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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, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 000-29829
PACIFIC FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1815009
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
300 East Market
Street Aberdeen, Washington 98520-5244
(360) 533-8870
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Title of Class Outstanding at July 31, 2004
-------------- ----------------------------
Common Stock, par value $1.00 per share 3,173,339 shares
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TABLE OF CONTENTS
PART I FINANCIAL INFORMATION 3
ITEM 1. FINANCIAL STATEMENTS 3
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2004 AND DECEMBER 31, 2003 3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2004 AND 2003 5
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS'
EQUITY SIX MONTH PERIODS ENDED JUNE 30, 2004 AND 2003 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 15
ITEM 4. CONTROLS AND PROCEDURES 16
PART II OTHER INFORMATION 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 17
SIGNATURES 17
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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
(Dollars in thousands)
Pacific Financial Corporation
June 30, 2004 and December 31, 2003
June 30, December 31,
2004 2003
(Unaudited)
Assets
Cash and due from banks $ 14,109 $ 9,280
Interest bearing balances with banks 10 15,392
Federal funds sold -- 5,000
Investment securities available for sale 40,479 57,473
Investment securities held-to-maturity 8,264 7,988
Federal Home Loan Bank stock, at cost 1,834 915
Loans held for sale 2,160 --
Loans 329,690 199,738
Allowance for credit losses 3,761 2,238
-------- --------
Loans, net 325,929 197,500
Premises and equipment 6,626 3,967
Foreclosed real estate 84 98
Accrued interest receivable 1,735 1,275
Cash surrender value of life insurance 8,857 6,193
Goodwill 10,651 --
Intangible assets 957 --
Other assets 1,638 1,634
-------- --------
Total assets $423,333 $306,715
======== ========
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing $ 66,110 $ 43,862
Interest bearing 276,436 216,938
-------- --------
Total deposits 342,546 260,800
Accrued interest payable 325 234
Short-term borrowings 13,756 --
Long-term borrowings 19,500 14,500
Other liabilities 1,793 5,531
-------- --------
Total liabilities 377,920 281,065
Shareholders' Equity
Common Stock (par value $1); authorized: 3,173 2,522
25,000,000 shares; issued June 30, 2004-
3,173,339 shares;
December 31, 2003-2,521,539 shares
Additional paid-in capital 26,880 10,005
Retained earnings 15,464 12,663
Accumulated other comprehensive income (104) 460
(loss) -------- --------
Total shareholders' equity 45,413 25,650
======== ========
Total liabilities and shareholders' equity $423,333 $306,715
-3-
Condensed Consolidated Statements of Income
(Dollars in thousands, except per share)
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
Interest Income
Loans $5,661 $3,362 $9,817 $6,612
Securities held to maturity:
Taxable 22 45 52 118
Tax-exempt 77 52 118 100
Securities available for sale:
Taxable 297 387 743 818
Tax-exempt 121 119 270 236
Deposits with banks
and federal funds sold 2 26 17 29
------ ------ ------ ------
Total interest income 6,180 3,991 11,017 7,913
Interest Expense
Deposits 904 774 1,652 1,564
Other borrowings 173 122 304 231
------ ------ ------ ------
Total interest expense 1,077 896 1,956 1,795
Net Interest Income 5,103 3,095 9,061 6,118
Provision for credit losses 300 -- 370 --
------ ------ ------ ------
Net interest income after provision
for credit losses 4,803 3,095 8,691 6,118
Non-interest Income
Service charges 337 278 625 528
Gain on sale of loans 320 -- 389 --
Mortgage loan origination fees -- 19 10 41
Gain (loss) on sale of foreclosed real estate 16 3 51 (5)
Gain on sale of investments held for sale -- -- 3 4
Other operating income 230 157 396 333
------ ------ ------ ------
Total non-interest income 903 457 1,474 901
Non-interest Expense
Salaries and employee benefits 2,080 1,173 3,705 2,313
Occupancy and equipment 409 240 711 478
Other 1,110 518 1,789 1,050
------ ------ ----- -----
Total non-interest expense 3,599 1,931 6,205 3,841
Income before income taxes 2,107 1,621 3,960 3,178
Provision for income taxes 680 470 1,159 915
------ ------ ------ ------
Net Income $1,427 $1,151 $2,801 $2,263
Comprehensive Income $ 564 $1,275 $2,237 $2,483
Earnings per common share:
Basic $ .45 $ .46 $ .95 $ .90
Diluted .44 .45 .92 .89
Average shares outstanding:
Basic 3,173,339 2,512,667 2,956,407 2,512,663
Diluted 3,268,873 2,559,680 3,031,350 2,547,491
-4-
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2004 and 2003
(Dollars in thousands)
2004 2003
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net income $ 2,801 $ 2,263
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for credit losses 370 --
Depreciation and amortization 288 207
Deferred income tax (benefit) (17) --
Stock dividends received (32) (26)
Origination of loans held for sale (30,578) --
Proceeds of loans held for sale 29,623 286
Gain on sales of loans (389) --
Gain on sale of investment securities (3) (4)
(Gain) loss on sale of foreclosed real estate (51) 5
Gain on sale of premises and equipment -- (2)
(Increase) decrease in accrued interest receivable (66) 91
Increase (decrease) in accrued interest payable 21 (48)
Write-down of foreclosed real estate -- 119
Other (756) (469)
------- -------
Net cash provided by operating activities 1,211 2,422
INVESTING ACTIVITIES
Net (increase) decrease in federal funds 5,000 (5,000)
(Increase) decrease in interest bearing
deposits with banks 15,574 (8,894)
Purchase of securities held to maturity (1,169) (390)
Purchase of securities available for sale (3,034) (6,553)
Proceeds from maturities of investments held to maturity 869 1,840
Proceeds from sales of securities available for sale 19,060 2,994
Proceeds from maturities of
securities available for sale 4,612 5,258
Net increase in loans (20,320) (975)
Additions to foreclosed real estate -- (21)
Proceeds from sales of foreclosed real estate 414 613
Additions to premises and equipment (1,789) (63)
Proceeds from sales of premises and equipment -- 2
Purchase of bank owned life insurance (2,500) --
Acquisition, net of cash received 3,146 --
------- -------
Net cash provided by (used in) investing activities 19,863 (11,189)
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FINANCING ACTIVITIES
Net increase (decrease) in deposits (6,344) 11,671
Net decrease in short-term borrowings (11,577) (1,800)
Proceeds from issuance of long-term debt 7,000 3,500
Repayments of long-term debt (2,000) --
Stock options exercised 206 --
Payment of dividends (3,530) (3,392)
------- -------
Net cash provided by (used in) financing activities (16,245) 9,979
Net increase (decrease) in cash and due from banks $ 4,829 $ 1,212
CASH AND DUE FROM BANKS
Beginning of period $ 9,280 $8,473
End of period $14,109 $ 9,685
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 1,865 $ 1,843
Income Taxes 1,070 1,180
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES
Foreclosed real estate acquired in settlement of loans $ (349) $(1,109)
Financed sale of foreclosed real estate -- 54
Change in fair value of securities available
for sale, net of tax 564 220
Common stock issued upon business combination 17,282 --
Condensed Consolidated Statements of Shareholders' Equity
Six months ended June 30, 2004 and 2003
(Dollars in thousands) (Unaudited)
ACCUMULATED
OTHER
ADDITIONAL COMPREHENSIVE
COMMON PAID-IN RETAINED INCOME
STOCK CAPITAL EARNINGS (LOSS) TOTAL
Balance December 31, 2002 $2,513 $ 9,839 $11,614 $ 717 $24,683
Other comprehensive income:
Net income 2,263 2,263
Change in fair value of
securities available for sale, net 220 220
Comprehensive income 2,483
------ ------ ------ ------ ------
Balance June 30, 2003 $2,513 $9,839 $13,877 $ 937 $27,166
Balance December 31, 2003 $2,522 $10,005 $12,663 $ 460 $25,650
Issuance of common stock 636 16,646 17,282
Stock options exercised 15 191 206
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 (564) (564)
securities available for sale, net
Comprehensive income 2,237
------ ------- ------- ----- -------
Balance June 30, 2004 $3,173 $26,880 $15,464 $(104) $45,413
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NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial
statements have been prepared by Pacific Financial Corporation ("Pacific" or the
"Company") in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with instructions
to Form 10-Q. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
six months ended June 30, 2004, are not necessarily indicative of the results
anticipated for the year ending December 31, 2004. Certain information and
footnote disclosures included in the Company's consolidated financial statements
for the year ended December 31, 2003, have been condensed or omitted from this
report. Accordingly, these statements should be read with the financial
statements and notes thereto included in the Company's December 31, 2003 Annual
Report on Form 10-K.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
All dollar amounts in tables, except per share information, are stated in
thousands.
2. INVESTMENT SECURITIES
Investment securities consist principally of short and
intermediate term debt instruments issued by the U.S. Treasury, other U.S.
government agencies, state and local government units, and other corporations.
SECURITIES HELD TO MATURITY AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
June 30, 2004
U.S. Government Securities $ 2,114 $ 11 $ -- $ 2,125
State and Municipal Securities 6,150 23 119 6,054
------- ---- ---- -------
TOTAL $ 8,264 $ 34 $119 $ 8,179
SECURITIES AVAILABLE FOR SALE AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
June 30, 2004
U.S. Government Securities $17,605 $149 $376 $17,378
State and Municipal Securities 14,963 334 212 15,083
Corporate Securities 4,109 87 57 4,139
Mutual Funds 3,958 -- 81 3,880
------- ---- ---- ------
TOTAL $40,635 $570 $726 $40,479
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3. ALLOWANCES FOR CREDIT LOSSES
TWELVE
THREE MONTHS ENDED SIX MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30, DECEMBER 31,
2004 2003 2004 2003 2003
---- ---- ---- ---- ----
Balance at beginning of period $3,466 $2,354 $2,238 $2,473 $2,473
BNW Bancorp, Inc. acquisition -- -- 1,172 -- --
Provision for possible credit losses 300 -- 370 -- --
Charge-offs (10) (5) (29) (125) (265)
Recoveries 5 1 10 2 30
Net charge-offs (5) (4) (19) (123) (235)
------ ------ ------ ------ ------
Balance at end of period $3,761 $2,350 $3,761 $2,350 $2,238
Ratio of net charge-offs to
average loans outstanding .01% .23% .01% .33% .12%
4. COMPUTATION OF BASIC EARNINGS PER SHARE:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
Net Income $1,427,000 $1,151,000 $2,801,000 $2,263,000
Average Shares Outstanding 3,173,339 2,512,667 2,956,407 2,512,663
Basic Earnings Per Share $ .45 $ .46 $ .95 $ .90
5. COMPUTATION OF DILUTED EARNINGS PER SHARE:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
Net Income $1,427,000 $1,151,000 $2,801,000 $2,263,000
Average Shares Outstanding 3,173,339 2,512,667 2,956,407 2,512,663
Effect of dilutive securities 95,534 47,013 74,943 34,828
Average Shares Outstanding and
Assumed conversion of dilutive
Stock options 3,268,873 2,559,680 3,031,350 2,547,491
Diluted Earnings Per Share $ 0.44 $ 0.45 $ .92 $ .89
-8-
6. EQUITY COMPENSATION PLANS
At June 30, 2004, 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, other than the $24,000 expensed in the current period for accelerated
vesting on retiring director options, as all options granted under this plan had
an exercise price equal to the market value of the underlying common stock on
the date of grant. The following table illustrates the effect on net income and
earnings per share had the Company applied the fair value recognition provisions
of FASB Statement No. 123, Accounting for Stock-Based Compensation, to
stock-based employee compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
Net Income, as reported $1,427,000 $1,151,000 $2,801,000 $2,263,000
Add stock compensation expensed 24,000 -- 24,000 --
Less total stock-based compensation
expense determined under fair value
method for all qualifying awards, net 39,000 21,000 79,000 43,000
of tax
Pro forma net income 1,412,000 1,130,000 2,746,000 2,220,000
Earnings per Share
Basic:
As reported .45 .46 .95 .90
Pro forma .44 .45 .93 .88
Diluted:
As reported .44 .45 .92 .89
Pro forma .43 .44 .91 .87
7. Acquisition
On February 27, 2004, the Company completed the acquisition of BNW Bancorp, Inc.
Each share of BNW Bancorp, Inc. was exchanged for 0.85 shares of the Company's
common stock resulting in the issuance of 636,562 new shares. The acquisition
was accounted for using the purchase method of accounting and, accordingly, the
assets and liabilities of BNW Bancorp, Inc. were recorded at their respective
fair value. Goodwill, the excess of the purchase price over the net fair value
of the assets and liabilities acquired, was recorded at $10,651,000. As part of
the accounting for the acquisition, the Company recorded an identifiable
intangible asset. A core deposit intangible of $993,000 was recorded.
The Company will follow the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 provides that goodwill is no longer amortized
and the value of an identifiable intangible asset is amortized over its useful
life, unless the asset is determined to
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have an indefinite life. The Company will review the recorded value of goodwill
on an annual basis for impairment. The annual test for impairment will be a two
step process. The first step will be to compare the current value of BNW
Bancorp, Inc. with its fair value on the purchase date. If the current value
exceeds the purchase value, goodwill will not be considered to be impaired and
the test is completed. If the purchase fair value is greater than the current
value, the implied value of the goodwill will be analyzed against the carrying
value of the goodwill. Any noted impairment losses will be taken at that time.
The core deposit intangible recorded as part of the acquisition has an estimated
life of seven years. Estimated amortization expense will be approximately
$118,000 for the year ended December 31, 2004 and $142,000 for the years ended
December 31, 2005 through 2010 and $23,000 for the year ended December 31, 2011.
The following unaudited pro forma financials for the three and six months ended
June 30, 2004 and 2003 assumes that the BNW acquisition occurred as of January
of each fiscal year, after giving effect to certain adjustments. The pro forma
results have been prepared for comparative purposes only and are not necessarily
indicative of the results of operations which may occur in the future or that
would have occurred had the BNW acquisition been consummated on the date
indicated.
Pro Forma Financial Information for the
Six Months Ended June 30,
2004 2003
----------------------
(in thousands)
Net Interest Income $ 9,952 $ 8,493
Non-interest Income 1,587 1,608
Non-interest Expense 7,652 6,180
------- -------
Net Income $ 2,422 $ 2,536
======= =======
Earnings Per Share:
Basic $ 0.76 $ 0.81
Diluted 0.74 0.79
Pro Forma Financial Information for the
Three Months Ended June 30,
2004 2003
----------------------
(in thousands)
Net Interest Income $ 5,104 $ 4,377
Non-interest Income 903 836
Non-interest Expense 3,587 3,118
------- -------
Net Income $ 1,604 $ 1,316
======= =======
Earnings Per Share:
Basic $ 0.51 $ 0.42
Diluted $ 0.49 0.41
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
A WARNING ABOUT FORWARD-LOOKING INFORMATION
This document contains forward-looking statements that are subject to risks and
uncertainties. These statements are based on the beliefs and assumptions of our
management, and on information currently available to them. Forward-looking
statements include the information concerning our possible future results of
operations set forth under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and statements preceded by, followed by or
that include the words "believes," "expects," "anticipates," "intends," "plans,"
"estimates" or similar expressions.
Any forward-looking statements in this document are subject to risks relating
to, among other things, the following:
1. competitive pressures among depository and other financial
institutions that may impede our ability to attract and retain borrowers,
depositors and other customers, retain key employees, and/or maintain our
interest margins and fee income;
2. changes in the interest rate environment that may reduce margins
or decrease the value of our securities;
3. our recent acquisition of BNW Bancorp may be dilutive to earnings
per share if we do not realize expected cost savings or successfully
integrate BNW Bancorp into the Company without significant customer or
employee disruptions or losses;
4. our growth strategy, particularly if accomplished through
acquisitions, may not be successful if we fail to accurately assess market
opportunities, asset quality, anticipated cost savings, and transaction
costs, or experience significant difficulty integrating acquired
businesses or assets;
5. general economic or business conditions, either nationally or in
the regions in which we do business, may be less favorable than expected,
resulting in, among other things, a deterioration in credit quality or a
reduced demand for credit; and
6. a lack of liquidity in the market for our common stock that may
make it difficult or impossible for you to liquidate your investment in
our stock or lead to distortions in the market price of our stock.
Our management believes the forward-looking statements are reasonable; however,
you should not place undue reliance on them. Forward-looking statements are not
guarantees of performance. They involve risks, uncertainties and assumptions.
Many of the factors that will determine our future results and share value are
beyond our ability to control or predict. We undertake no obligation to update
forward-looking statements.
-11-
NET INCOME. For the three months ended June 30, 2004, Pacific's net income was
$1,427,000 compared to $1,151,000 for the same period in 2003. For the six
months ended June 30, 2004, net income was $2,801,000 compared to $2,263,000 for
the same period in 2003. The most significant factor contributing to the
increase was the acquisition of BNW Bancorp ("BNW") effective as of the close of
business on February 27, 2004. We expect the BNW acquisition to continue to have
a significant effect on net income for the remainder of the year 2004 due to
strong loan demand in both the Bank's new market area and its historical market
area.
NET INTEREST INCOME. Net interest income for the three and six months ended June
30, 2004 increased $2,008,000, or 64.9%, and $2,943,000 or 48.1%, respectively,
compared to the same periods in 2003. This is due primarily to increased
interest income from loans and the effect of the BNW acquisition at the end of
February 2004. The Company acquired $109,569,000 of net loans as part of the BNW
acquisition. The portfolio consisted of approximately $79,700,000 in real estate
loans, $25,600,000 in commercial loans and $4,269,000 in consumer loans, the
average yield on the portfolio was approximately 6.83% at June 30, 2004.
Interest income for the three and six months ended June 30, 2004, increased
$2,189,000, or 54.8%, and $3,104,000, or 39.2%, respectively, compared to the
same period in 2003. Average total loans outstanding for the six months ended
June 30, 2004, and June 30, 2003, were $327,146,000, and $186,573,000,
respectively, or an increase of 75.3% in 2004 over 2003.
Interest expense for the three and six months ended June 30, 2004 increased
$181,000, or 20.2%, and $161,000, or 9.0%, respectively, compared to the same
period in 2003. The increase is attributable primarily due to increased short
term borrowings. Average interest-bearing deposit balances for the six months
ended June 30, 2004 and June 30, 2003 were $276,678,000 and $192,177,000,
respectively, representing an increase of 44.0% compared to last year's period.
The increase is attributable primarily to the BNW acquisition closed February
27, 2004. The Company acquired deposits valued at $88,853,000 as part of the
acquisition. The deposit composition consists of approximately $15,600,000 in
non-interest bearing accounts, $33,800,000 in certificates of deposit, and
approximately $39,400,000 in other savings deposits with an average cost of
total deposits of 1.39% at June 30, 2004.
Average short term borrowings for the six months ended June 30, 2004 and June
30, 2003 were $13,620,000 and none, respectively, an increase of 100.0% over the
2003 period. The increase was applied primarily to funding the loan commitments
outstanding for the BNW acquisition. Average long term borrowings for the six
months ended June 30, 2004 were $13,923,000 compared to $13,634,000 for the same
period in 2003.
PROVISION AND ALLOWANCE FOR CREDIT LOSSES. The allowance for credit losses
reflects management's current estimate of the amount required to absorb losses
on existing loans and commitments to extend credit. Loans deemed uncollectible
are charged against and reduce the allowance. Periodically, a provision for
credit losses is charged to current expense. This provision acts to replenish
the allowance for credit losses and to maintain the allowance at a level that
management deems adequate.
-12-
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, 2004.
Periodic provisions for credit losses are made to maintain the allowance for
credit losses at an appropriate level. The provisions are based on an analysis
of various factors including historical loss experience based on volumes and
types of loans, volumes and trends in delinquencies and non-accrual loans,
trends in portfolio volume, results of internal and independent external credit
reviews, and anticipated economic conditions. For additional information, please
see the discussion under the heading "Critical Accounting Policy" in Item 7 of
our Annual Report on Form 10-K for the year ended December 31, 2003.
During the three and six months ended June 30, 2004, a provision of $300,000 and
$370,000, respectively, was provided for possible credit losses, compared to no
provision in the same periods in 2003. For the three and six months ended June
30, 2004, net charge-offs were $5,000, and $19,000, respectively, compared to
net charge-offs of $4,000 and $123,000, during the same periods in 2003, and
compared to $235,000 in net charge-offs during the twelve months ended December
31, 2003.
At June 30, 2004, the allowance for credit losses stood at $3,761,000 compared
to $2,238,000 at December 31, 2003, and $2,350,000 at June 30, 2003.
Approximately $1,172,000 of this increase was attributable to the BNW
acquisition. The ratio of the allowance to total loans outstanding was 1.13%,
1.12% and 1.27%, respectively, at June 30, 2004, December 31, 2003, and June 30,
2003.
NON-PERFORMANING ASSETS AND FORECLOSED REAL ESTATE OWNED. Non-performing assets
totaled $313,000 at June 30, 2004. This represents .09% of total loans, compared
to $563,000 or .27% at December 31, 2003, and $1,663,000 or .90% at June 30,
2003. The decrease during the period ended June 30, 2004, is due primarily to
the pay-off of a USDA guaranteed commercial loan, that was previously in
non-accrual status. Non-accrual loans at June 30, 2004 totaled $227,000. Based
on current analysis, management believes losses associated with non-accrual
loans will be minimal. Foreclosed real estate consists of two properties secured
by real estate with no individual material balances.
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ANALYSIS OF NON-PERFORMING ASSETS
JUNE 30 DECEMBER 31 JUNE 30
(in thousands) 2004 2003 2003
Accruing loans past due 90 days or more $ 2 $ -- $ 148
Non-accrual loans 227 465 490
Foreclosed real estate 84 98 1,025
---- ---- ------
TOTAL $313 $563 $1,663
NON-INTEREST INCOME AND EXPENSE. Non-interest income for the three and six
months ended June 30, 2004 increased $446,000, and $573,000, respectively,
compared to the same period in 2003. The primary reason for the increases, were
due to service charge income and gain on sale of loans. Service charges on
deposit accounts increased $59,000, and $97,000, respectively, compared to the
three and six months ended June 30, 2003. This is due in part to the
implementation of the Bank's customer overdraft protection program in the
branches acquired with the BNW transaction. Gain on sale of loans totaled
$320,000 for the three months ended June 30, 2004, and totaled $389,000 for the
six month period in 2004. Prior to 2004, the Company did not sell loans into the
secondary market. However, a real estate mortgage department was included with
the BNW acquisition, resulting in revenues relating to gain on sale of loans.
Commitment to sell and sale price is established at the time of origination to
limit any potential price risk.
Non-interest expense for the three and six months ended June 30, 2004 increased
$1,668,000, and $2,364,000, respectively, compared to the same period in 2003.
The BNW acquisition was the major contributing factor to increased non-interest
expense due to the increase of full time equivalent employees and the addition
of five branches.
INCOME TAXES. The federal income tax provision for the three and six months
ended June 30, 2004 was $680,000, and $1,159,000, respectively, an increase of
$210,000 for the three month period, and an increase of $244,000, for the six
month period, compared to the same periods in 2003. The effective tax rate for
the three and six months ended June 30, 2004 was 32.27% and 29.26%. Financial
Condition. Total assets were $423,333,000 at June 30, 2004, an increase of
$116,618,000, or 38.1%, over year-end 2003. Loans, including loans held for
sale, were $331,850,000 at June 30, 2004, an increase of $132,112,000, or 66.1%,
over year-end 2003. Total deposits were $342,546,000 at June 30, 2004, an
increase of $81,746,000, or 31.3%, compared to December 31, 2003. Increases in
assets, loans and deposit balances were primarily the result of the BNW
acquisition, although the Company did see growth in each category in its
historical markets.
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LOANS. Loan detail by category, including loans held for sale, as of June 30,
2004 and December 31, 2003 follows:
June 30, December 31,
2004 2003
Commercial and industrial $ 87,923 $ 59,665
Agricultural 18,640 4,679
Real estate mortgage 172,712 117,940
Real estate construction 42,020 11,894
Installment 7,077 4,625
Credit cards and other 3,478 935
-------- --------
Total Loans 331,850 199,738
Allowance for credit losses (3,761) (2,238)
-------- --------
Net Loans $328,089 $197,500
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 $45,413,000 at June 30,
2004, an increase of $19,763,000, or 77.0%, compared to December 31, 2003. The
increase was due to net income and the acquisition of BNW Bancorp effective
February 27, 2004, which was accounted for as a purchase transaction. Tangible
book value per share was $10.95 at June 30, 2004 compared to $10.17 at December
31, 2003. Tangible book value is calculated by dividing total equity capital
minus goodwill, by total shares outstanding.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate, credit, and operations risks are the most significant market
risks which affect the Company's performance. The Company relies on loan review,
prudent loan underwriting standards and an adequate allowance for possible
credit losses to mitigate credit risk.
An asset/liability management simulation model is used to measure interest rate
risk. The model produces regulatory oriented measurements of interest rate risk
exposure. The model quantifies interest rate risk by simulating forecasted net
interest income over a 12 month time period under various interest rate
scenarios, as well as monitoring the change in the present value of equity under
the same rate scenarios. The present value of equity is defined as the
difference between the market value of assets less current liabilities. By
measuring the change in the present value of equity under various rate
scenarios, management is able to identify interest rate risk that may not be
evident from changes in forecasted net interest income.
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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, 2004, and believes
that there has been no material change since December 31, 2003.
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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
See Exhibit Index immediately following signatures below.
(b) Reports on Form 8-K:
8-K filed April 9, 2004, to release earnings for the quarter ended March 31,
2004
8-K/A filed April 26, 2004, amending previously filed report to provide
required financial information relating to the BNW acquisition
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 11, 2004 By: /s/ Dennis A. Long
------------------------
Dennis A. Long
President
By: /s/ John Van Dijk
------------------------
John Van Dijk, Secretary
(Principal Financial and
Accounting Officer)
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Exhibit Index
EXHIBIT NO. EXHIBIT
----------- -------
31.1 Certification of CEO under Rule 13a - 14(a) of the Exchange Act.
31.2 Certification of CFO under Rule 13a - 14(a) of the Exchange Act.
32 Certification of CEO and CFO under 18 U.S.C. Section 1350.
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