Pacific Financial Corp 1Q17 Earnings Increase 16% to $1.6 Million, or $0.15 per Share, from 1Q16; 1Q17 Profits Grow 9% from 4Q16

ABERDEEN, Wash., April 20, 2017 (GLOBE NEWSWIRE) — Pacific Financial Corporation (OTCQB:PFLC), the holding company for Bank of the Pacific today reported net income increased 9% to $1.6 million, or $0.15 per share, for the first quarter of 2017, compared to $1.5 million, or $0.14 per share for the fourth quarter of 2016, and grew 16% from $1.4 million, or $0.13 per share, for the first quarter of 2016. Driving profitability in 2017 was steady loan growth, an expanded net interest margin and improving operating efficiencies. All results are unaudited.

“After delivering record earnings for 2016, we continued the momentum of achieving sound financial results for the first quarter. The sustained strength of our core earnings resulted from steady loan growth, expanding net interest margin and improved expense controls. In addition, revenue from our residential real estate mortgage operation continued to be a solid source of non-interest income, despite recent increases in mortgage interest rates,” remarked Denise Portmann, President & Chief Executive Officer. “Financing of purchase activity continues to be strong. Demand for residential housing remains robust, but low supply in several of our markets is inhibiting sales to some degree. As construction activity accelerates to meet demand for additional housing, our residential mortgage lending group is well situated to generate additional revenue from the anticipated increase in purchase activity.”

“Our asset quality continues to be solid, as delinquent and non-performing loans remain at low levels. The payoff of a $2.0 million adversely classified loan and sale of our last other-real-estate-owned (OREO) property during the quarter further strengthened our asset quality,” added Portmann. “Our loan growth over the recent quarters has been moderate as we continue to foster a strong risk management culture by administering our commercial real estate portfolio well within regulatory concentration guidelines.”

First Quarter 2017 Highlights (as of, or for the period ended March 31, 2017, except as noted):

Net interest margin (NIM), on a tax equivalent basis, expanded 19 basis point to 4.19%, as compared to 4.00% in the preceding quarter, primarily due to an increase in loan and investment security yields, impacted by recent increases in interest rates. NIM contracted 8 basis points from 4.27% for the first quarter 2016, which was enhanced by 12 basis points (annualized) due to additional one-time interest income resulting from a loan agreement breach.
Total assets declined slightly to $872.8 million, at March 31, 2017, compared to $891.4 million, at December 31, 2016, and grew 5% from $829.5 million, at March 31, 2016.
Gross loans grew by $9.1 million, or 1%, to $668.4 million, on a linked quarter basis and increased by $23.5 million, or 4%, over the first quarter of 2016.
Total deposits decreased 2% to $762.0 million, compared to $779.7 million at December 31, 2016, and increased 5% from a year earlier. Seasonal outflows of deposits normally begin in the winter and extend into spring due to the slowdown of tourism activity in certain core markets. As a result, non-interest bearing demand deposits declined 2% on a linked quarter basis, but grew 18% over the first quarter of 2016.
Nonperforming assets were $1.3 million, or 0.15% of total assets, compared to 0.20% on a linked quarter basis and 0.47% a year ago. The allowance for loan losses to gross loans stood at 1.38% at March 31, 2017, as compared to 1.39% and 1.33% at December 31, 2016 and March 31, 2016, respectively.
Net charge-offs totaled $97,000, or 0.06% of average gross loans in the first quarter, compared to net recoveries of $48,000, or 0.03% of average gross loans, in fourth quarter 2016 and net charge-offs of $27,000, or 0.02% of average gross loans, in first quarter 2016. Loans 30 – 89 days’ delinquent, not in nonaccrual status, were minimal at 0.03% of total loans outstanding.
Adversely classified loans were $15.0 million, or 2.24% of gross loans, compared to 2.68% and 2.72% at December 31, 2016 and March 31, 2016, respectively. The recent decrease was primarily due to the payoff of a $2.0 million adversely classified commercial participation loan during the current period.

Operating Results

Total assets were down slightly from the linked quarter, due primarily to expected seasonal declines in deposits. Growth in loans and loans held for sale was offset by declines in cash equivalents and investment securities. Total assets were higher year-over-year primarily in loans, investment securities and cash equivalents, funded by increases in core deposits resulting from growth in commercial deposit relationships from both new and existing clients. Liquidity remains strong, including ample unused borrowing capacity. Capital ratios continue to exceed the thresholds to be considered “Well-Capitalized” under published regulatory standards.

Balance Sheet Overview
(Unaudited)

		March 31, 2017			Dec 31, 2016			$ Change		% Change			March 31, 2016			$ Change		% Change
Assets:		(Dollars in thousands, except per share data)
Cash and cash equivalents	$	28,230		$	59,298		$	(31,068	)	-52	%	$	22,961		$	5,269		23	%
Other interest earning deposits		2,231			2,231			–		0	%		2,727			(496	)	-18	%
Investment securities		109,963			112,155			(2,192	)	-2	%		96,004			13,959		15	%
Loans held-for-sale		12,309			6,572			5,737		87	%		9,446			2,863		30	%
Loans, net of deferred fees		666,918			657,803			9,115		1	%		643,377			23,541		4	%
Allowance for loan losses		(9,217	)		(9,192	)		(25	)	0	%		(8,552	)		(665	)	8	%
Net loans		657,701			648,611			9,090		1	%		634,825			22,876		4	%
Federal Home Loan Bank and Pacific Coast Bankers’ Bank stock, at cost		2,413			2,335			78		3	%		2,339			74		3	%
Other assets		59,962			60,181			(219	)	0	%		61,205			(1,243	)	-2	%
Total assets	$	872,809		$	891,383		$	(18,574	)	-2	%	$	829,507		$	43,302		5	%

Liabilities and Shareholders’ Equity:
Total deposits	$	761,951		$	779,731		$	(17,780	)	-2	%	$	722,736		$	39,215		5	%
Borrowings		22,019			22,056			(37	)	0	%		22,169			(150	)	-1	%
Accrued interest payable and other liabilities		7,008			9,591			(2,583	)	-27	%		6,147			861		14	%
Shareholders’ equity		81,831			80,005			1,826		2	%		78,455			3,376		4	%
Total liabilities and shareholders’ equity	$	872,809		$	891,383		$	(18,574	)	-2	%	$	829,507		$	43,302		5	%

Common Stock Shares Outstanding		10,436,544			10,424,541			12,003		0	%		10,417,868			18,676		0	%

Book value per common share ⁽¹⁾	$	7.84		$	7.67		$	0.17		2	%	$	7.53		$	0.31		4	%
Tangible book value per common share ⁽²⁾	$	6.54		$	6.38		$	0.16		3	%	$	6.23		$	0.31		5	%
Gross loans to deposits ratio		87.5	%		84.4	%							89.0	%

⁽¹⁾ Book value per common share is calculated as the total common shareholders’ equity divided by the period ending number of common stock shares outstanding.
⁽²⁾ Tangible book value per common share is calculated as the total common shareholders’ equity less total intangible assets and liabilities, divided by the period ending number of common stock shares outstanding.

Net interest income remained relatively unchanged from the linked quarter, due primarily to a moderation of loan growth and a reduction in investment securities and cash equivalents caused by a seasonal decline in deposits. Net interest income grew 2% versus the comparable quarter a year ago, reflecting the growth in earning assets over the recent quarters. Loan balances increased year-over-year due to loan production generated predominately in Western Washington and Oregon. Interest expense remained virtually unchanged as compared to the linked quarter.

Interest expense grew compared to the corresponding period in 2016, reflecting growth in core deposits and rate increases LIBOR-based junior subordinated debentures. The continued growth of noninterest bearing deposits mitigated the impact of the addition of longer-term deposits on funding costs.

Pre-tax, pre-credit operating income (non-GAAP) declined 20% to $2.2 million for the first quarter of 2017 from $2.8 million for the fourth quarter of 2016. This decline was primarily due to a decrease of $576,000 in gains on sale of residential real estate loans as a result of typical seasonal slowdown in mortgage activity during the reporting quarter. Pre-tax, pre-credit operating income (non-GAAP) increased 27%, compared to $1.8 million for the first quarter of 2016, primarily due to growth in net interest income, fee income and reduction in noninterest expense.

Income Statement Overview
(Unaudited)

			For the Three Months Ended,
			March 31, 2017		Dec 31, 2016		$ Change		% Change			March 31, 2016		$ Change		% Change
			(Dollars in thousands, except per share data)
Interest and dividend income		$	8,678	$	8,694	$	(16	)	0	%	$	8,529	$	149		2	%
Interest expense			620		621		(1	)	0	%		607		13		2	%
	Net interest income		8,058		8,073		(15	)	0	%		7,922		136		2	%
Loan loss provision			122		184		(62	)	-34	%		262		(140	)	-53	%
Noninterest income			2,281		2,571		(290	)	-11	%		2,531		(250	)	-10	%
Noninterest expense			8,150		8,507		(357	)	-4	%		8,270		(120	)	-1	%
Income before income taxes			2,067		1,953		114		6	%		1,921		146		8	%
Income tax expense			476		493		(17	)	-3	%		545		(69	)	-13	%
	Net Income	$	1,591	$	1,460	$	131		9	%	$	1,376	$	215		16	%

Average common shares outstanding – basic			10,430,276		10,422,889		7,387		0	%		10,401,140		29,136		0	%
Average common shares outstanding – diluted			10,653,999		10,625,295		28,704		0	%		10,547,413		106,586		1	%

Income per common share
	Basic	$	0.15	$	0.14	$	0.01		7	%	$	0.13	$	0.02		15	%
	Diluted	$	0.15	$	0.14	$	0.01		7	%	$	0.13	$	0.02		15	%

The following tables provide the reconciliation of net income to pre-tax, pre-credit operating income (non-GAAP):

Reconciliation of Non-GAAP Measure
(Unaudited)

		For the Three Months Ended,
		March 31, 2017		Dec 31, 2016		$ Change		% Change			March 31, 2016			$ Change		% Change
Non-GAAP Operating Income		(Dollars in thousands)
Net Income	$	1,591	$	1,460	$	131		9	%	$	1,376		$	215		16	%
Loan loss provision		122		184		(62	)	-34	%		262			(140	)	-53	%
Loss on sale of other real estate owned, net		52		328		(276	)	-84	%		(420	)		472		-112	%
Loss on real estate owned, net		–		324		(324	)	100	%		–			–		0	%
Income tax expense		476		493		(17	)	-3	%		545			(69	)	-13	%
Pre-tax, pre-credit operating income	$	2,241	$	2,789	$	(548	)	-20	%	$	1,763		$	478		27	%

Noninterest Income

Noninterest income was down versus the linked quarter, primarily due to a decline in gross revenue from the sale of residential mortgage loans, primarily due to seasonal decreases in residential sales activity typical for the first quarter. Also, recent increases in mortgage rates have moderated demand for refinancing. However, demand for purchase financing remains strong, with robust demand for new homes chasing a limited supply of new houses in several of our Western Washington and Oregon markets. Indicative of these trends, Realtor.com recently ranked Seattle, WA and Portland, OR as the #1 and #8 cities, respectively, for housing shortages in the country. Supply constraints have also resulted from increased governmental regulations governing real estate development promulgated over the past several years.

Loss on sale of OREO during the current period declined as compared to the linked quarter, with the disposal of the Bank’s last OREO property. Noninterest income also declined, compared to the year-over-year quarter, primarily as a result of a $351,000 gain on the sale of a $1.2 million OREO property in the first quarter of 2016. In addition, fee income from ATM/debit card activity increased on a linked quarter basis and year-over-year, mainly due to the impacts of recent promotional activities and growth in debit card usage.

Noninterest Income
(Unaudited)
			For the Three Months Ended,
			March 31, 2017			Dec 31, 2016			$ Change		% Change			March 31, 2016		$ Change		% Change
			(Dollars in thousands)
Service charges on deposits		$	460		$	465		$	(5	)	-1	%	$	449	$	11		2	%
Net loss on sale of other real estate owned, net			(52	)		(328	)		276		100	%		420		(472	)	-112	%
Gain on sale of loans, net			1,020			1,596			(576	)	-36	%		1,032		(12	)	-1	%
Gain on sale of securities available for sale, net			79			–			79		0	%		–		79		100	%
Earnings on bank owned life insurance			110			114			(4	)	-4	%		121		(11	)	-9	%
Other noninterest income
	Fee income		609			616			(7	)	-1	%		443		166		37	%
	Other		55			108			(53	)	-49	%		66		(11	)	-17	%
Total noninterest income		$	2,281		$	2,571		$	(290	)	-11	%	$	2,531	$	(250	)	-10	%

Noninterest Expense

Noninterest expense decreased from the immediate prior quarter, primarily due to a write-down of $324,000 taken in the fourth quarter of 2016 to reduce the carrying value of a former branch property, now held for sale, to reflect its current fair value. In addition, compensation expenses declined on a linked quarter basis due to a drop in commissions paid associated with a reduction in residential real estate mortgage activity during the current period. Noninterest expense was also down compared to the year-over-year quarter, primarily related to $348,000 in OREO operating expense incurred in the first quarter of 2016 to prepare a $1.2 million OREO property for its eventual sale. Executive recruitment expenses of $49,000 were also incurred in the current period to engage a firm to conduct a search to replace the Bank’s Chief Credit Officer who retired as of April 1, 2017.

Noninterest Expense
(Unaudited)

		For the Three Months Ended,
		March 31, 2017		Dec 31, 2016		$ Change		% Change			March 31, 2016		$ Change		% Change
		(Dollars in thousands)
Salaries and employee benefits	$	5,147	$	5,341	$	(194	)	-4	%	$	5,057	$	90		2	%
Occupancy		502		537		(35	)	-7	%		495		7		1	%
Equipment		282		266		16		6	%		259		23		9	%
Data processing		539		532		7		1	%		491		48		10	%
Professional services		217		170		47		28	%		151		66		44	%
Other real estate owned write-downs		–		–		–		0	%		–		–		0	%
Other real estate owned operating costs		11		26		(15	)	-58	%		417		(406	)	-97	%
State and local taxes		130		87		43		49	%		121		9		7	%
FDIC and State assessments		106		78		28		36	%		134		(28	)	-21	%
Other noninterest expense:
Director fees		51		71		(20	)	-28	%		72		(21	)	-29	%
Communication		88		77		11		14	%		64		24		38	%
Advertising		81		85		(4	)	-5	%		71		10		14	%
Professional liability insurance		47		47		–		0	%		48		(1	)	-2	%
Amortization		62		62		–		0	%		57		5		9	%
Loss on real estate owned, net		–		324		(324	)	100	%		–		–		0	%
Other		887		804		83		10	%		833		54		6	%
Total noninterest expense	$	8,150	$	8,507	$	(357	)	-4	%	$	8,270	$	(120	)	-1	%

Financial Performance Overview
(Unaudited)

	For the Three Months Ended
	March 31, 2017		Dec 31, 2016		Change		March 31, 2016		Change
Performance Ratios
Return on average assets, annualized	0.75	%	0.65	%	0.10		0.67	%	0.08
Return on average equity, annualized	7.92	%	6.94	%	0.98		7.11	%	0.81
Efficiency ratio ⁽¹⁾	78.83	%	79.92	%	(1.09	)	79.12	%	(0.29	)

⁽¹⁾ Non-interest expense divided by net interest income plus noninterest income.

LIQUIDITY

Cash and Cash Equivalents and Investment Securities
(Unaudited)
		March 31, 2017	% of Total			Dec 31, 2016	% of Total			$ Change		% Change			March 31, 2016	Total			$ Change		% Change
		(Dollars in thousands)
Cash on hand and in banks	$	16,057	11	%	$	15,707	9	%	$	350		2	%	$	13,868	12	%	$	2,189		16	%
Interest bearing deposits		12,173	9	%		43,591	25	%		(31,418	)	-72	%		9,093	7	%		3,080		34	%
Other interest earning deposits		2,231	2	%		2,231	1	%		–		0	%		2,727	2	%		(496	)	-18	%
Total cash equivalents and interest earning deposits		30,461	22	%		61,529	35	%		(31,068	)	-50	%		25,688	21	%		4,773		19	%

Investment securities:
Collateralized mortgage obligations: agency issued		40,079	29	%		35,514	20	%		4,565		13	%		35,020	29	%		5,059		14	%
Collateralized mortgage obligations: non-agency		305	0	%		331	0	%		(26	)	-8	%		483	0	%		(178	)	-37	%
Mortgage-backed securities: agency issued		14,645	10	%		14,166	8	%		479		3	%		10,920	9	%		3,725		34	%
U.S. Government and agency securities		2,617	2	%		8,716	5	%		(6,099	)	-70	%		9,929	8	%		(7,312	)	-74	%
State and municipal securities		52,317	37	%		53,428	31	%		(1,111	)	-2	%		39,652	33	%		12,665		32	%
Total investment securities		109,963	78	%		112,155	65	%		(2,192	)	-2	%		96,004	79	%		13,959		15	%
Total cash equivalents and investment securities	$	140,424	100	%	$	173,684	100	%	$	(33,260	)	-19	%	$	121,692	100	%	$	18,732		15	%

Total cash equivalents and investment securities as a percent of total assets			16	%			19	%								15	%

Liquidity remains strong based on existing levels of combined cash equivalents, investment securities and unused borrowing capacity. “During the current quarter, we redeployed some of our cash equivalents to fund continued loan growth and anticipated seasonal deposit outflows,” said Douglas N. Biddle, EVP and Chief Financial Officer. “Our investment securities include a large component of fully amortized U.S. agency collateralized mortgage and mortgage-backed securities, for which we expect to have limited extension risk.” The securities portfolio also contains municipal securities rated A or better. The expected modified duration (adjusted for calls, consensus pre-payment speeds and rate adjustment dates) of the investment portfolio was 4.0 years at March 31, 2017, 3.9 years at December 31, 2016, and 3.3 years at March 31, 2016.

The Bank had $8.6 million in outstanding borrowings against its $241.8 million in established borrowing capacity with the Federal Home Loan Bank of Des Moines (FHLB) at March 31, 2017. The Bank had $8.7 million and $8.8 million in outstanding borrowings with the FHLB at December 31, 2016 and March 31, 2016, respectively. The Bank’s borrowing facility with the FHLB is subject to collateral and stock ownership requirements. The Bank also has available a discount window primary credit line with the Federal Reserve Bank of San Francisco of approximately $61.3 million, subject to collateral requirements, and $16.0 million from correspondent banks, with no balance outstanding on any of these facilities.

LOANS

Loans by Category
(unaudited)

		March 31, 2017		% of Gross Loans			Dec 31, 2016		% of Gross Loans			$ Change			% Change			March 31, 2016		% of Gross Loans			$ Change		% Change
		(Dollars in thousands)
Commercial and agricultural	$	133,533		20	%	$	134,318		20	%	$	(785	)		-1	%	$	134,540		21	%	$	(1,007	)	-1	%
Real estate:
Construction and development		46,049		7	%		41,983		6	%		4,066			10	%		34,469		5	%		11,580		34	%
Residential 1-4 family		91,924		14	%		91,686		14	%		238			0	%		93,826		15	%		(1,902	)	-2	%
Multi-family		28,619		4	%		29,747		5	%		(1,128	)		-4	%		27,505		4	%		1,114		4	%
Commercial real estate — owner occupied		131,507		20	%		132,449		20	%		(942	)		-1	%		135,704		21	%		(4,197	)	-3	%
Commercial real estate — non owner occupied		143,578		21	%		138,078		21	%		5,500			4	%		141,203		22	%		2,375		2	%
Farmland		27,850		4	%		25,588		4	%		2,262			9	%		22,182		3	%		5,668		26	%
Consumer		65,306		10	%		65,442		10	%		(136	)		0	%		55,427		9	%		9,879		18	%
Gross loans		668,366		100	%		659,291		100	%		9,075			1	%		644,856		100	%		23,510		4	%
Less: allowance for loan losses		(9,217	)				(9,192	)				(25	)					(8,552	)				(665	)
Less: deferred fees		(1,448	)				(1,488	)				40						(1,479	)				31
Loans, net	$	657,701				$	648,611				$	9,090					$	634,825				$	22,876



Loan Concentration
(unaudited)
		March 31, 2017		% of Risk Based Capital			Dec 31, 2016		% of Risk Based Capital			Change			March 31, 2016			% of Risk Based Capital		Change
		(Dollars in thousands)
Commercial and agricultural	$	133,533		148	%	$	134,318		149	%		-1	%	$	134,540			157	%	-9	%
Real estate:
Construction and development		46,049		51	%		41,983		47	%		4	%		34,469			40	%	11	%
Residential 1-4 family		91,924		102	%		91,686		102	%		0	%		93,826			109	%	-7	%
Multi-family		28,619		32	%		29,747		33	%		-1	%		27,505			32	%	0	%
Commercial real estate — owner occupied		131,507		145	%		132,449		147	%		-2	%		135,704			158	%	-13	%
Commercial real estate — non owner occupied		143,578		159	%		138,078		153	%		6	%		141,203			165	%	-6	%
Farmland		27,850		31	%		25,588		28	%		3	%		22,182			26	%	5	%
Consumer		65,306		72	%		65,442		73	%		-1	%		55,427			65	%	7	%
Gross loans	$	668,366				$	659,291							$	644,856
Regulatory Commercial Real Estate	$	208,604		231	%	$	200,010		222	%		9	%	$	199,148			232	%	-1	%
Total Risk Based Capital*	$	90,420				$	89,999							$	85,814

*Bank of the Pacific

The loan portfolio continues to be well-diversified with balances in most lending categories originating predominately within the Western Washington and Oregon markets. Increases in loans were generated in most categories during the current quarter. The portfolio includes $34.5 million in lower-yielding LIBOR-based floating rate commercial real estate loans. The portfolio also includes $19.8 million in purchased government-guaranteed commercial and commercial real estate loans. In addition, the portfolio contains $54.3 million in indirect consumer loans to finance luxury and classic cars as a part of a strategy to diversify the loan portfolio. These loans have been made to individuals with high credit scores and have exhibited a very low loss experience to date. The Company manages new loan origination volume using concentration limits that establish maximum exposure levels by designated industry segment, real estate product types, geography and single borrower limits. While the Bank’s recent loan growth does include commercial real estate, the amount of such exposure continues to be managed within regulatory guidelines.

DEPOSITS


Deposits by Category
(Unaudited)

		March 31, 2017	% of Total			Dec 31, 2016	% of Total			$ Change		% Change			March 31, 2016	% of Total			$ Change		% Change
		(Dollars in thousands)
Interest-bearing demand and money market	$	323,471	43	%	$	332,779	42	%	$	(9,308	)	-3	%	$	295,056	41	%	$	28,415		10	%
Savings		86,151	11	%		84,146	11	%		2,005		2	%		94,734	13	%		(8,583	)	-9	%
Time deposits (CDs)		122,813	16	%		129,175	17	%		(6,362	)	-5	%		138,277	19	%		(15,464	)	-11	%
Total interest-bearing deposits		532,435	70	%		546,100	70	%		(13,665	)	-3	%		528,067	73	%		4,368		1	%
Non-interest bearing demand		229,516	30	%		233,631	30	%		(4,115	)	-2	%		194,669	27	%		34,847		18	%
Total deposits	$	761,951	100	%	$	779,731	100	%	$	(17,780	)	-2	%	$	722,736	100	%	$	39,215		5	%

Total deposits declined during the current quarter, primarily due to seasonal outflows that normally begin in the winter and extend into spring due to the slowdown of tourism activity in certain core markets. Time deposits continue to decline as a component of funding due to the increasing propensity of retail depositors to not lock in relatively low interest rates for an extended period. The proportion of noninterest bearing deposits to total deposits remained unchanged despite the seasonal outflows referenced above.

Total brokered deposits were $52.1 million, which included $2.9 million via reciprocal deposit arrangements, up from $50.3 million at December 31, 2016 and $53.7 million at March 31, 2016. The brokered deposits were acquired during the latter part of 2015 with fixed rates with terms ranging from 2 to 5 years. “These deposits were obtained to lock in historically low rates to enhance the Bank’s interest rate risk mitigation strategies,” explained Biddle.

CAPITAL

Pacific Financial Corporation (“Company”), and its subsidiary Bank of the Pacific (“Bank”), met the thresholds to be considered “Well-Capitalized” under regulatory standards for total risk-based capital, Tier 1 risk-based capital, Common equity Tier 1 and Tier 1 leverage capital. The current period leverage and risk-weighted ratios have increased as compared to the linked quarter, due to the seasonal decline in total assets, as referenced above. Ratios declined as compared to the like quarter a year ago primarily due to the successful execution of the Company’s growth strategy. However, a shift in balance sheet mix to lower risk-weighted investment securities in the current quarter as compared to the year-over-year quarter partially mitigated the decline in risk-weighted capital ratios between the periods.

The Federal Deposit Insurance Corporation (“FDIC”) has established minimum requirements for capital adequacy for banks under the Basel III capital framework. On April 9, 2015, The Board of Governors of the Federal Reserve System (“Federal Reserve”) issued a final rule to amend the Small Bank Holding Company Policy Statement. With this amendment, small bank holding companies, including Pacific Financial Corporation, are not being subject to Basel III capital rules. For illustrative purposes, Basel III framework capital ratios are displayed below for both the Company and the Bank.

The total risk-based capital ratios of the Company include $13.4 million of junior subordinated debentures, all of which qualified as Tier 1 capital under guidance issued by the Federal Reserve. As provided in the Dodd-Frank Act, the Company expects to continue to rely on these junior subordinated debentures as part of its regulatory capital.

The following table summarizes the capital measures of the Company and the Bank respectively, at the dates listed below.

Capital Measures
(unaudited)
	March 31, 2017		Dec 31, 2016		Change	March 31, 2016		Change		To be Well Capitalized Under Prompt Correction Action Regulations*
Pacific Financial Corporation
Total risk-based capital ratio	12.72	%	12.56	%	0.16	12.73	%	(0.01	)	N/A
Tier 1 risk-based capital ratio	11.46	%	11.31	%	0.15	11.48	%	(0.02	)	N/A
Common equity tier 1 ratio	9.65	%	9.49	%	0.16	9.57	%	0.08		N/A
Leverage ratio	9.66	%	9.25	%	0.41	9.58	%	0.08		N/A

Tangible common equity ratio	8.03	%	7.63	%	0.40	7.95	%	0.08		N/A

Bank of the Pacific
Total risk-based capital ratio	12.60	%	12.47	%	0.13	12.66	%	(0.06	)	10.5	%
Tier 1 risk-based capital ratio	11.35	%	11.22	%	0.13	11.41	%	(0.06	)	8.5	%
Common equity tier 1 ratio	11.35	%	11.22	%	0.13	11.41	%	(0.06	)	7.0	%
Leverage ratio	12.60	%	9.18	%	3.42	9.50	%	3.10		7.5	%

*Includes Basel III 2019 Capital Conservation Buffer

Net Interest Margin

Net interest margin expanded compared to the linked quarter primarily due to an increase in loan and investment securities yields, impacted by recent increases in interest rates recently initiated by the Federal Reserve. Net interest margin contracted in the current period compared to first quarter of 2016 due to additional one-time interest income assessed for a breach in loan agreement. As a result, net interest margin was enhanced by 12 basis points on an annualized basis during first quarter 2016.

Cost of deposits remained relatively unchanged in the current quarter, compared to the linked and year-over-year quarter. The increase in the proportion of deposits coming from non-interest bearing deposits favorably impacted funding costs during these respective periods. Improvement in loan and investment security yields offset increases in the cost of LIBOR-based junior subordinated debentures experienced in the current quarter as compared to the linked and year-over-year quarters.

The following tables set forth information with regard to average balances of interest-earning assets and interest-bearing liabilities and the resultant yields or cost, and the net interest margin on a tax equivalent basis. Loans held for sale and non-accrual loans are included in total loans.

Net Interest Margin
(Unaudited)
(Annualized, tax-equivalent basis)

		For the Three Months Ended,

		March 31, 2017			Dec 31, 2016			$ Change		% Change			March 31, 2016			$ Change		% Change
Average Balances		(Dollars in thousands)
Gross loans	$	665,281		$	651,985		$	13,296		2	%	$	637,187		$	28,094		4	%
Loans held for sale	$	5,058		$	10,690		$	(5,632	)	-53	%	$	9,957		$	(4,899	)	-49	%
Investment securities	$	130,594		$	158,255		$	(27,661	)	-17	%	$	115,892		$	14,702		13	%
Total interest-earning assets	$	800,933		$	820,930		$	(19,997	)	-2	%	$	763,036		$	37,897		5	%
Non-interest bearing demand deposits	$	225,494		$	231,457		$	(5,963	)	-3	%	$	181,777		$	43,717		24	%
Interest bearing deposits	$	529,367		$	540,687		$	(11,320	)	-2	%	$	522,327		$	7,040		1	%
Borrowings	$	22,076		$	22,070		$	6		0	%	$	37,238		$	(15,162	)	-41	%
Total interest-bearing liabilities	$	551,443		$	562,757		$	(11,314	)	-2	%	$	559,565		$	(8,122	)	-1	%
Total Equity	$	81,438		$	83,428		$	(1,990	)	-2	%	$	77,853		$	3,585		5	%

		For the Three Months Ended,
		March 31, 2017			Dec 31, 2016			Change		March 31, 2016			Change
Yield on average gross loans ⁽¹⁾		4.92	%		4.86	%		0.06		5.01	%		(0.09	)
Yield on average investment securities ⁽¹⁾		2.34	%		1.94	%		0.40		2.26	%		0.08
Cost of average interest bearing deposits		0.37	%		0.36	%		0.01		0.36	%		0.01
Cost of average borrowings		2.52	%		2.43	%		0.09		1.51	%		1.01
Cost of average total deposits and borrowings		0.32	%		0.31	%		0.01		0.33	%		(0.01	)

Yield on average interest-earning assets		4.50	%		4.30	%		0.20		4.59	%		(0.09	)
Cost of average interest-bearing liabilities		0.46	%		0.44	%		0.02		0.44	%		0.02
Net interest spread		4.04	%		3.86	%		0.18		4.15	%		(0.11	)

Net interest margin ⁽¹⁾		4.19	%		4.00	%		0.19		4.27	%		(0.08	)

⁽¹⁾ Tax-exempt income has been adjusted to a tax equivalent basis at a 34% rate.

ASSET QUALITY

Adversely classified loans decreased compared to the preceding quarter, primarily due to the payoff of a $2.0 million adversely classified commercial loan participation. Total 30-89 day delinquencies remained below 0.50%, a positive leading indicator of future credit quality.


Adversely Classified Loans and Securities
(Unaudited)

		March 31, 2017			Dec 31, 2016			$ Change		% Change			March 31, 2016			$ Change		% Change
		(Dollars in thousands)
Rated substandard or worse, but not impaired	$	13,434		$	16,086		$	(2,652	)	-16	%	$	15,597		$	(2,163	)	-14	%
Impaired		1,537			1,615			(78	)	-5	%		1,915			(378	)	-20	%
Total adversely classified loans¹	$	14,971		$	17,701		$	(2,730	)	-15	%	$	17,512		$	(2,541	)	-15	%

Total adversely classified investment securities²	$	–		$	–		$	–		–		$	165		$	(165	)	-100	%


Gross loans (excluding deferred loan fees)	$	668,366		$	659,291		$	9,075		1	%	$	644,856		$	23,510		4	%
Adversely classified loans to gross loans		2.24	%		2.68	%							2.72	%
Allowance for loan losses	$	9,217		$	9,192		$	25		0	%	$	8,552		$	665		8	%
Allowance for loan losses as a percentage of adversely classified loans		61.57	%		51.93	%							48.84	%
Allowance for loan losses to total impaired loans		599.67	%		569.16	%							446.58	%
Adversely classified loans and securities to total assets		1.72	%		1.99	%							2.13	%
Delinquent loans to gross loans, not in nonaccrual status		0.03	%		0.03	%							0.31	%

¹Adversely classified loans are defined as loans having a well-defined weakness or weaknesses related to the borrower’s financial capacity or to pledged collateral that may jeopardize the repayment of the debt. They are characterized by the possibility that the Bank may sustain some loss if the deficiencies giving rise to the substandard classification are not corrected. Note that any loans internally rated worse than substandard are included in the impaired loan totals.

²Adversely classified investment securities consist of one private label collateralized mortgage obligation (CMO) as of March 31, 2016.

Nonperforming assets decreased on a linked quarter basis, primarily due to the sale of a $400,000 commercial real estate OREO asset during the period. In addition, nonperforming assets declined as compared to the year-over year quarter due to the sale of a $1.9 million commercial real estate OREO asset and several nonaccrual loans totaling $208,000 were paid off during the fourth quarter of 2016. As a result, nonperforming assets declined, as a percentage of total assets, on a linked quarter basis and year-over-year quarter.

Nonperforming Assets
(Unaudited)

		March 31, 2017			Dec 31, 2016			$ Change		% Change			March 31, 2016			$ Change		% Change
		(Dollars in thousands)
Loans on nonaccrual status	$	1,154		$	1,229		$	(75	)	-6	%	$	1,373		$	(219	)	-16	%
Total nonaccrual loans		1,154			1,229			(75	)	-6	%		1,373			(219	)	-16	%

Other real estate owned and foreclosed assets		144			549			(405	)	-74	%		2,557			(2,413	)	-94	%
Total nonperforming assets	$	1,298		$	1,778		$	(480	)	-27	%	$	3,930		$	(2,632	)	-67	%


Restructured performing loans	$	383		$	386		$	(3	)	-1	%	$	542		$	(159	)	-29	%
Accruing loans past due 90 days or more	$	–		$	–		$	–		0	%	$	–		$	–		0	%
Percentage of nonperforming assets to total assets		0.15	%		0.20	%							0.47	%
Nonperforming loans to total loans		0.17	%		0.19	%							0.21	%

The remaining nonperforming assets consist of a commercial sea vessel and a repossessed automobile with book values of $105,000 and $39,000, respectively.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses has increased in concert with recent loan growth. With changes in the loan portfolio composition over the past several years and overall improvement in credit quality, loss factors used in estimates to establish reserve levels have declined commensurately.

For the first quarter 2017, there was a charge-off of $121,000 related to the payoff of the $2.0 million adversely classified commercial loan participation, as noted above. This compares to a net recovery in the linked quarter due to the collection of a $88,000 judgement on a previously charged off loan. Negligible net charge-offs were recorded in the year-over-year quarter. “The low level of charge-offs and ratio of net loan charge-offs to average gross loans are indicative of the solid credit quality of the portfolio,” said Biddle. The overall risk profile of the loan portfolio continues to be modest, illustrative of the solid credit risk management framework in place. However, the trend of future provisions for loan losses will depend primarily on economic conditions, growth in the loan portfolio, level of adversely-classified assets, and changes in collateral values.

Allowance for Loan Losses
(Unaudited)

		For the Three Months Ended,
		March 31, 2017			Dec 31, 2016			$ Change		% Change			March 31, 2016			$ Change		% Change
		(Dollars in thousands)
Gross loans outstanding at end of period	$	668,366		$	659,291		$	9,075		1	%	$	644,856		$	23,510		4	%
Average loans outstanding, gross	$	665,281		$	651,985		$	13,296		2	%	$	637,187		$	28,094		4	%
Allowance for loan losses, beginning of period	$	9,192		$	8,960		$	232		3	%	$	8,317		$	875		11	%
Commercial		(131	)		–			(131	)	100	%		–			(131	)	100	%
Commercial Real Estate		–			–			–		0	%		–			–		0	%
Residential Real Estate		–			(15	)		15		100	%		(16	)		16		-100	%
Consumer		(16	)		(41	)		25		-61	%		(26	)		10		-38	%
Total charge-offs		(147	)		(56	)		(91	)	163	%		(42	)		(105	)	N/M
Commercial		40			5			35		N/M			1			39		N/M
Commercial Real Estate		–			2			(2	)	-100	%		2			(2	)	-100	%
Residential Real Estate		8			96			(88	)	-92	%		11			(3	)	-27	%
Consumer		2			1			1		100	%		1			1		100	%
Total recoveries		50			104			(54	)	-52	%		15			35		N/M
Net recoveries/(charge-offs)		(97	)		48			(145	)	N/M			(27	)		(70	)	N/M
Provision charged to income		122			184			(62	)	-34	%		262			(140	)	-53	%
Allowance for loan losses, end of period	$	9,217		$	9,192		$	25		0	%	$	8,552		$	665		8	%
Ratio of net loans charged-off to average
gross loans outstanding, annualized		0.06	%		-0.03	%		0.09	%	N/M			0.02	%		0.04	%	200	%
Ratio of allowance for loan losses to
gross loans outstanding		1.38	%		1.39	%		-0.01	%	-1	%		1.33	%		0.05	%	4	%

ABOUT PACIFIC FINANCIAL CORPORATION

Pacific Financial Corporation of Aberdeen, Washington, is the bank holding company for Bank of the Pacific, a state chartered and federally insured commercial bank. Bank of the Pacific offers banking products and services to small-to-medium sized businesses and professionals in western Washington and Oregon. At March 31, 2017, the Company had total assets of $873 million and operated fifteen branches in the communities of Grays Harbor, Pacific, Whatcom, Skagit, Clark and Wahkiakum counties in the State of Washington, and three branches in Clatsop County, Oregon. The Company also operated loan production offices in the communities of DuPont and Burlington in Washington and Salem, Oregon. Visit the Company’s website at www.bankofthepacific.com. Member FDIC.

Cautions Concerning Forward-Looking Statements

This press release contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other laws, including all statements in this release that are not historical facts or that relate to future plans or events or projected results of Pacific Financial Corporation and its wholly-owned subsidiary, Bank of the Pacific. These forward-looking statements are subject to risks and uncertainties that could cause actual events or results to differ materially from those projected, anticipated or implied. These risks and uncertainties include various risks associated with growing the Bank and expanding the services it provides, successfully completing and integrating the acquisition of new branches and development of new business lines and markets, competition in the marketplace, general economic conditions, changes in interest rates, extensive and evolving regulation of the banking industry, and many other risks. We undertake no obligation to update or revise any forward-looking statement. Readers of this release are cautioned not to put undue reliance on forward-looking statements.

CONTACT: CONTACTS:
DENISE PORTMANN, PRESIDENT & CEO
DOUGLAS BIDDLE, EVP & CFO
360.533.8873

The Cereghino Group
IR CONTACT: 206-388-5785