration in credit quality or a
reduced demand for credit; and
5. a lack of liquidity in the market for our common stock may make
it difficult or impossible for you to liquidate your investment in our
stock or lead to distortions in the market price of our stock.
Our management believes the forward-looking statements in this report are
reasonable; however, you should not place undue reliance on them.
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. Many of the factors that will determine
our future results and share value are beyond our ability to control or predict.
We undertake no obligation to update forward-looking statements.
-11-
Net income. For the three months ended June 30, 2005, Pacific's net income was
$1,496,000 compared to $1,427,000 for the same period in 2004. For the six
months ended June 30, 2005, net income was $2,786,000 compared to $2,801,000 for
the same period in 2004. Increases in staffing, director and data processing
expenses, and professional fees led to an increase in non-interest expense for
the three and six months ended June 30, 2005, compared to the same periods in
2004.
Net interest income. Net interest income for the three and six months ended June
30, 2005 increased $410,000, or 8.0%, and $1,579,000, or 17.4%, respectively,
compared to the same periods in 2004. The net interest margin (net interest
income divided by average earning assets) decreased to 5.23% for June 30, 2005
from 5.29% for the same period last year. This is due primarily to an increase
in cost of funds from 1.15% to 1.59% for the six months ended June 30, 2004 and
2005, respectively. We have, however, been able to maintain our net interest
margin over 5.0% in part due to our continued focus on variable rate loans and
fixed rate loan terms of not longer than three years.
Interest income for the three and six months ended June 30, 2005, increased
$1,217,000, or 19.7%, and $3,026,000 or 27.5%, respectively, compared to the
same period in 2004. Loans averaged $349.5 million with an average yield of
7.29% for the six months ended June 30, 2005 compared to average loans of $285.6
million with an average yield of 6.89% for the same period in 2004. While a
portion of the increase in average loans is due to the BNW acquisition that
closed February 27, 2004, the Company also experienced significant loan growth
in its historical operations in the quarter ended June 30, 2005.
Interest expense for the three and six months ended June 30, 2005 increased
$807,000, or 74.9%, and $1,447,000, or 74.0%, respectively, compared to the same
periods in 2004. The increase is primarily attributable to increased deposit
balances and increased expense of long term borrowings, as well as higher
interest rates. Average interest-bearing deposit balances for the six months
ended June 30, 2005 and June 30, 2004 were $373,908,000 and $312,235,000,
respectively, with an average cost of 1.51% and 1.06%, respectively.
Average secured borrowings for the six months ended June 30, 2005 and June 30,
2004 were $4,704,000 and none, respectively, an increase of 100.0% over the 2004
period. The secured borrowings represent borrowings collateralized by
participation interests in loans originated by the Company. These borrowings are
repaid as payments are made on the underlying loans, bearing interest rates
ranging from 5.5% to 8.5%. Average long term borrowings for the six months ended
June 30, 2005 were $21,454,000 with an average cost of 3.13% compared to
$26,863,000 with an average cost of 2.27% for the same period in 2004.
Provision and allowance for credit losses. The allowance for credit losses
reflects management's current estimate of the amount required to absorb losses
on existing loans and commitments to extend credit. Loans deemed uncollectible
are charged against and reduce the allowance. Periodically, a provision for
credit losses is charged to current expense. This provision acts to replenish
the allowance for credit losses and to maintain the allowance at a level that
management deems adequate.
There is no precise method of predicting specific credit losses or amounts that
ultimately may be charged off on segments of the loan portfolio. The
determination that a loan may become uncollectible, in whole or in part, is a
matter of judgment. Similarly, the adequacy of the allowance for credit losses
can be determined only on a judgmental basis, after full review, including (a)
consideration of economic conditions and the effect on particular industries and
specific borrowers; (b) a review of borrowers' financial data, together with
industry data, the competitive situation, the borrowers' management capabilities
and other factors; (c) a continuing evaluation of the loan portfolio, including
monitoring by lending officers and staff credit personnel of all loans which are
identified as being of less than acceptable quality; (d) an in-depth appraisal,
on a monthly basis, of all loans judged to present a possibility of loss (if, as
a result of such monthly appraisals, the loan is judged to be not fully
collectible, the carrying value of the loan is reduced to that portion
considered collectible); and (e) an evaluation of the underlying collateral for
secured lending, including the use of independent appraisals of real estate
properties securing loans. A formal analysis of the adequacy of the allowance is
conducted quarterly and is reviewed by the Board of Directors. Based on this
analysis, management considers the allowance for credit losses to be adequate at
June 30, 2005.
-12-
Periodic provisions for credit losses are made to maintain the allowance for
credit losses at an appropriate level. The provisions are based on an analysis
of various factors including historical loss experience based on volumes and
types of loans, volumes and trends in delinquencies and non-accrual loans,
trends in portfolio volume, results of internal and independent external credit
reviews, and anticipated economic conditions. For additional information, please
see the discussion under the heading "Critical Accounting Policy" in Item 7 of
our Annual Report on Form 10-K for the year ended December 31, 2004.
During the three and six months ended June 30, 2005, a provision of $300,000 and
$600,000, respectively, was provided for possible credit losses, compared to
$300,000 and $370,000 for the same period in 2004. For the three months ended
June 30, 2005, net charge-offs were $2,000 compared to $5,000 for the same
period in 2004. For the six months ended June 30, 2005, net recoveries were
$6,000 compared to net charge-offs of $19,000, for the same period in 2004, and
compared to $144,000 in net charge-offs during the twelve months ended December
31, 2004.
At June 30, 2005, the allowance for credit losses stood at $4,842,000 compared
to $4,236,000 at December 31, 2004, and $3,761,000 at June 30, 2004. This
increase was attributable to the additions in loan loss provision that was
allocated to the allowance for credit losses as a result of continued growth in
the loan portfolio. The ratio of the allowance to total loans outstanding
including loans held for sale was 1.31%, 1.23% and 1.13%, respectively, at June
30, 2005, December 31, 2004, and June 30, 2004.
Non-performing assets and foreclosed real estate owned. Non-performing assets
totaled $8,327,000 at June 30, 2005. This represents 2.25% of total loans
including loans held for sale, compared to $510,000 or .15% at December 31,
2004, and $313,000 or .09% at June 30, 2004. Non-accrual loans at June 30, 2005
totaled $8,287,000. This relates primarily to one borrower involved in the
forest products industry. Although the borrower is continuing operations, the
deteriorating financial condition of the borrower creates the potential the
Company may not be able to collect all principal and interest according to the
terms of the loan. Of the non-accrual loans outstanding, $3,518,000 are
guaranteed by the United States Department of Agriculture representing 42.45% of
non-accrual loans outstanding. Based on current analysis, management has made
provisions in the loan loss reserves for potential losses associated with
non-accrual loans. Foreclosed real estate consists of two properties secured by
real estate with no individual material balances.
ANALYSIS OF NON-PERFORMING ASSETS
JUNE 30 DECEMBER 31 JUNE 30
(in thousands) 2005 2004 2004
Accruing loans past due 90 days or more $ -- $ -- $ 2
Non-accrual loans 8,287 470 227
Foreclosed real estate 40 40 84
TOTAL $8,327 $510 $313
Ratio of non-performing assets to total
total loans outstanding 2.25% .15% .09%
Ratio of non-performing assets to
allowance for credit losses 171.97% 12.04% 8.32%
Non-interest income and expense. Non-interest income for the three and six
months ended June 30, 2005 increased $131,000 and $446,000, respectively,
compared to the same period in 2004. The primary reason for the increases was
gain on sale of loans. Gain on sale of loans totaled $455,000 and $320,000,
respectively, for the three months ended June 30, 2005 and 2004 and totaled
$734,000 and $389,000,
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respectively for the six months ended June 30, 2005 and 2004. This increase is
attributable to a greater volume of loans sold in the secondary market over the
prior year. Origination of loans held for sale were $49,825,000 for the six
months ended June 30, 2005, compared $30,578,000 for the same period in 2004.
Commitment to sell and sale price is established at the time of origination of
loans to limit any potential price risk. Management expects modest levels of
growth in mortgage banking activity to continue for the remainder of the year.
Non-interest expense for the three and six months ended June 30, 2005 increased
$502,000 and $1,774,000, respectively, compared to the same period in 2004. The
BNW acquisition was the major contributing factor to increased non-interest
expense due to the increase of full time equivalent employees, the addition of
five branches, and other operating expenses including expenses incurred in the
opening of the Ferndale, Washington branch in May 2005. Full time equivalent
employees at June 30, 2005 were 171 compared to 156 at June 30, 2004.
Income taxes. The federal income tax provision for the three and six months
ended June 30, 2005 was $650,000 and $1,195,000, respectively, a decrease of
$30,000 for the three month period, and an increase of $36,000 for the six month
period compared to the same periods in 2004. The effective tax rate for the
three and six months ended June 30, 2005 was 30.29% and 30.02%.
Financial Condition. Total assets were $465,673,000 at June 30, 2005, an
increase of $23,882,000, or 5.4%, over year-end 2004. Loans, including loans
held for sale, were $369,541,000 at June 30, 2005, an increase of $21,782,000,
or 6.26%, over year-end 2004. Total deposits were $385,686,000 at June 30, 2005,
an increase of $22,185,000, or 6.10%, compared to December 31, 2004.
Loans. Loan detail by category, including loans held for sale, as of June 30,
2005 and December 31, 2004 follows:
June 30, December 31,
2005 2004
Commercial and industrial $105,808 $ 87,985
Agricultural 20,919 23,065
Real estate mortgage 170,838 175,730
Real estate construction 60,576 49,347
Installment 9,631 9,934
Credit cards and other 1,769 1,698
Total Loans 369,541 347,759
Allowance for credit losses (4,842) (4,236)
Net Loans $364,699 $343,523
Liquidity. Adequate liquidity is available to accommodate fluctuations in
deposit levels, fund operations, and provide for customer credit needs and meet
obligations and commitments on a timely basis. The Company has generally been a
net seller of federal funds. When necessary, liquidity can be increased by
taking advances available from the Federal Home Loan Bank of Seattle.
Shareholders' equity. Total shareholders' equity was $47,912,000 at June 30,
2005, an increase of $2,609,000, or 5.8%, compared to December 31, 2004.
Tangible book value per share was $5.58 at June 30, 2005 compared to $5.16 at
December 31, 2004. Tangible book value is calculated by dividing total equity
capital minus goodwill, by total shares outstanding.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate, credit, and operations risks are the most significant market
risks which affect the Company's performance. The Company relies on loan review,
prudent loan underwriting standards and an adequate allowance for possible
credit losses to mitigate credit risk.
An asset/liability management simulation model is used to measure interest rate
risk. The model produces regulatory oriented measurements of interest rate risk
exposure. The model quantifies interest rate risk by simulating forecasted net
interest income over a 12 month time period under various interest rate
scenarios, as well as monitoring the change in the present value of equity under
the same rate scenarios. The present value of equity is defined as the
difference between the market value of assets less current liabilities. By
measuring the change in the present value of equity under various rate
scenarios, management is able to identify interest rate risk that may not be
evident from changes in forecasted net interest income.
The Company is currently asset sensitive, meaning that interest earning assets
mature or re-price more quickly than interest-bearing liabilities in a given
period. Therefore, a significant increase in market rates of interest could
improve net interest income. Conversely, a decreasing rate environment may
adversely affect net interest income.
It should be noted that the simulation model does not take into account future
management actions that could be undertaken should actual market rates change
during the year. Also, the model simulation results are not exact measures of
the Company's actual interest rate risk. They are rather only indicators of rate
risk exposure, based on assumptions produced in a simplified modeling
environment designed to heighten sensitivity to changes in interest rates. The
rate risk exposure results of the simulation model typically are greater than
the Company's actual rate risk. That is due to the conservative modeling
environment, which generally depicts a worst-case situation. Management has
assessed the results of the simulation reports as of June 30, 2005, and believes
that there has been no material change since December 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
The Company's disclosure controls and procedures are designed to ensure that
information the Company must disclose in its reports filed or submitted under
the Securities Exchange Act of 1934 ("Exchange Act") is recorded, processed,
summarized, and reported on a timely basis. Our management has evaluated, with
the participation and under the supervision of our chief executive officer (CEO)
and chief financial officer (CFO), the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act)
as of the end of the period covered by this report. Based on this evaluation,
our CEO and CFO have concluded that, as of such date, the Company's disclosure
controls and procedures are effective in ensuring that information relating to
the Company, including its consolidated subsidiaries, required to be disclosed
in reports that it files under the Exchange Act is (1) recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (2) accumulated and communicated to our management, including our CEO
and CFO, as appropriate to allow timely decisions regarding required
disclosures.
No change in the Company's internal control over financial reporting occurred
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Previously reported.
ITEM 5. OTHER INFORMATION
Effective July 31, 2005, the Board of Directors of Pacific accelerated the
vesting of underwater stock options previously awarded under the Pacific
Financial Corporation 2000 Stock Option Plan in light of the new accounting
regulations that will take effect in the Company's next fiscal year. The Board
took this action with the belief that it is in the best interests of its
shareholders as it will reduce the Company's reported compensation expense in
future periods.
As a result of the vesting acceleration, options to purchase approximately
257,600 shares of Pacific common stock became exercisable immediately. All of
the stock options were considered underwater or out of the money since the
option exercise price was greater than the current market value. The weighted
average exercise price of accelerated options was $16.59 and the closing price
of the Company's common stock on July 31, 2005 was $14.50.
Under the recently issued Financial Accounting Standard Board Statement No. 123
(Revised 2004), "Share Based Payment " ("FAS 123R"), the Company will be
required to apply the expense recognition provisions of FAS 123R beginning with
the first quarter of its 2006 fiscal year, which begins on January 1, 2006. As a
result of the acceleration, Pacific expects to avoid being required to recognize
stock option expense, net of taxes, totaling approximately $249,000 during
fiscal years 2006 through 2009. The Company, will, however, as a result of this
action show a pro forma stock based compensation expense in the footnotes to its
financial statements of approximately $313,000 net of taxes in the quarter
ending September 30, 2005.
ITEM 6. EXHIBITS
See Exhibit Index immediately following signatures below.
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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 FINANCIAL CORPORATION
DATED: August 8, 2005 By: /s/ Dennis A. Long
------------------
Dennis A. Long
President
By: /s/ Denise Portmann
-------------------
Denise Portmann
Treasurer
Exhibit Index
EXHIBIT NO. EXHIBIT
- ----------- -------
31.1 Certification of CEO under Rule 13a - 14(a) of the Exchange Act.
31.2 Certification of CFO under Rule 13a - 14(a) of the Exchange Act.
32 Certification of CEO and CFO under 18 U.S.C. Section 1350.
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