<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
/X/ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended DECEMBER 31, 1999 or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
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
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-8870
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
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 periods that the Registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days.
Yes X No
------ ------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ X ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 29, 2000 was $54,811,960.
As of February 29, 2000, there were issued and outstanding 496,770 shares of the
Registrant's Common Stock.
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DOCUMENTS INCORPORATED BY REFERENCE
PARTS II and IV of Form 10-K - Annual Report to Stockholders for the Fiscal Year
Ended December 31, 1999 (only portions of which are incorporated by reference).
PART III of Form 10-K - The definitive Proxy Statement filed with the Securities
and Exchange Commission in connection with Registrant's annual meeting to be
held April 17, 2000 (only portions of which are incorporated by reference).
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PACIFIC FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I Page
<S> <C>
Item 1. Business 4
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 11
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial 13
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosure About Market Risk 26
Item 8. Financial Statements and Supplementary Data 28
Item 9. Changes in and Disagreements with Accountants on Accounting 28
And Financial Disclosure
PART III
Item 10. Directors and Executive Officers of the Registrant 28
Item 11. Executive Compensation 28
Item 12. Security Ownership of Certain Beneficial Owners and Management 28
Item 13. Certain Relationships and Related Transactions 28
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 28
SIGNATURES 30
</TABLE>
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PART I
ITEM 1. BUSINESS
Pacific Financial Corporation (the Company) is a multi-bank holding company
headquartered in Aberdeen, Washington. The Company owns two banks, The Bank of
Grays Harbor (Harbor) and Bank of the Pacific (Pacific) (collectively, Banks)
both of which are located in Washington. The Company conducts its banking
business through 10 branches located in communities throughout three Southwest
Washington Counties. An S-4 Registration Statement was filed with the SEC
pursuant to the merger of equals of Pacific Financial Corporation and Harbor
Bancorp, Inc. which became effective on December 15, 1999. Under the terms of
the merger agreement governing the transaction, Pacific Financial Corporation
was merged with and into Harbor Bancorp, Inc., with Harbor Bancorp, Inc. as the
surviving corporation, operating under the name Pacific Financial Corporation.
Shares of Pacific Financial Corporation common stock were converted into shares
of the combined corporation (Harbor Bancorp) common stock at the rate of 0.785
shares of combined corporation common stock for each share of Pacific Financial
Corporation common stock, with cash being paid in lieu of issuing fractional
shares of combined corporation common stock. The transaction was accounted for
as a pooling-of-interest. At December 31, 1999, the Company had total
consolidated assets of $242 million, loans of $152.6 million, and deposits of
$206.1 million. The Company was incorporated in the State of Washington on
February 12, 1997, pursuant to a holding company reorganization of The Bank of
Grays Harbor. Although an SEC reporting company, the Company's stock is not
listed on any exchange.
THE BANKS
The Bank of Grays Harbor was organized in 1978 and opened for business in 1979
to meet the need for a local community bank with local interests to serve the
small to medium-sized local businesses and professionals. Harbor has five branch
locations situated in Grays Harbor County. Bank of the Pacific was organized and
opened for business in 1971 to meet the need for a local community bank with
local interests to serve the needs of individuals and small to medium-sized
local businesses. Pacific has five branch offices with four located in Pacific
County, and one located in Wahkiakum County. The Banks market areas consist
primarily of Grays Harbor, Pacific, and Wahkiakum Counties in the State of
Washington. Services offered by the Banks include commercial loans, installment
loans, real estate loans, and personal and business deposit products.
The Banks originate loans primarily in their respective local markets. The
underwriting policies focus on assessment of each borrower's ability to service
and repay the debt, and the availability of collateral that can be used to
secure the loan. Depending on the nature of the borrower and the purpose and
amount of the loan, the Banks loans may be secured by a variety of collateral,
including business assets, real estate, and personal assets.
The Banks commercial and agricultural loans consist primarily of secured
revolving operating lines of credit and business term loans, some of which may
be partially guaranteed by the Small Business Administration or the U.S.
Department of Agriculture.
Consumer installment loans and other loans represent a small percentage of total
outstanding loans and include home equity loans, auto loans, boat loans, and
personal lines of credit.
The Banks primary source of deposits are from individuals and businesses in
their respective local markets. A concerted effort has been made to attract
deposits in the local market areas through competitive pricing and delivery of
quality products. These products include demand accounts, negotiable order of
withdrawal ("NOW") accounts, money market investment accounts, savings accounts,
and time deposits. The Banks traditionally have not sought brokered deposits and
do not intend to do so in the future.
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The Banks operate under the banking laws of the State of Washington and the
rules and regulations of the Federal Deposit Insurance Corporation("FDIC").
COMPETITION
Competition in the banking industry is significant and has intensified with
interest rate deregulation. The Company competes in Grays Harbor County with
well-established thrifts which are headquartered in the area along with branches
of large banks and small community banks with headquarters outside the area. The
Company competes with well-established branches of large banks, thrifts and
credit unions in Pacific and Wahkiakum Counties. Other non-bank and
non-depository institutions can be expected to increase competition further as
they offer bank like products.
Although it cannot guarantee that it will continue to do so, the Company has
been able to maintain a competitive advantage as a result of its status as a
local institution, offering products and services tailored to the needs of the
community. Further, because of the extensive experience of management in its
market area and the business contacts of management and the directors,
management believes the Company can continue to compete effectively.
According to the Market Share Report compiled by the Federal Deposit Insurance
Corporation, as of June 30, 1999, the Company held a deposit market share of
33.9% in Pacific County, and a 16.1% in Grays Harbor County.
EMPLOYEES
As of December 31, 1999, the Banks employed 84 full time equivalent employees.
Management believes relations with its employees are good.
SUPERVISION AND REGULATION
The following generally refers to certain significant statutes and
regulations affecting the banking industry. These references are only intended
to provide brief summaries and, therefore, are not complete and are qualified by
the statutes and regulations referenced. Changes in applicable laws or
regulations may have a material effect on the business and prospects of the
Company. The operations of the Company may also be affected by changes in the
policies of banking and other government regulators. The Company cannot
accurately predict the nature or extent of the effects on its business and
earnings that fiscal or monetary policies, or new federal or state laws, may
have in the future.
CHANGES IN BANKING LAWS AND REGULATIONS
The laws and regulations that affect banks and bank holding companies have
recently undergone significant changes. On November 12, 1999, the president
signed into law the Financial Services Modernization Act of 1999. Generally, the
act (i) repeals the historical restrictions on preventing banks from affiliating
with securities firms, (ii) provides a uniform framework for the activities of
banks, savings institutions and their holding companies, (iii) broadens the
activities that may be conducted by national banks and banking subsidiaries of
bank holding companies, (iv) provides an enhanced framework for protecting the
privacy of consumers' information and (v) addresses a variety of other legal and
regulatory issues affecting both day-to-day operations and long-term activities
of financial institutions.
5
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THE COMPANY
GENERAL
As a bank holding company, the Company is subject to the Bank Holding
Company Act of 1956 ("BHCA"), as amended, which places the Company under the
supervision of the Board of Governors of the Federal Reserve. The Company must
file annual reports with the Federal Reserve and must provide it with such
additional information as it may require. In addition, the Federal Reserve
periodically examines the Company and its subsidiaries, including the Banks.
BANK HOLDING COMPANY REGULATION
In general, the BHCA limits bank holding company business to owning or
controlling banks and engaging in other banking-related activities. Bank holding
companies must obtain the FRB's approval before they: (1) acquire direct or
indirect ownership or control of any voting shares of any bank that results in
total ownership or control, directly or indirectly, of more than 5% of the
voting shares of such bank; (2) merge or consolidate with another bank holding
company; or (3) acquire substantially all of the assets of any additional banks.
Subject to certain state laws, such as age and contingency laws, a bank holding
company that is adequately capitalized and adequately managed may acquire the
assets of both in-state and out-of-state banks.
CONTROL OF NONBANKS. With certain exceptions, the BHCA prohibits bank
holding companies from acquiring direct or indirect ownership or control of
voting shares in any company that is not a bank or a bank holding company unless
the FRB determines that the activities of such company are incidental or closely
related to the business of banking. If a bank holding company is
well-capitalized and meets certain criteria specified by the FRB, it may engage
de novo in certain permissible nonbanking activities without prior FRB approval.
CONTROL TRANSACTIONS. The Change in Bank Control Act of 1978, as amended,
requires a person (or group of persons acting in concert) acquiring "control" of
a bank holding company to provide the FRB with 60 days' prior written notice of
the proposed acquisition. Following receipt of this notice, the FRB has 60 days
within which to issue a notice disapproving the proposed acquisition, but the
FRB may extend this time period for up to another 30 days. An acquisition may be
completed before expiration of the disapproval period if the FRB issues written
notice of its intent not to disapprove the transaction. In addition, any
"company" must obtain the FRB's approval before acquiring 25% (5% if the
"company" is a bank holding company) or more of the outstanding shares or
otherwise obtaining control over the Company.
TRANSACTIONS WITH AFFILIATES
The Company and the Banks are deemed affiliates within the meaning of the
Federal Reserve Act, and transactions between affiliates are subject to certain
restrictions. Accordingly, the Company and the Banks must comply with Sections
23A and 23B of the Federal Reserve Act. Generally, Sections 23A and 23B (1)
limit the extent to which a financial institution or its subsidiaries may engage
in "covered transactions" with an affiliate, as defined, to an amount equal to
10% of such institution's capital and surplus and an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital and
surplus, and (2) require all transactions with an affiliate, whether or not
"covered transactions," to be on terms substantially the same, or at least as
favorable to the institution or subsidiary, as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and other similar types of
transactions.
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REGULATION OF MANAGEMENT
Federal law (1) sets forth the circumstances under which officers or
directors of a financial institution may be removed by the institution's federal
supervisory agency; (2) places restraints on lending by an institution to its
executive officers, directors, principal stockholders, and their related
interests; and (3) prohibits management personnel from serving as a director or
in other management positions with another financial institution which has
assets exceeding a specified amount or which has an office within a specified
geographic area.
TIE-IN ARRANGEMENTS
The Company and the Banks cannot engage in certain tie-in arrangements in
connection with any extension of credit, sale or lease of property or furnishing
of services. For example, with certain exceptions, neither the Company nor the
Banks may condition an extension of credit on either (1) a requirement that the
customer obtain additional services provided by it or (2) an agreement by the
customer to refrain from obtaining other services from a competitor.
The FRB has adopted amendments to its anti-tying rules that: (1) removed
FRB-imposed anti-tying restrictions on bank holding companies and their non-bank
subsidiaries; (2) allow banks greater flexibility to package products with their
affiliates; and (3) establish a safe harbor from the tying restrictions for
certain foreign transactions. These amendments were designed to enhance
competition in banking and nonbanking products and to allow banks and their
affiliates to provide more efficient, lower cost service to their customers.
STATE LAW RESTRICTIONS
As a Washington business corporation, the Company may be subject to certain
limitations and restrictions as provided under applicable Washington corporate
law. In addition, Washington banking law restricts and governs certain
activities of the Banks.
THE BANKS
GENERAL
The Banks, as non-Fed member FDIC insured institutions, are subject to
regulation and examination by the FDIC and the State of Washington. The federal
laws that apply to the Banks regulate, among other things, the scope of its
business, its investments, its reserves against deposits, the timing of the
availability of deposited funds and the nature and amount of and collateral for
loans. The laws and regulations governing the Banks generally have been
promulgated to protect depositors and not to protect stockholders of the bank or
its holding company.
CRA. The Community Reinvestment Act (the "CRA") requires that, in
connection with examinations of financial institutions within their
jurisdiction, the FDIC evaluates the record of the financial institutions in
meeting the credit needs of their local communities, including low and moderate
income neighborhoods, consistent with the safe and sound operation of those
banks. These factors are also considered in evaluating mergers, acquisitions,
and applications to open a branch or facility.
7
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INSIDER CREDIT TRANSACTIONS. Banks are also subject to certain restrictions
imposed by the Federal Reserve Act on extensions of credit to executive
officers, directors, principal shareholders, or any related interests of such
persons. Extensions of credit (i) must be made on substantially the same terms,
including interest rates and collateral, and follow credit underwriting
procedures that are not less stringent than those prevailing at the time for
comparable transactions with persons not covered above and who are not
employees; and (ii) must not involve more than the normal risk of repayment or
present other unfavorable features. Banks are also subject to certain lending
limits and restrictions on overdrafts to such persons. A violation of these
restrictions may result in the assessment of substantial civil monetary
penalties on the affected bank or any officer, director, employee, agent, or
other person participating in the conduct of the affairs of that bank, the
imposition of a cease and desist order, and other regulatory sanctions.
FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act of
1991 (the "FDICIA"), each federal banking agency has prescribed, by regulation,
noncapital safety and soundness standards for institutions under its authority.
These standards cover internal controls, information systems, and internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, compensation, fees and benefits, such other operational and managerial
standards as the agency determines to be appropriate, and standards for asset
quality, earnings and stock valuation. An institution which fails to meet these
standards must develop a plan acceptable to the agency, specifying the steps
that the institution will take to meet the standards. Failure to submit or
implement such a plan may subject the institution to regulatory sanctions.
Management of the Company believes that the Banks meet all such standards, and
therefore, does not believe that these regulatory standards materially affect
the Company's business operations.
INTERSTATE BANKING AND BRANCHING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Interstate Act") permits nationwide interstate banking and branching under
certain circumstances. This legislation generally authorizes interstate
branching and relaxes federal law restrictions on interstate banking. Currently,
bank holding companies may purchase banks in any state, and states may not
prohibit such purchases. Additionally, banks are permitted to merge with banks
in other states as long as the home state of neither merging bank has "opted
out." The Interstate Act requires regulators to consult with community
organizations before permitting an interstate institution to close a branch in a
low-income area.
With regard to interstate bank mergers, Washington has "opted in" to the
Interstate Act and allows in-state banks to merge with out-of-state banks
subject to certain aging requirements. Washington law generally authorizes the
acquisition of an in-state bank by an out-of-state bank through merger with a
Washington financial institution that has been in existence for at least 5 years
prior to the acquisition. With regard to interstate bank branching, out-of-state
banks that do not already operate a branch in Washington may not establish de
novo branches in Washington or establish and operate a branch by acquiring a
branch in Washington. Under FDIC regulations, banks are prohibited from using
their interstate branches primarily for deposit production. The FDIC has
accordingly implemented a loan-to-deposit ratio screen to ensure compliance with
this prohibition.
DEPOSIT INSURANCE
The deposits of the Banks are currently insured to a maximum of $100,000
per depositor through the Bank Insurance Fund ("BIF") administered by the FDIC.
All insured banks are required to pay semi-annual deposit insurance premium
assessments to the FDIC.
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The FDICIA included provisions to reform the Federal Deposit Insurance
System, including the implementation of risk-based deposit insurance premiums.
The FDICIA also permits the FDIC to make special assessments on insured
depository institutions in amounts determined by the FDIC to be necessary to
give it adequate assessment income to repay amounts borrowed from the U.S.
Treasury and other sources, or for any other purpose the FDIC deems necessary.
The FDIC has implemented a risk-based insurance premium system under which banks
are assessed insurance premiums based on how much risk they present to the BIF.
Banks with higher levels of capital and a low degree of supervisory concern are
assessed lower premiums than banks with lower levels of capital or a higher
degree of supervisory concern.
DIVIDENDS
The principal source of the Company's cash revenues is dividends received
from the Banks. The payment of dividends is subject to government regulation, in
that regulatory authorities may prohibit banks and bank holding companies from
paying dividends which would constitute an unsafe or unsound banking practice.
In addition, a bank may not pay cash dividends if that payment could reduce the
amount of its capital below that necessary to meet minimum applicable regulatory
capital requirements. Other than the laws and regulations noted above, which
apply to all banks and bank holding companies, neither the Company nor the Banks
are currently subject to any regulatory restrictions on their dividends.
CAPITAL ADEQUACY
Federal bank regulatory agencies use capital adequacy guidelines in the
examination and regulation of bank holding companies and banks. If capital falls
below minimum guideline levels, the holding company or bank may be denied
approval to acquire or establish additional banks or nonbank businesses or to
open new facilities.
The FDIC and Federal Reserve use risk-based capital guidelines for banks
and bank holding companies. These are designed to make such capital requirements
more sensitive to differences in risk profiles among banks and bank holding
companies, to account for off-balance sheet exposure and to minimize
disincentives for holding liquid assets. Assets and off-balance sheet items are
assigned to broad risk categories, each with appropriate weights. The resulting
capital ratios represent capital as a percentage of total risk-weighted assets
and off-balance sheet items. The guidelines are minimums, and the Federal
Reserve has noted that bank holding companies contemplating significant
expansion programs should not allow expansion to diminish their capital ratios
and should maintain ratios well in excess of the minimum. The current guidelines
require all bank holding companies and federally-regulated banks to maintain a
minimum risk-based total capital ratio equal to 8%, of which at least 4% must be
Tier I capital. Tier I capital for bank holding companies includes common
shareholders' equity, certain qualifying perpetual preferred stock and minority
interests in equity accounts of consolidated subsidiaries, less intangibles
except as described above.
The Federal Reserve also employs a leverage ratio, which is Tier I capital
as a percentage of total assets less intangibles, to be used as a supplement to
risk-based guidelines. The principal objective of the leverage ratio is to
constrain the maximum degree to which a bank holding company may leverage its
equity capital base. The Federal Reserve requires a minimum leverage ratio of
3%. However, for all but the most highly rated bank holding companies and for
bank holding companies seeking to expand, the Federal Reserve expects an
additional cushion of at least 1% to 2%.
FDICIA created a statutory framework of supervisory actions indexed to the
capital level of the individual institution. Under regulations adopted by the
FDIC, an institution is assigned to one of five capital categories depending on
its total risk-based capital ratio, Tier I risk-based capital ratio, and
leverage ratio, together with certain subjective factors. Institutions which are
deemed to be "undercapitalized" depending on the category to which they are
assigned are subject to certain mandatory supervisory corrective actions. The
Company does not believe that these regulations have any material effect on its
operations.
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EFFECTS OF GOVERNMENT MONETARY POLICY
The earnings and growth of the Company are affected not only by general
economic conditions, but also by the fiscal and monetary policies of the federal
government, particularly the Federal Reserve. The Federal Reserve can and does
implement national monetary policy for such purposes as curbing inflation and
combating recession, but its open market operations in U.S. government
securities, control of the discount rate applicable to borrowings from the
Federal Reserve, and establishment of reserve requirements against certain
deposits, influence the growth of bank loans, investments and deposits, and also
affect interest rates charged on loans or paid on deposits. The nature and
impact of future changes in monetary policies and their impact on the Company
and the Banks cannot be predicted with certainty.
ITEM 2. PROPERTIES
The Company's administrative offices are located in Aberdeen, Washington. The
building at 300 East Market Street, is owned by The Bank of Grays Harbor, which
also houses the main branch and the administrative and operations offices of The
Bank of Grays Harbor and Pacific Financial Corporation. The Bank completed
construction and occupied the building in December of 1979. There are four
branches in addition to the main office owned by Harbor.
Harbor owns the building and land occupied by the Hoquiam branch, it owns the
land and building housing the Ocean Shores branch, and owns the land and
building occupied by the Pacific Beach branch. Harbor further owns the building
occupied by the Montesano branch. Harbor and IDC Parking Company are parties to
a lease dated July 8, 1997, under which the Harbor leases, with an option to
purchase, the property on which the Montesano branch is located. Under the terms
of the lease, IDC Parking Company may exercise an option to receive 3,300 shares
of the Company's stock if the bank exercises its option to purchase the
Montesano branch property.
In addition to the land and buildings owned by Harbor, it also owns all of its
furniture, fixtures and equipment including data processing equipment. At
December 31, 1999, the net book value of Harbor's premises and equipment was
$2.3 million.
Bank of the Pacific owns the land and building of its main branch which is
located at 1007 South Pacific Highway, Long Beach, Washington. The building also
houses the administrative and operations offices of Bank of the Pacific. The
Bank completed construction of the facilities and occupied the building in 1971.
Pacific owns the land and buildings occupied by four branches: the Ocean Park
Office in Ocean Park, the Ilwaco Office in Ilwaco, the Naselle Office in
Naselle, and the Cathlamet Office in Cathlamet.
In addition to the land and buildings owned by Pacific, it also owns all of its
furniture, fixtures and equipment including data processing equipment. At
December 31, 1999, the net book value of Pacific's premises and equipment was
$1.2 million.
ITEM 3. LEGAL PROCEEDINGS
The Company and the Banks from time to time are party to various legal
proceedings arising in the ordinary course of their business. Management
believes that there are no threatened or pending procedures against the Company
or the Banks which, if determined adversely, would have a material effect on its
business or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the fourth quarter of
1999.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDERS
MATTERS
No broker makes a market in the Company's common stock, and trading has not
otherwise been extensive. The trades that have occurred cannot be characterized
as amounting to an established public trading market. The Company's common stock
is traded by individuals on a personal basis and is not listed on any exchange
or traded on the over-the-counter market, and the prices reported reflect only
the transactions known to Company management. Because only limited information
is available, the following data may not accurately reflect the actual market
value of the Company's common stock. The stock prices shown reflect those of
Harbor Bancorp in 1998, and as the combined entity in 1999. The following data
includes trades between individual investors, as reported to the Company as its
own transfer agent.
<TABLE>
<CAPTION>
1999 1998
Shares Traded High Low High Low
<S> <C> <C> <C> <C> <C>
First Quarter 1,195 $ 130 $ 125 $ 115 $ 100
Second Quarter 3,581 $ 135 $ 130 $ 125 $ 100
Third Quarter 200 $ 135 $ 135 $ 125 $ 125
Fourth Quarter 82 $ 140 $ 135 $ 120 $ 120
</TABLE>
As of December 31, 1999, there were approximately 786 stockholders of record of
the Company common stock.
The Company's Board of Directors declared dividends on its common stock in
December 1999 and 1998 in the amounts per share of $6.25 and $4.86 respectively.
The Board of Directors have adopted a dividend policy which is reviewed
annually.
Payment of dividends is subject to regulatory limitations. Under federal banking
law, the payment of dividends by the Company and the Banks is subject to capital
adequacy requirements established by the Federal Reserve Board and the FDIC.
Under Washington general corporate law as it applies to the Company, no cash
dividend may be declared or paid, if, after giving effect to the dividend, the
Company is insolvent or the liabilities exceed the assets. Payment of dividends
on the Common Stock is also affected by statutory limitations, which restrict
the ability of the Banks to pay upstream dividends to the Company. Under
Washington banking law as it applies to the Banks, no dividend may be declared
or paid in an amount greater than net profits then available, and after a
portion of such net profits have been added to the surplus funds of the Banks.
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ITEM 6. SELECTED FINANCIAL DATA
The financial data presented in this report have been restated to reflect the
merger, as discussed in item 1 of this report, which was accounted for as a
pooling of interests transaction. The following table sets forth certain
selected consolidated financial data of the Company at and for the years ended
December 31:
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
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($ in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
OPERATIONS DATA
Net interest income $ 11,430 11,100 10,692 9,817 9,565
Provision for credit losses 60 110 142 172 232
Noninterest income 1,255 1,281 1,149 1,072 1,059
Noninterest expense 7,011 6,687 6,188 5,575 5,471
Provision for income taxes 1,692 1,590 1,643 1,493 1,416
Net income 3,922 3,994 3,868 3,649 3,505
Net income per share:
Basic 8.01 8.19 7.97 7.53 7.27
Diluted 7.93 8.06 7.92 7.49 7.24
Dividends paid 3,105 2,379 2,118 1,895 1,756
Dividends paid ratio 79% 60% 55% 52% 50%
PERFORMANCE RATIOS
Net interest margin 5.20% 5.37% 5.90% 5.86% 6.13%
Efficiency ratio 55.27% 54.01% 52.26% 51.20% 51.50%
Return on average assets 1.64% 1.80% 1.99% 2.04% 2.10%
Return on average equity 17.26% 18.57% 19.70% 20.79% 22.55%
BALANCE SHEET DATA
Total assets $ 242,189 236,364 208,551 191,512 173,806
Loans, net 150,734 145,416 141,780 135,835 120,189
Total deposits 206,139 210,650 178,726 170,697 155,019
Short-term borrowings 9,675 86 6,625 172 33
Shareholders' equity 21,438 21,485 19,657 17,829 16,088
Book value per share $ 43.15 43.94 40.34 36.81 33.24
Equity to assets ratio 8.85% 9.09% 9.43% 9.31% 9.26%
ASSET QUALITY RATIOS
Nonperforming loans to loans 0.21% 0.01% 0.29% 0.04% 0.25%
Allowance for loan losses
To total loans 1.26% 1.27% 1.35% 1.33% 1.33%
Allowance for loan losses
To nonperforming loans 612.69% 12426.67% 459.00% 3316.36% 523.87%
Nonperforming assets to
Total assets 0.13% 0.06% 0.22% 0.03% 0.18%
</TABLE>
As discussed in Item 1 and Item 7 of this document, merger expenses totaling
approximately $349,000 negatively impacted financial results for the fiscal year
ended December 31, 1999.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT
OF OPERATIONS
RESULT OF OPERATIONS
Years ended December 31, 1999, 1998 and 1997
General. The Company's net income for 1999 was $3,922,000 a 1.8% decrease
compared to $3,994,000 in 1998, and an increase of 1.4% over $3,868,000 in 1997.
Basic earnings per share were $8.01, $8.19, and $7.97 for 1999, 1998, and 1997
respectively. Return on average assets was 1.64%, 1.80%, and 1.99% in 1999, 1998
and 1997 respectively. Return on average equity was 17.26%, 18.57% and 19.70%
respectively in 1999, 1998 and 1997.
As described in more detail in Item I of this document, the Company completed a
merger of equals with Pacific Financial Corporation, which became effective on
December 15, 1999. Under the terms of the merger agreement governing the
transaction, Pacific Financial Corporation was merged with and into Harbor
Bancorp, Inc., with Harbor Bancorp, Inc. as the surviving corporation, operating
under the name Pacific Financial Corporation. The transaction was accounted for
as a pooling-of-interests. Nonrecurring costs associated with the merger totaled
approximately $349,000 during 1999 which was a main factor contributing to the
decline in net income in 1999 compared to 1998. These one time merger expenses
reduced earnings by .48 cents per share.
The following table presents condensed consolidated statements of income for the
Company for each of the years in the three year period ended December 31, 1999.
<TABLE>
<CAPTION>
INCREASE INCREASE
(DECREASE) (DECREASE)
(DOLLARS IN THOUSANDS) 1999 AMOUNT % 1998 AMOUNT % 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest income $18,354 $ 402 2.2 $17,952 $ 1,196 7.1 $16,756
Interest expense 6,924 72 1.1 6,852 788 13.0 6,064
Net interest income 11,430 330 3.0 11,100 408 3.8 10,692
Provision for credit losses 60 (50) (45.5) 110 (32) (22.5) 142
Net interest income after
provision for credit losses 11,370 380 3.5 10,990 440 4.2 10,550
Other operating income 1,255 (26) (2.03) 1,281 132 11.5 1,149
Other operating expense 7,011 324 4.8 6,687 499 8.1 6,188
Income before income taxes 5,614 30 .5 5,584 73 1.3 5,511
Income taxes 1,692 102 6.4 1,590 (53) (3.2) 1,643
Net income $ 3,922 (72) (1.8) 3,994 126 3.3 3,868
</TABLE>
NET INTEREST INCOME. The Company derives the majority of its earnings from net
interest income, which is the difference between interest income earned on
interest earning assets and interest expense incurred on interest bearing
liabilities. The following table sets forth information with regard to average
balances of the interest earning assets and interest bearing liabilities and the
resultant yields or cost, net interest income, and the net interest margin.
13
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998 1997
---- ---- ----
INTEREST INTEREST INTEREST
AVERAGE INCOME AVG AVERAGE INCOME AVG AVERAGE INCOME AVG
BALANCE (EXPENSE) RATE BALANCE (EXPENSE) RATE BALANCE (EXPENSE) RATE
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS (DOLLARS IN THOUSANDS)
Earning assets:
Loans $ 147,689 14,129* 9.57% 145,493 14,427* 9.92% 138,720 14,155* 10.20%
Investments Securities:
Taxable 51,439 2,987 5.81 31,986 1,925 6.11 23,371 1,562 6.31
Tax-Exempt 14,333 1,114* 7.77 14,595 1,172* 7.82 12,974 1,084* 8.36
Total Investment
Securities 65,772 4,101 6.24 46,581 3,097 6.65 36,345 2,646 7.01
Federal funds sold and
Deposits in banks 10,476 570 5.44 14,760 877 5.94 6,026 328 5.44
TOTAL EARNING ASSETS/
INTEREST INCOME $ 223,937 18,800 8.40% 206,834 18,401 8.90% 181,091 17,129 9.39%
Cash and due from banks 8,599 6,511 6,125
Bank premises and equipment
(net) 3,596 3,786 3,624
Other assets 5,303 6,555 5,439
Allowance for credit losses (1,922) (1,863) (1,909)
TOTAL ASSETS $ 239,513 221,823 194,370
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Deposits:
Savings and interest-
Bearing demand $ 112,452 (3,435) 3.05 103,163 (3,207) 3.11 89,511 (2,963) 3.31
Time 65,524 (3,277) 5.00 61,657 (3,379) 5.48 55,326 (3,049) 5.51
TOTAL DEPOSITS 177,976 (6,712) 3.77 164,820 (6,586) 3.99 144,837 (6,012) 4.15
Other borrowings 4,091 (212) 5.18 4,505 (266) 5.90 750 (52) 6.93
TOTAL INTEREST-BEARING LIABILITIES/
INTEREST EXPENSE $ 182,067 (6,924) 3.80% 169,325 (6,852) 4.05 145,587 (6,064) 4.17
Demand deposits 32,921 29,254 27,860
Other liabilities 1,804 1,740 1,292
Shareholders' equity 22,721 21,504 19,631
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 239,513 221,823 194,370
NET INTEREST INCOME $ 11,876 11,549 11,065
NET INTEREST INCOME AS A PERCENTAGE OF
AVERAGE EARNING ASSETS
Interest income 8.40% 8.90% 9.39%
Interest expense 3.10% 3.31% 3.35%
NET INTEREST INCOME 5.30% 5.59% 6.04%
</TABLE>
* TAX EQUIVALENT BASIS
Net interest income increased 3.0% to $11,430,000 in 1999 compared to 1998. The
increase is primarily the result of increased volume in investment securities
which grew substantially more than loans. This also caused the decline of yields
on earning assets, as investment securities realize lower yields than loans.
14
<PAGE>
The following table presents changes in net interest income attributable to
changes in volume or rate. Changes not solely due to volume or rate are
allocated to volume and rate based on the absolute values of each.
<TABLE>
<CAPTION>
1999 COMPARED TO 1998 1998 COMPARED TO 1997
--------------------------- -----------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
--------------------------- -----------------------------
(dollars in thousands) VOLUME RATE NET VOLUME RATE NET
------ ---- --- ------ ---- ---
<S> <C> <C> <C> <C> <C> <C>
Interest earned on:
Loans $ 215 $ (513) $ (298) $ 677 $ (405) $ 272
Securities:
Taxable 1,132 (70) 1,062 520 (126) 394
Tax-exempt (21) (37) (58) 118 (61) 57
Total Securities 1,111 (107) 1,004 638 (187) 451
Fed funds sold and
Interest bearing deposits
In other banks (238) (69) (307) 515 34 549
Total interest earning assets 1,088 (689) 399 1,830 (558) 1,272
Interest paid on:
Savings and Interest bearing
demand deposits 285 (57) 228 453 (209) 244
Time deposits 204 (306) (102) 348 (18) 330
Short term borrowings (23) (31) (54) 222 (8) 214
Total interest bearing liabilities 466 (394) 72 1,023 (235) 788
Change in net interest income 622 (295) 327 807 (323) 484
</TABLE>
NON-INTEREST INCOME. Non-interest income was $1,255,000 for 1999, down $26,000
or 2.0% from 1998 when it totaled $1,281,000. This was an increase of $132,000
or 11.5% compared to the 1997 total of $1,149,000. In 1999, service charges on
deposit accounts increased $60,000 or 8.8% to a total of $745,000 compared to
$685,000 in 1998. The 1998 total was up $47,000 or 7.4% over the 1997 total of
$638,000.
GAIN ON LOAN SALES. From time to time loans are sold, but it is the general
practice of the Company that loans are originated for the portfolio and are
held. Gain on sale of loans is not looked to as a regular source of non-interest
income. In 1999 a loss of $3,000 were realized from the sale of loans: in 1998
and 1997 gain on sale of loans totaled $17,000 and $76,000, respectively.
Other operating income totaled $468,000 in 1999, a decrease of $59,000 from
1998, or 11.2%. The primary reason for the decrease was the decrease in revenue
received from other service fees which included loan servicing fees, fees on
loans originated for others, and check cashing fees. Other operating income for
1998 was $527,000 an increase of $128,000 compared to 1997 or 32% the result of
ATM fee income and fees on loans originated for others.
15
<PAGE>
The following table represents the principal categories of non-interest income
for each of the years in the three-year period ended December 31, 1999.
<TABLE>
<CAPTION>
INCREASE INCREASE
(DECREASE) (DECREASE)
---------- ----------
(DOLLARS IN THOUSANDS) 1999 AMOUNT % 1998 AMOUNT % 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Service charges on
Deposit accounts $ 745 $ 60 8.8% $ 685 $ 47 7.4% $ 638
Gain on sale of loans (3) (20) (118.0%) 17 (59) (77.6%) 76
Other operating income 513 (66) (12.6%) 579 144 33.1% 435
Total non-interest income $ 1,255 (26) (2.30%) 1,281 132 11.5% 1,149
</TABLE>
NON-INTEREST EXPENSE. Total non-interest expense was $7,011,000 an increase of
$324,000 or 4.8% compared to $6,687,000 in 1998. In 1998 non-interest expense
increased $499,000 or 8.1% compared to $6,188,000 in 1997.
Salary and employee benefits increased $170,000, or 4.6% in 1999; $158,000, or
4.5% in 1998. The primary reason for the increase in 1999 and 1998 is
attributable to increased bonuses and merit raises. Employee benefit increases
during 1999, totaled $70,000 compared to 1998, in large part, due to medical
insurance premiums, which increased $42,000, or 22.5%. Employee benefits
decreased $15,000 in 1998 due to lower contributions for defined benefit
retirement plans, however, medical insurance premiums increased $18,000 or 10.5%
compared to 1997.
Occupancy and equipment expense was down $9,000 in 1999 or .9%; increased
$112,000 in 1998 or 12.3%. In 1999, 47% of occupancy and equipment expense was
depreciation.
Other expense increased $163,000 or 8.3% in 1999 compared to an increase of
$229,000 or 13.2% in 1998 compared to 1997. Non-recurring merger expenses
totaled approximately $349,000 during 1999. Without these one time expenses,
other expense would have decreased $186,000 or 9.4% compared to 1998. The
increase in 1998 was due to greater general and administrative costs.
The following table represents the principal categories of non-interest expense
for each of the years in the three-year period ended December 31, 1999.
<TABLE>
<CAPTION>
INCREASE INCREASE
(DECREASE) (DECREASE)
---------- ----------
(DOLLARS IN THOUSANDS) 1999 AMOUNT % 1998 AMOUNT % 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Salaries and employee benefits $3,871 $ 170 4.6% $3,701 $ 158 4.5% $3,543
Occupancy and equipment 1,013 (9) (.9%) 1,022 112 12.3% 910
Other expense 2,127 163 8.3% 1,964 229 13.2% 1,735
Total non-interest expense $7,011 324 4.8% 6,687 499 8.1% 6,188
</TABLE>
16
<PAGE>
ASSET AND LIABILITY MANAGEMENT
The largest component of the Company's earnings is net interest income. Interest
income and interest expense are affected by general economic conditions,
competition in the market place, market interest rates and repricing and
maturity characteristics of the Company's assets and liabilities. Exposure to
interest rate risk is primarily a function of differences between the maturity
and repricing schedules of assets (principally loans and investment securities)
and liabilities (principally deposits). Assets and liabilities are described as
interest sensitive for a given period of time when they mature or can reprice
within that period. The difference between the amount of interest sensitive
assets and interest sensitive liabilities is referred to as the interest
sensitive "GAP" for any given period. The "GAP" may be either positive or
negative. If positive, more assets reprice than liabilities. If negative, the
reverse is true.
Certain shortcomings are inherent in the interest sensitivity "GAP" method of
analysis. Complexities such as prepayment risk and customer responses to
interest rate changes are not taken into account in the "GAP" analysis.
Accordingly, management also utilizes a net interest income simulation model to
measure interest rate sensitivity. Simulation modeling gives a broader view of
net interest income variability, by providing various rate shock exposure
estimates. Management regularly reviews the interest rate risk position and
provides measurement reports to the Board of Directors.
The following table shows the dollar amount of interest sensitive assets and
interest sensitive liabilities at December 31, 1999 and difference between them
for the maturity or repricing periods indicated.
<TABLE>
<CAPTION>
DUE AFTER
DUE IN ONE ONE THROUGH DUE AFTER
(DOLLARS IN THOUSANDS) YEAR OR LESS FIVE YEARS FIVE YEARS TOTAL
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST EARNING ASSETS
Loans $ 80,096 24,961 47,607 152,664
Investment securities 15,242 32,824 19,174 67,240
Fed Funds and interest
Bearing balances with banks 1,744 -0- -0- 1,744
Total interest earning assets $ 97,082 57,785 66,781 221,648
INTEREST BEARING LIABILITIES
Interest bearing demand deposits $ 27,689 -0- -0- 27,689
Savings deposits 77,142 -0- -0- 77,142
Time deposits 50,344 16,605 -0- 66,949
Short term borrowings 9,675 -0- -0- 9,675
Total interest bearing liabilities $ 164,850 16,644 -0- 181,455
Net interest rate sensitivity GAP $ (67,768) 41,141 66,781 40,193
</TABLE>
17
<PAGE>
The following table shows the dollar amount of interest sensitive assets and
interest sensitive liabilities at December 31, 1998 and difference between them
for the maturity or repricing periods indicated.
<TABLE>
<CAPTION>
DUE AFTER
DUE IN ONE ONE THROUGH DUE AFTER
(DOLLARS IN THOUSANDS) YEAR OR LESS FIVE YEARS FIVE YEARS TOTAL
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST EARNING ASSETS
Loans $ 82,537 19,763 44,980 147,280
Investment securities 22,691 16,905 15,254 54,850
Fed Funds and interest
Bearing balances with banks 18,984 -0- -0- 18,984
Total interest earning assets $ 124,212 36,668 60,234 221,114
INTEREST BEARING LIABILITIES
Interest bearing demand deposits $ 33,576 -0- -0- 33,576
Savings deposits 78,020 78,020
Time deposits 59,008 8,091 -0- 67,099
Short term borrowings 86 -0- -0- 86
Total interest bearing liabilities $ 170,690 8,091 -0- 178,781
Net interest rate sensitivity GAP $ (46,478) 28,577 60,234 42,333
</TABLE>
EFFECTS OF CHANGING PRICES. The results of operations and financial conditions
presented in this report are based on historical cost information, and are
unadjusted for the effects of inflation. Since the assets and liabilities of
financial institutions are primarily monetary in nature, the performance of the
Company is affected more by changes in interest rates than by inflation.
Interest rates generally increase as the rate of inflation increases, but the
magnitude of the change in rates may not be the same.
The effects of inflation on financial institutions is normally not as
significant as its influence on businesses which have investments in plants and
inventories. During periods of high inflation there are normally corresponding
increases in the money supply, and financial institutions will normally
experience above-average growth in assets, loans and deposits. Inflation does
increase the price of goods and services, and therefore does increase operating
expenses during inflationary periods.
18
<PAGE>
INVESTMENT PORTFOLIO
The Company's investment securities portfolio increased $12,393,000, or 22.6%
during 1999 to $67,240,000 at year end from $54,850,000 in 1998, which was a
$15,783,000 increase over 1997. The changes in 1999 and 1998 were primarily in
U.S. Government agency securities and other securities.
The carrying values of investment securities at December 31, in each of the last
three years are as follows:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Treasury securities $ 997 $ 996 $ 2,504
U.S. Agencies securities 33,655 25,996 17,338
Obligations of states and political subdivisions 14,291 13,639 14,503
Other securities 14,957 11,319 2,150
FHLB Stock 3,340 2,900 2,572
Total $ 67,240 54,850 39,067
</TABLE>
The following table presents the maturities of investment securities at December
31, 1999. Taxable equivalent values are used in calculating yields assuming a
tax rate of 34%.
<TABLE>
<CAPTION>
DUE AFTER DUE AFTER
DUE IN ONE ONE THROUGH FIVE THROUGH DUE AFTER
(DOLLARS IN THOUSANDS) YEAR OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Treasury securities $ 500 497 -0- -0- 997
Weighted average yield 5.85% 5.85% -0- -0-
U.S. Agency securities 7,859 17,472 7,775 549 33,655
Weighted average yield 5.20% 5.84% 6.19% 8.14%
Obligations of states and political
Subdivisions 1,566 5,601 5,558 1,566 14,291
Weighted average yield 7.35% 7.28% 7.02% 7.44%
Other securities 1,977 9,254 3,726 -0- 14,957
Weighted average yield 6.45% 6.56% 6.10% -0-
FHLB stock 3,340 -0- -0- -0- 3,340
Weighted average yield 7.25% -0- -0- -0-
Total $ 15,242 32,824 17,059 2,115 67,240
</TABLE>
19
<PAGE>
LENDING
GENERAL. The Company's policy is to originate loans primarily in its local
markets. Depending on the purpose of the loan, the loans may be secured by a
variety of collateral, including business assets, real estate, and personal
assets.
The following table sets forth the composition of the Company's loan portfolio
at December 31, in each of the past five years.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial $ 56,198 48,455 44,815 42,129 40,122
Real Estate Construction 3,325 4,929 4,258 3,618 2,273
Real Estate Mortgage 88,905 90,027 90,631 87,791 75,398
Installment 3,379 3,104 3,276 3,414 3,284
Credit cards and overdrafts 857 764 747 707 736
Total $152,664 147,280 143,727 137,659 121,813
</TABLE>
LOAN MATURITIES AND SENSITIVITY IN INTEREST RATES. The following table presents
information related to maturity distribution and interest rate sensitivity of
commercial and real estate construction loans outstanding, based on scheduled
repayments at December 31, 1999.
<TABLE>
<CAPTION>
DUE AFTER
DUE IN ONE ONE THROUGH DUE AFTER
(DOLLARS IN THOUSANDS) YEAR OR LESS FIVE YEARS FIVE YEARS TOTAL
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial $ 45,405 5,704 5,089 56,198
Real estate construction 2,699 216 410 3,325
Total $ 48,104 5,920 5,656 59,523
TOTAL LOANS MATURING AFTER ONE YEAR WITH
Predetermined interest rates (fixed) 13,872 45,559 59,431
Floating or adjustable rates (variable) 10,249 114 10,363
Total $ 24,121 45,673 69,794
</TABLE>
At December 31, 1999, 45% of the loan portfolio presented above, was due in one
year or less.
RISK ELEMENTS. Risk elements include accruing loans past due ninety days or
more, non-accrual loans, and loans which have been restructured to provide
reduction or deferral of interest or principal for reasons related to the
debtors financial difficulties. The Company's policy for placing loans on
non-accrual status is based upon management's evaluation of the ability of the
borrower to meet both principal and interest payments as they become due.
Generally, loans with interest or principal payments, which are ninety or more
days past due are placed on non-accrual, unless they are well-secured and in the
process of collection, and the interest accrual is reversed against income.
20
<PAGE>
The following table presents information related to the Company's non-accrual
loans and other non-performing assets at December 31, in each of the last five
years.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1999 1998 1997 1996 1995
- ----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans $175 15 422 55 310
Accruing loans past due
90 days or more $140 4 184 341 51
Restructured loans 0 0 0 0 0
</TABLE>
Non-accrual loans increased $160,000 in 1999 from 1998 primarily due to an
increase in non-accrual real estate loans. Non-accrual loans declined $407,000
to $15,000 at year-end 1998 after increasing to $422,000 in 1997 from $55,000,
and $310,000 respectively in 1996 and 1995. Interest income on non-accrual loans
that would have been recorded had those loans performed in accordance with their
initial terms, as of December 31, was $10,000 for 1999, $20,000 for 1998,
$45,000 for 1997, $2,000 for 1996, and $14,000 for 1995. Interest income
recognized on impaired loans for the years 1999 was $11,000, and none for 1998,
1997, 1996 and 1995.
There are $140,000 of loans which are ninety days or more past due and still
accruing at year-end 1999. Of those loans, $137,000 are secured by real estate
and are adequately collateralized. It is management's opinion that if
foreclosure and sale of collateral is necessary, no loss will be incurred.
LOAN CONCENTRATIONS. The Company has credit risk exposure related to real estate
loans. The Company makes real estate loans for construction and loans for other
purposes which are secured by real estate. At December 31, 1999 loans secured by
real estate totaled $92,230,000, which represents 60% of the total loan
portfolio. Real estate construction loans comprised $3,325,000 of that amount,
while real estate loans secured by residential properties totaled $36,373,000.
The ultimate collectibility of the loan portfolio is susceptible to changes in
economic and market conditions in the region. The Company generally requires
collateral on all real estate exposures and typically maintains loan-to-value
ratios of no greater than 80%.
21
<PAGE>
SUMMARY OF LOAN LOSS EXPERIENCE. The following table presents data related to
the aggregate allowance for credit losses and net charge offs for each of the
years in the five-year period ended December 31, 1999.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $ 1,864 1,937 1,824 1,624 1,432
Charge-offs:
Commercial 114 9 5 28 50
Real estate loans 0 194 0 0 0
Credit card 13 18 20 22 12
Installment 7 0 16 12 1
Total charge-offs $ 134 221 41 62 63
Recoveries:
Commercial $ 23 34 7 80 12
Real estate loans 110 0 0 0 0
Credit card 6 3 2 6 1
Installment 1 1 3 4 1
Total recoveries $ 140 38 12 90 23
Net charge-offs (recoveries) (6) 183 29 (28) 40
Provision for credit losses 60 110 142 172 232
Balance at end of year $ 1,930 1,864 1,937 1,824 1,624
Ratio of net charge-offs (recoveries)
To average loans outstanding -- .13% .02% (.02%) .03%
</TABLE>
The allowance for credit losses was $1,930,000 at year-end 1999, compared with
$1,864,000 at year-end 1998. The aggregate increase resulted from the provision
of $60,000 and the net recoveries from previous charge-offs. The allowance for
loan loss as a percentage of total loans outstanding at year-end 1999 was 1.26%,
which in managements' opinion is adequate and reasonable in comparison to the
Company's credit risk experience.
The allowance for credit losses during 1998 decreased $73,000 compared to
year-end 1997. Total allowance for credit losses was $1,864,000 at year-end 1998
and $1,937,000 in 1997. The aggregate decrease during 1998 was the result of the
provision of $110,000 and net charge-offs of $183,000. The allowance increased
in 1997 from the provision of $142,000 and net charge-offs of $29,000. The
allowance for credit losses as a percentage of total loans outstanding at
year-end 1998 was 1.27% and 1.35% in 1997.
The allowance for credit losses at year-end 1996 was $1,824,000 compared to
$1,624,000 in 1995. The net recoveries were $28,000 in 1996 compared to
charge-offs of $40,000 during 1995. Provisions for credit losses were $172,000
in 1996 and $232,000 in 1995. The allowance for credit losses as a percentage of
total loans outstanding at year-end 1996 was 1.33% and 1.33% in 1995.
22
<PAGE>
PROVISION AND ALLOWANCE FOR CREDIT LOSSES. The Company provided $60,000 for
credit losses during 1999 compared to $110,000 in 1998 and $142,000 in 1997,
$172,000 in 1996 and $232,000 in 1995. The provisions are made to insure
adequate reserves for potential losses. The provision for credit losses charged
to operating income is based on, historical loss experience, volume and types of
loans, trends in delinquencies and non-accrual loans. Further analysis is
performed regarding trends in portfolio volume, results of internal and
independent external credit reviews, and anticipated economic conditions in the
Company's market area. The Company determines the adequacy of its loan loss
reserves through a formula applying risk factors to outstanding loans and
certain unused commitments, in each case based on the internal risk grade of
those loans or commitments. Based on this analysis and the loan quality and
historical loss experience the past three years, the provision has declined
while a strong total allowance has been maintained. The Company's allowance
further incorporates the results of measuring impaired loans as provided in
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan" and Statement of Financial Accounting Standards No.
118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosure."
Based on certain characteristics of the loan portfolio, potential losses can be
anticipated for major loan categories. The following table presents the
allocation of the allowance for credit losses among the major loan categories
based primarily on their historical net charge off experience and other business
considerations at December 31, in each of the last five years.
<TABLE>
<CAPTION>
% OF % OF % OF % OF % OF
1999 TOTAL 1998 TOTAL 1997 TOTAL 1996 TOTAL 1995 TOTAL
(DOLLARS IN THOUSANDS) RESERVE RESERVE RESERVE RESERVE RESERVE RESERVE RESERVE RESERVE RESERVE RESERVE
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial loans $ 720 37% $ 710 38% $ 798 41% $ 605 33% $ 503 31%
Real estate loans 1,153 60% 1,091 58% 1,089 56% 1,165 64% 1,072 66%
Consumer loans 58 3% 63 4% 50 3% 54 3% 49 3%
Total allowance $1,930 100% $1,864 100% $1,937 100% $1,824 100% $1,624 100%
Ratio of allowance
for credit
Losses to loans
outstanding
At end of year 1.26% 1.27% 1.35% 1.33% 1.33%
</TABLE>
DEPOSITS
The Company's primary source of funds has historically been customer deposits. A
variety of deposit products are offered to attract customer deposits. The
products include non-interest bearing demand accounts, negotiable order of
withdrawal (NOW) accounts, savings accounts, and time deposits. Interest-bearing
accounts earn interest at rates established by management, based on competitive
market factors and the need to increase or decrease certain types of maturities
of deposits.
23
<PAGE>
The following table sets forth the average balances for each major category of
deposits and the weighted average interest rate paid for deposits for the
periods indicated.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1999 RATE 1998 RATE 1997 RATE
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Demand deposits $ 32,921 0.00% 29,254 0.00% 27,860 0.00%
Interest bearing demand deposits 31,980 2.51% 38,495 2.41% 27,903 2.57%
Savings deposits 80,472 3.67% 64,668 3.35% 61,608 3.41%
Time deposits 65,524 5.00% 61,657 5.48% 55,326 5.51%
Total $210,897 3.77% 194,074 3.99% 172,697 4.15%
</TABLE>
Maturities of time certificates of deposit as of December 31, 1999 are
summarized as follows:
<TABLE>
<CAPTION>
UNDER OVER
$100,000 $100,000 TOTAL
-------- -------- ------
<C> <C> <C> <C>
3 months or less $10,065 7,236 17,301
Over 3 through 6 months 10,754 4,373 15,127
Over 6 through 12 months 14,876 3,040 17,916
Over 12 months 11,741 4,864 16,605
Total $47,436 19,513 66,949
</TABLE>
SHORT-TERM BORROWINGS
The following is information regarding the Company's short-term borrowings for
the years ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1999 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Amount outstanding at end of period $ 9,675 $ 86 $ 6,625
Weighted average interest rate thereon 5.50% 5.15% 5.65%
Maximum amount outstanding at any month end during period 11,375 2,550 6,625
Average amounts outstanding during the period 4,091 4,505 653
Weighted average interest rate during period 5.18% 5.90% 7.04%
</TABLE>
KEY FINANCIAL RATIOS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Return on average assets 1.64% 1.80% 1.99% 2.04% 2.10%
Return on average equity 17.26% 18.57% 19.70% 20.79% 22.55%
Average equity to average assets ratio 9.49% 9.69% 10.09% 9.82% 9.30%
Dividend Payout ratio 79% 60% 55% 52% 50%
</TABLE>
YEAR 2000
The Year 2000 or Y2K problem is a result of the inability of computer software
programs to recognize the year 2000, as most programs and systems were designed
to store calendar years in the 1900's by assuming the "19" and storing only the
last two digits of the year. As the Company has reported in the past, it has
spent considerable effort in preparing for Y2K in the period leading up to
January 1, 2000.
24
<PAGE>
The Company has not experienced any significant Y2K problems and has not been
informed of any Y2K problems by its customers or vendors. However, although
January 1, 2000 is past, it is possible that some problems have gone undetected,
or that other dates in the future may further affect computer software and
systems, or equipment with embedded chip technology.
The Company will continue to monitor the Y2K compliance of its own computer
systems and equipment with embedded technology, as well as any Y2K related
problems that may be reported to it by third parties with whom it does business.
As discussed in the Company's Form 10-Q for the fiscal quarter ended September
30, 1999, the estimated costs associated with the Y2K issue were $200,000. The
Company believes, based on its review of such costs to January 31, 2000, that
total costs will not be higher than the amount previously estimated. However, as
noted above, it is possible that additional costs will be incurred in connection
with Y2K problems that may still occur in the future.
FORWARD LOOKING STATEMENTS. The discussion above regarding the Company's Y2K
status includes certain "forward looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "PLSRA"). The Company
desires to take advantage of the "safe harbor" provisions of the PLSRA as they
apply to forward looking statements. The Company's ability to predict the
results of future plans is inherently uncertain, and is subject to factors that
may cause actual results to differ materially from those projected. Factors that
could affect the actual results include the possibility that system
modifications will not operate as intended, and that the Company or its
significant customers or vendors have not yet detected Y2K problems that have
arisen or will arise in the future.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY. The primary concern of depositors, creditors and regulators is the
Company's ability to have sufficient funds readily available to repay
liabilities as they mature. In order to insure adequate funds are available at
all times, the Company monitors and projects the amount of funds required on a
daily basis. Through the Banks, the Company obtains funds from its customer base
which provides a stable source of "core" demand and consumer deposits. Other
sources are available with borrowings from the Federal Home Loan Bank and
correspondent banks. Liquidity requirement can also be met through disposition
of short-term assets. The Company in its opinion, maintains an adequate level of
liquid assets, consisting of cash and due from banks, interest bearing deposits
with banks, and federal funds sold to support the daily cash flow requirements.
CAPITAL. The Company endeavors to maintain equity capital at an adequate level
to support and promote investor confidence. The Company conducts its business
through its Banks. Thus, the Company needs to be able to provide capital and
financing to the Banks should the need arise.
The primary source for obtaining capital is through additional stock sales.
Total shareholder equity averaged $22,721,000 in 1999 compared to $21,504,000 in
1998 an increase of 5.7%, and $19,631,000 in 1997 an increase of 9.5%.
The Company's Board of Directors considers financial results, growth plans, and
anticipated capital needs in formulating its dividend policy. The payment of
dividends is subject to adequate financial results of the Company's Banks, and
limitations imposed by law and governmental regulations.
The Federal Reserve Bank has established guidelines that mandate risk-based
capital requirements for bank holding companies. Under the guidelines, one of
four risk weights is applied to balance sheet assets, each with different
capital requirements based on the credit risk of the asset. The Company's
capital ratios include the assets of the Banks on a consolidated basis in
accordance with the requirements of the Federal Reserve Bank. The Company's
capital ratios have exceeded the minimum required to be classified "well
capitalized" for all of the past three years.
25
<PAGE>
The following table sets forth the minimum required capital ratios and actual
ratios for December 31, 1999, 1998, and 1997.
<TABLE>
<CAPTION>
CAPITAL
ADEQUACY
ACTUAL PURPOSES
(DOLLARS IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1999
Tier 1 capital (to average assets) 22,389 9.28% 9,646 4.00%
Tier 1 capital (to risk-weighted 22,389 12.93% 6,929 4.00%
Assets)
Total capital (to risk-weighted 24,319 14.04% 13,857 8.00%
Assets)
December 31, 1998
Tier 1 capital (to average assets) 21,117 9.03% 9,313 4.00%
Tier 1 capital (to risk-weighted 21,117 12.63% 6,686 4.00%
Assets)
Total capital (to risk-weighted 22,981 13.75% 13,372 8.00%
Assets)
December 31, 1997
Tier 1 capital (to average assets) 19,403 9.64% 8,054 4.00%
Tier 1 capital (to risk-weighted 19,403 13.93% 5,571 4.00%
Assets)
Total capital (to risk-weighted 21,146 15.18% 11,143 8.00%
Assets)
</TABLE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's result of operations are largely dependent upon its ability to
manage interest rate risk. Management considers interest rate risk to be a
significant market risk that could have a material effect on the Company's
financial condition and results of operations. The Company does not currently
use derivatives to manage market and interest rate risks. All of the Company's
transactions are denominated in U.S. dollars. Approximately 45% of the Company's
loan portfolio have interest rates which float with the Company's reference
rate. Fixed rate loans generally are made with a term of five years or less.
In the Asset and Liability section of the Management Discussion and Analysis is
a table presenting estimated maturity or pricing information indicating the
Company's exposure to interest changes. The assumptions and description of the
process used to manage interest rate risk is further discussed in the Asset and
Liability section. The following table discloses the balances of the financial
instruments including the fair value as of December 31, 1999. The expected
maturities are disclosed based on contractual schedules. Principal repayments
are not considered. The expected maturities for financial liabilities with no
stated maturity reflect estimated future roll-off rates. The roll-off rates for
non-interest bearing deposits, interest bearing demand deposits, money market
accounts, and savings deposits are 15%, 25%, 25% and 20% respectively. The
interest rates disclosed are based on rates in effect at December 31, 1999. Fair
values are used in accordance with generally accepted accounting principles as
disclosed in the financial statement.
26
<PAGE>
EXPECTED MATURITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 THERE FAIR
(DOLLARS IN THOUSANDS) 2000 2001 2002 2003 2004 AFTER TOTAL VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents
Non-interest bearing 13,080 -- -- -- -- -- 13,080 13,080
Interest bearing deposits in banks 1,744 -- -- -- -- -- 1,744 1,744
Weighted average interest rate 5.23%
Federal funds sold
Fixed rate -0- -- -- -- -- -- -- --
Weighted average interest rate
Securities available for sale
Fixed rate 11,713 11,909 4,829 6,098 11,660 17,522 63,731 62,285
Weighted average interest rate 5.95% 5.91% 6.96% 6.37% 6.46% 6.58%
Securities held to maturity
Fixed rate 45 8 44 20 100 1,398 1,615 1,615
Weighted average interest rate 6.42% 6.03% 5.80% 6.50% 5.49% 6.61%
Loans receivable
Fixed rate 9,972 2,625 2,532 4,458 4,257 45,559 69,403 68,037
Weighted average interest rate 9.39% 9.22% 8.99% 8.72% 8.73% 8.41%
Adjustable rate 72,898 1,949 1,205 2,935 4,160 114 83,261 83,261
Weighted average interest rate 9.78% 8.41% 8.46% 8.62% 8.64% 6.50%
Federal Home Loan Bank stock 3,340 -- -- -- -- -- 3,340 3,340
Weighted average interest rate 7.25%
</TABLE>
EXPECTED MATURITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 THERE FAIR
(DOLLARS IN THOUSANDS) 2000 2001 2002 2003 2004 AFTER TOTAL VALUE
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FINANCIAL LIABILITIES
Non-interest bearing deposits 5,407 4,596 3,907 3,320 2,823 14,306 34,359 34,359
Interest bearing checking accounts 6,921 5,191 3,893 2,920 2,190 6,574 27,689 27,689
Weighted average interest rate 1.68% 1.68% 1.68% 1.68% 1.68% 1.68%
Money Market accounts 6,060 4,546 3,409 2,557 1,917 5,753 24,242 24,242
Weighted average interest rate 1.49% 1.49% 1.49% 1.49% 1.49% 1.49%
Savings accounts 10,587 8,470 6,776 5,420 4,336 17,311 52,900 52,900
Weighted average interest rate 2.49% 2.49% 2.49% 2.49% 2.49% 2.49%
Certificates of deposit
Fixed rate 48,043 8,603 5,770 1,549 ---- ---- 63,965 63,982
Weighted average interest rate 4.88% 5.48% 5.55% 5.40%
Variable rate 2,301 683 ---- ---- ---- ---- 2,984 2,984
Weighted average interest rate 5.38% 5.40%
FHLB advances and other borrowings
Fixed rate 9,675 ---- ---- ---- ---- ---- 9,675 9,675
Weighted average interest rate 5.50%
</TABLE>
While the table presented above provides information about the Company's
interest sensitivity, it does not predict the trends of future earnings. For
this reason, financial modeling is used to forecast earnings under varying
interest rate projections. While this process assists in managing interest rate
risk, it does require significant assumptions for the projection of loan
prepayments, loan origination volumes and liability funding sources that may
prove to be inaccurate.
27
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required for this item is included in Item 14 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors and executive officers requested by this item
is contained in the registrant's 2000 Proxy Statement in the sections entitled
"MANAGEMENT-Certain Executive Officers," "Proposal No. 1 - Election of
Directors," and "Compliance with Section 16(a) of the Exchange Act" and is
incorporated by reference herein.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation requested by this item is
contained in the registrant's 2000 Proxy Statement in the sections entitled
"DIRECTOR'S COMPENSATION" and "EXECUTIVE COMPENSATION", and is incorporated by
reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management requested by this item is contained in the registrant's 2000 Proxy
Statement in the section entitled "MANAGEMENT - Security Ownership of Certain
Beneficial Owners and Management," and is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions requested
by this item is contained in the registrant's 2000 Proxy Statement in the
section entitled "TRANSACTIONS WITH MANAGEMENT," and is incorporated by
reference herein.
28
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
Independent Auditor's Report on Consolidated Financial Statements
Consolidated Statements of Condition
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Cash Flow
Notes to Consolidated Financial Statements
(a) (2) Schedules: None
(a) (3) Exhibits
EXHIBIT NO. EXHIBIT
3.1 Restated Articles of Incorporation (1)
3.2 Bylaws (1)
10.1 Employment Agreement for Robert J. Worrell (2)
10.2 First Amendment of Employment Agreement for Robert J. Worrell (2)
10.3 Employment Agreement for Dennis A. Long (2)
10.4 Employment Agreement for Wayne D. Gale (2)
10.5 Employment Agreement for Patricia C. Nelson (2)
10.6 Employment Agreement for John Van Dijk (2)
10.7 Bank of the Pacific Incentive Stock Option Plan
10.8 The Bank of Grays Harbor Incentive Stock Option Plan
21 Subsidiaries of Registrant (see Item 1 - Business, of this report)
23 Consent of Knight Vale & Gregory PLLC, Independent Auditors
27 Financial Data Schedule
(1) Incorporated by reference to Exhibit 2a. and 2b. of the Form 8-A filed
by the Company and Declared effective on March 7, 2000 (Registration
No. 000-29829)
29
<PAGE>
(2) Incorporated by reference to Exhibits 10.2, 10.2.1, 10.3, 10.4, 10.5
and 10.6 of the Registration Statement on Form S-4 filed by the
Company and declared effective on November 10, 1999 (Registration No.
333-86687)
(a) (4) Form 8-K: None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized on the 20th of March 2000.
PACIFIC FINANCIAL CORPORATION
(Registrant)
/s/ Robert J. Worrell /s/ Dennis A. Long
- ------------------------------------------ -----------------------------------
Robert J. Worrell, Chief Executive Officer Dennis A. Long, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant in
the capacities indicated, on the 20th of March 2000.
Principal Executive Officer Principal Accounting Officer
/s/ Dennis A. Long /s/ John Van Dijk
- ------------------------------------------ -----------------------------------
Dennis A. Long, President and Director John Van Dijk, Treasurer
(Chief Financial Officer)
Remaining Board of Directors
/s/ Joseph A. Malik /s/ Sidney R. Snyder
- ------------------------------------------ -----------------------------------
Joseph A. Malik (Chairman of the Board) Sidney R. Snyder
/s/ Gary C. Forcum /s/ Duane E. Hagstrom
- ------------------------------------------ -----------------------------------
Gary C. Forcum Duane E. Hagstrom
/s/ Walter L. Westling /s/ Robert A. Hall
- ------------------------------------------ -----------------------------------
Walter L. Westling Robert A. Hall
/s/ David L. Woodland /s/ Robert J. Worrell
- ------------------------------------------ -----------------------------------
David L. Woodland Robert J. Worrell
30
<PAGE>
Pacific
Financial
Corporation
and
Subsidiaries
CONSOLIDATED
FINANCIAL
REPORT
December 31
1999
<PAGE>
CONTENTS
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT...................................................1
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets....................................................2
Consolidated Statements of Income..............................................3
Consolidated Statements of Shareholders' Equity................................4
Consolidated Statements of Cash Flows........................................5-6
Notes to Consolidated Financial Statements..................................7-26
SUPPLEMENTARY INFORMATION
Consolidated Average Balances and Net Interest Income.........................27
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
PACIFIC FINANCIAL CORPORATION
Aberdeen, Washington
We have audited the accompanying consolidated balance sheets of PACIFIC
FINANCIAL CORPORATION AND SUBSIDIARIES as of December 31, 1999 and 1998, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PACIFIC FINANCIAL
CORPORATION AND SUBSIDIARIES as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The supplementary
information is presented for purposes of additional analysis and is not a
required part of the basic consolidated financial statements. The supplementary
information has been subjected to the auditing procedures applied in the audits
of the basic consolidated financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic consolidated financial
statements taken as a whole.
/s/ KNIGHT VALE & GREGORY PLLC
KNIGHT VALE & GREGORY PLLC
Tacoma, Washington
January 28, 2000
<PAGE>
INDEPENDENT AUDITORS' REPORT
January 28, 2000
Board of Directors
PACIFIC FINANCIAL CORPORATION
Aberdeen, Washington
We have audited the accompanying consolidated balance sheets of PACIFIC
FINANCIAL CORPORATION AND SUBSIDIARIES as of December 31, 1999 and 1998, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PACIFIC FINANCIAL
CORPORATION AND SUBSIDIARIES as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The supplementary
information is presented for purposes of additional analysis and is not a
required part of the basic consolidated financial statements. The supplementary
information has been subjected to the auditing procedures applied in the audits
of the basic consolidated financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic consolidated financial
statements taken as a whole.
<PAGE>
CONSOLIDATED
FINANCIAL
STATEMENTS
<PAGE>
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
(Dollars in Thousands)
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
ASSETS
Cash and due from banks $ 13,080 $ 8,634
Interest bearing deposits in banks 1,744 6,389
Federal funds sold -- 12,595
Securities available for sale 65,625 53,125
Securities held to maturity (market value $1,615 and $1,725) 1,615 1,725
Loans 152,664 147,280
Allowance for credit losses 1,930 1,864
LOANS - NET 150,734 145,416
Premises and equipment 3,510 3,668
Foreclosed real estate 177 131
Accrued interest receivable 2,004 1,864
Cash surrender value of life insurance 2,330 2,226
Other assets 1,370 591
TOTAL ASSETS $ 242,189 $ 236,364
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand $ 34,359 $ 31,988
Savings and interest-bearing demand 104,831 111,563
Time 66,949 67,099
TOTAL DEPOSITS 206,139 210,650
Accrued interest payable 549 483
Short-term borrowings 9,675 86
Other liabilities 4,388 3,660
TOTAL LIABILITIES 220,751 214,879
COMMITMENTS AND CONTINGENT LIABILITIES -- --
SHAREHOLDERS' EQUITY
Common stock (par value $1); authorized 1,000,000 shares;
issued: 1999 - 496,770 shares; 1998 - 488,969 shares 497 489
Surplus 11,420 10,972
Retained earnings 10,473 9,656
Accumulated other comprehensive income (loss) (952) 368
TOTAL SHAREHOLDERS' EQUITY 21,438 21,485
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 242,189 $ 236,364
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Pacific Financial Corporation and Subsidiaries
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
INTEREST INCOME
Loans $ 14,062 $ 14,366 $ 14,145
Federal funds sold and deposits in banks 570 877 328
Securities available for sale:
Taxable 2,767 1,925 1,540
Tax exempt 847 663 626
Securities held to maturity - tax exempt 108 121 117
TOTAL INTEREST INCOME 18,354 17,952 16,756
INTEREST EXPENSE
Deposits 6,712 6,586 6,012
Short-term borrowings 212 266 52
TOTAL INTEREST EXPENSE 6,924 6,852 6,064
NET INTEREST INCOME 11,430 11,100 10,692
PROVISION FOR CREDIT LOSSES 60 110 142
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 11,370 10,990 10,550
NON-INTEREST INCOME
Service charges on deposit accounts 745 685 638
Mortgage loan origination fees 36 35 --
Net gain (loss) on sales of loans (3) 17 76
Net gain on sales of securities available for sale 9 17 36
Other operating income 468 527 399
TOTAL NON-INTEREST INCOME 1,255 1,281 1,149
NON-INTEREST EXPENSE
Salaries 3,250 3,150 2,977
Employee benefits 621 551 566
Occupancy 367 379 345
Furniture and equipment 646 643 565
Other 2,127 1,964 1,735
TOTAL NON-INTEREST EXPENSE 7,011 6,687 6,188
INCOME BEFORE INCOME TAXES 5,614 5,584 5,511
INCOME TAXES 1,692 1,590 1,643
NET INCOME $ 3,922 $ 3,994 $ 3,868
EARNINGS PER SHARE
Basic $ 8.01 $ 8.19 $ 7.97
Diluted 7.93 8.06 7.92
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
(Dollars in Thousands)
Pacific Financial Corporation and Subsidiaries
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
ACCUMULATED
SHARES OF OTHER
COMMON COMMON RETAINED COMPREHENSIVE
STOCK STOCK SURPLUS EARNINGS INCOME (LOSS) TOTAL
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997 484,399 $ 484 $ 10,811 $ 6,291 $ 243 $ 17,829
Comprehensive income:
Net income -- -- -- 3,868 -- 3,868
Other comprehensive income,
net of tax:
Change in unrealized gain
on securities -- -- -- -- 11 11
COMPREHENSIVE INCOME 3,879
Stock options exercised 2,850 3 63 -- -- 66
Sale of common stock 18 -- 1 -- -- 1
Dividends on common stock
($4.35 per share) -- -- -- (2,118) -- (2,118)
BALANCE AT DECEMBER 31, 1997 487,267 487 10,875 8,041 254 19,657
Comprehensive income:
Net income -- -- -- 3,994 -- 3,994
Other comprehensive income,
net of tax:
Change in unrealized gain
on securities -- -- -- -- 114 114
COMPREHENSIVE INCOME 4,108
Stock options exercised 1,678 2 95 -- -- 97
Sale of common stock 24 -- 2 -- -- 2
Dividends on common stock
($4.86 per share) -- -- -- (2,379) -- (2,379)
BALANCE AT DECEMBER 31, 1998 488,969 489 10,972 9,656 368 21,485
Comprehensive income:
Net income -- -- -- 3,922 -- 3,922
Other comprehensive loss,
net of tax:
Change in unrealized loss
on securities -- -- -- -- (1,320) (1,320)
COMPREHENSIVE INCOME 2,602
Stock options exercised 8,000 8 472 -- -- 480
Repurchase of common stock
fractional shares (199) -- (24) -- -- (24)
Dividends on common stock
($6.25 per share) -- -- -- (3,105) -- (3,105)
BALANCE AT DECEMBER 31, 1999 496,770 $ 497 $ 11,420 $ 10,473 $(952) $ 21,438
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
(Dollars in Thousands)
Pacific Financial Corporation and Subsidiaries
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,922 $ 3,994 $ 3,868
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 496 518 470
Provision for credit losses 60 110 142
Deferred income tax (34) 17 79
Stock dividends received (172) (211) (195)
Gain on sales of securities available for sale (9) (17) (36)
(Gain) loss on sales of loans 3 (17) (76)
Loss on sale of foreclosed real estate 2 21 --
Gain on sale of premises and equipment (12) -- --
Increase in interest receivable (140) (224) (109)
Increase in interest payable 66 73 31
Other - net (220) (420) 142
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,962 3,844 4,316
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) decrease in interest bearing deposits in banks 4,645 236 (981)
Net (increase) decrease in federal funds sold 12,595 (7,900) (2,420)
Activity in securities available for sale:
Sales 1,478 -- 947
Maturities, prepayments and calls 27,560 26,823 10,421
Purchases (43,322) (41,974) (15,051)
Activity in securities held to maturity:
Maturities 210 365 183
Purchases (100) (295) (215)
Proceeds from sales of loans 468 2,657 1,567
Increase in loans made to customers, net of principal collections (5,921) (6,645) (7,593)
Purchases of premises and equipment (322) (214) (706)
Proceeds from sale of foreclosed real estate 26 151 --
Purchase of life insurance -- -- (1,850)
Proceeds from sales of premises and equipment 12 -- --
NET CASH USED IN INVESTING ACTIVITIES (2,671) (26,796) (15,698)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits (4,511) 31,924 8,029
Net increase (decrease) in short-term borrowings 9,589 (6,539) 6,453
Common stock issued 480 99 67
Cash dividends paid (2,379) (2,118) (1,894)
Repurchase of common stock fractional shares (24) -- --
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,155 23,366 12,655
NET CHANGE IN CASH AND DUE FROM BANKS 4,446 414 1,273
CASH AND DUE FROM BANKS
Beginning of year 8,634 8,220 6,947
END OF YEAR $13,080 $ 8,634 $ 8,220
</TABLE>
(CONTINUED)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
(CONCLUDED) (Dollars in Thousands)
Pacific Financial Corporation and Subsidiaries
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid $ 6,858 $ 6,779 $ 6,033
Income taxes paid 1,750 1,640 1,521
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING ACTIVITIES
Fair value adjustment of securities available for sale, net of tax $(1,320) $ 114 $ 11
Transfer of loans to foreclosed real estate 74 274 --
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Pacific Financial
Corporation (formerly Harbor Bancorp, Inc.) (the Company) and its wholly owned
subsidiaries, The Bank of Grays Harbor (Harbor) and Bank of the Pacific
(Pacific), collectively "the Banks". All significant intercompany transactions
and balances have been eliminated.
NATURE OF OPERATIONS
The Company is a holding company which operates primarily through its subsidiary
banks. The Banks operate ten branches in Grays Harbor, Pacific and Wahkiakum
Counties. The Banks' primary source of revenue is providing loans to customers,
who are predominately small- and middle-market businesses and middle-income
individuals. The Banks' primary sources of funds are deposits from customers and
borrowings from the Federal Home Loan Bank of Seattle.
CONSOLIDATED FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and practices within the banking
industry. The preparation of consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, and the disclosure of contingent assets and liabilities, as of the
date of the balance sheet, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in
the near term relate to the determination of the allowance for credit losses and
the valuation of foreclosed real estate and deferred tax assets.
Certain prior year amounts have been reclassified to conform to the 1999
presentation. All dollar amounts, except per share information, are stated in
thousands.
SECURITIES AVAILABLE FOR SALE
Securities available for sale consist of debt securities which may be sold to
implement the Banks' asset/liability management strategies and in response to
changes in interest rates and similar factors, and certain equity securities.
Securities available for sale are reported at fair value. Unrealized gains and
losses, net of the related deferred tax effect, are reported as a net amount in
a separate component of shareholders' equity entitled "accumulated other
comprehensive income (loss)." Realized gains and losses on securities available
for sale, determined using the specific identification method, are included in
earnings. Premiums are amortized over the period to maturity or call date,
whichever is earlier, and discounts are accreted over the period to maturity.
Declines in the fair value of individual securities available for sale and held
to maturity below their carrying value that are other than temporary are written
down to fair value by a charge to earnings.
(CONTINUED)
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SECURITIES HELD TO MATURITY
Debt securities for which the Company has the positive intent and ability to
hold to maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts, which are recognized in interest income over the period
to maturity.
LOANS
Loans are stated at the amount of unpaid principal, reduced by an allowance for
credit losses. Interest on loans is accrued daily based on the principal amount
outstanding.
Generally the accrual of interest on loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due or when
they are past due 90 days as to either principal or interest, unless they are
well secured and in the process of collection. When interest accrual is
discontinued, all unpaid accrued interest is reversed against current income. If
management determines that the ultimate collectibility of principal is in doubt,
cash receipts on nonaccrual loans are applied to reduce the principal balance.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated. The allowance is
increased by provisions charged to operations and reduced by loans charged off,
net of recoveries. The allowance is based on management's periodic evaluation of
potential losses in the loan portfolio after consideration of historical loss
experience, adverse situations that may affect the borrowers' ability to repay,
the estimated value of any underlying collateral, economic conditions, the
results of examination of individual loans, the evaluation of the overall
portfolio by senior credit personnel and federal and state regulatory agencies,
and other risks inherent in the portfolio. This evaluation is inherently
subjective, as it requires the use of current estimates, which may vary from the
ultimate collectibility experienced in the future. The estimates used are
reviewed periodically, and, as adjustments become necessary, they are charged to
operations in the period in which they become known.
When management determines it is possible that a borrower will be unable to
repay all amounts due according to the terms of the loan agreement, including
scheduled interest payments, the loan is considered impaired. Loans that
experience insignificant payment delays and payment shortfalls are generally not
classified as impaired. Management determines the significance of payment delays
and payment shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the length of
the delay, the reasons for the delay, the borrower's prior payment record, and
the amount of shortfall in relation to the principal and interest owed. The
amount of impairment is measured based on the present value of expected future
cash flows discounted at the loan's effective interest rate or, when the primary
source of repayment is provided by real estate collateral, at the fair value of
the collateral less estimated selling costs. The amount of impairment and any
subsequent charges are recorded through the provision for credit losses as an
adjustment to the allowance for credit losses.
(CONTINUED)
8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation, which
is computed on a straight-line method over the estimated useful lives of the
assets. Leasehold improvements are amortized over the terms of the respective
leases or the estimated useful lives of the improvements, whichever is less.
Gains or losses on dispositions are reflected in earnings.
FORECLOSED REAL ESTATE
Real estate properties acquired through, or in lieu of, foreclosure are to be
sold and are initially recorded at the fair value of the properties less
estimated costs of disposal. Any write-down to fair value at the time of
transfer to other real estate owned is charged to the allowance for credit
losses. Properties are evaluated regularly to ensure that the recorded amounts
are supported by their current fair values, and that valuation allowances to
reduce the carrying amounts to fair value less estimated costs to dispose are
recorded as necessary. Additions to or reductions from valuation allowances are
recorded in income.
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Banks, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Banks do not maintain effective control over the transferred assets through
an agreement to repurchase them before their maturity.
INCOME TAXES
Deferred tax assets and liabilities result from differences between the
financial statement carrying amounts and the tax bases of assets and
liabilities, and are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled. The deferred tax provision represents the difference
between the net deferred tax asset/liability at the beginning and end of the
year. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes.
The Banks provide for income taxes on a separate company basis and remit to the
Company amounts currently due.
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the intrinsic
value method, in accordance with APB No. 25, ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES. Accordingly, no compensation expense has been recognized in the
financial statements for employee stock arrangements. However, the required pro
forma disclosures of the effects of all options granted on or after January 1,
1995 have been provided in accordance with SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION.
(CONTINUED)
9
- --------------------------------------------------------------------------------
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating the
fair values of financial instruments disclosed in these financial statements:
CASH AND SHORT-TERM INSTRUMENTS
The carrying amounts of cash and short-term instruments approximate their
fair value.
SECURITIES AVAILABLE FOR SALE AND HELD TO MATURITY
Fair values for securities, excluding restricted equity securities, are
based on quoted market prices. The carrying values of restricted equity
securities approximate fair values.
LOANS
For variable rate loans that reprice frequently and have no significant
change in credit risk, fair values are based on carrying values. Fair
values for fixed rate loans are estimated using discounted cash flow
analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. Fair values for
impaired loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
DEPOSIT LIABILITIES
The fair values disclosed for demand deposits are, by definition, equal to
the amount payable on demand at the reporting date (that is, their carrying
amounts). The carrying amounts of variable rate, fixed term money market
accounts and certificates of deposit approximate their fair values at the
reporting date. Fair values for fixed rate certificate of deposit are
estimated using a discounted cash flow calculation based on interest rates
currently being offered on similar certificates.
OTHER BORROWINGS
The carrying amounts of federal funds purchased and other short-term
borrowings maturing within 90 days approximate their fair values. Fair
values of other borrowings are estimated using discounted cash flow
analyses based on the current incremental borrowing rates for similar types
of borrowing arrangements.
CASH AND CASH EQUIVALENTS
The Company considers all amounts included in the balance sheets caption "Cash
and due from banks" to be cash equivalents.
The Company maintains balances in depository institution accounts, which, at
times, may exceed federally insured limits. The Company has not experienced any
losses in such accounts.
(CONTINUED)
10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONCLUDED)
EARNINGS PER SHARE
Basic earnings per share exclude dilution and are computed by dividing net
income by the weighted average number of common shares outstanding. Diluted
earnings per share reflect the potential dilution that could occur if common
shares were issued pursuant to the exercise of options under the Company's stock
option plans.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in its balance sheet and measure those instruments at fair value.
Under this statement, an entity that elects to apply hedge accounting is
required to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. Those methods must
be consistent with the entity's approach to managing risk. This statement is
effective for all fiscal years beginning after June 15, 2000. The Company had no
derivatives as of December 31, 1999, nor does the Company engage in any hedging
activities. The Company does not anticipate that the adoption of SFAS No. 133
will have a material effect on its financial position or results of operations.
NOTE 2 - BUSINESS COMBINATION
On December 15, 1999, Harbor Bancorp, Inc. effected a business combination with
Pacific Financial Corporation by exchanging 230,389 shares of its common stock
for all of the common stock of Pacific Financial Corporation. Pacific Financial
Corporation was a one-bank holding company based in Long Beach, Washington. Its
bank subsidiary, Bank of the Pacific, will continue to operate as a separate
subsidiary of the Company for the foreseeable future. Following the merger,
Harbor Bancorp, Inc. changed its name to Pacific Financial Corporation. The
combination has been accounted for as a pooling of interests and, accordingly,
all prior financial statements have been restated to include Pacific Financial
Corporation. The results of operations of the separate companies for periods
prior to the combination are summarized as follows:
<TABLE>
<CAPTION>
NET
INTEREST NET
INCOME INCOME
<S> <C> <C>
Eleven and one-half months ended December 15, 1999:
Harbor Bancorp, Inc. $ 6,087 $ 2,112
Pacific Financial Corporation 4,690 1,941
Year ended December 31, 1998:
Harbor Bancorp, Inc. $ 6,273 $ 2,073
Pacific Financial Corporation 4,827 1,921
Year ended December 31, 1997:
Harbor Bancorp, Inc. $ 5,842 $ 1,938
Pacific Financial Corporation 4,850 1,930
</TABLE>
11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 3 - RESTRICTED ASSETS
Federal Reserve Board regulations require that the Banks maintain certain
minimum reserve balances on deposit with the Federal Reserve Bank. The average
amounts of such balances for the years ended December 31, 1999 and 1998 were
approximately $1,396 and $1,325, respectively.
NOTE 4 - DEBT AND EQUITY SECURITIES
Debt and equity securities have been classified according to management's
intent. The carrying amounts of securities and their approximate fair value are
as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
DECEMBER 31, 1999
U.S. Treasury and Government agency securities $ 35,597 $ 5 $ 950 $34,652
Obligations of states and political subdivisions 12,750 95 169 12,676
Corporate bonds 15,383 -- 426 14,957
Federal Home Loan Bank stock 3,340 -- -- 3,340
$ 67,070 $ 100 $ 1,545 $65,625
DECEMBER 31, 1998
U.S. Treasury and Government agency securities $ 26,922 $ 82 $ 13 $26,991
Obligations of states and political subdivisions 11,419 495 -- 11,914
Corporate bonds 11,329 34 44 11,319
Federal Home Loan Bank stock 2,901 -- -- 2,901
$ 52,571 $ 611 $ 57 $53,125
SECURITIES HELD TO MATURITY
DECEMBER 31, 1999
State and municipal securities $ 1,615 $ -- $ -- $ 1,615
DECEMBER 31, 1998
State and municipal securities $ 1,725 $ -- $ -- $ 1,725
</TABLE>
(CONTINUED)
12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 4 - DEBT AND EQUITY SECURITIES (CONCLUDED)
The contractual maturities of debt securities held to maturity and available for
sale at December 31, 1999 are as follows:
<TABLE>
<CAPTION>
HELD TO MATURITY AVAILABLE FOR SALE
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
<S> <C> <C> <C> <C>
Due in one year or less $ 45 $ 45 $14,168 $14,078
Due from one year to five years 172 172 31,529 30,906
Due from five to ten years 680 680 15,808 15,121
Due after ten years 718 718 613 596
Mortgage-backed securities -- -- 1,612 1,584
TOTAL $ 1,615 $ 1,615 $63,730 $62,285
</TABLE>
Gross gains realized on sales of securities were $11 in 1999, and gross losses
realized were $2.
Securities carried at approximately $14,385 at December 31, 1999 and $11,146 at
December 31, 1998 were pledged to secure public deposits and for other purposes
required or permitted by law.
NOTE 5 - LOANS
Loans at December 31 consist of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Commercial and agricultural $ 56,198 $ 48,455
Real estate:
Construction 3,325 4,929
1-4 family residential 29,526 29,292
Multi-family 6,847 4,345
Commercial 50,448 54,261
Farmland 2,084 2,129
Consumer 4,236 3,869
$152,664 $147,280
</TABLE>
(CONTINUED)
13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 5 - LOANS (CONCLUDED)
Changes in the allowance for credit losses for the years ended December 31 are
as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Balance at beginning of year $ 1,864 $ 1,937 $ 1,824
Provision for credit losses 60 110 142
Charge-offs (134) (221) (41)
Recoveries 140 38 12
NET (CHARGE-OFFS) RECOVERIES 6 (183) (29)
BALANCE AT END OF YEAR $ 1,930 $ 1,864 $ 1,937
</TABLE>
Following is a summary of information pertaining to impaired loans:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
DECEMBER 31
Impaired loans without a valuation allowance $175 $ 15 $408
Impaired loans with a valuation allowance -- -- 14
TOTAL IMPAIRED LOANS $175 $ 15 $422
VALUATION ALLOWANCE RELATED TO IMPAIRED LOANS $-- $-- $ 8
YEARS ENDED DECEMBER 31
Average investment in impaired loans $ 59 $552 $336
Interest income recognized on a cash basis on impaired loans 11 -- --
</TABLE>
At December 31, 1999, there were no commitments to lend additional funds to
borrowers whose loans have been modified. Loans 90 days and over past due and
still accruing interest totaled $140 and $4 at December 31, 1999 and 1998,
respectively.
As of December 31, 1999 and 1998, government guaranteed loans with a carrying
value of $575 and $1,725, respectively, were pledged as collateral for other
purposes required or permitted by law.
Certain related parties of the Banks, principally directors and their
associates, were loan customers of the Banks in the ordinary course of business
during 1999 and 1998. Total loans outstanding at December 31, 1999 and 1998 to
key officers and directors were $3,096 and $2,523, respectively. During 1999,
new loans of $4,149 were made, and repayments totaled $3,576.
14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 6 - PREMISES AND EQUIPMENT
The components of premises and equipment at December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Land $ 712 $ 712
Premises 3,644 3,599
Equipment, furniture and fixtures 3,609 3,377
Leasehold improvements 18 18
7,983 7,706
Less accumulated depreciation and amortization 4,473 4,038
TOTAL PREMISES AND EQUIPMENT $3,510 $3,668
</TABLE>
The Company has a three-year lease for the property on which the Montesano
Branch is located. The monthly payments required by the lease beginning in July
1997 are $1. The lease agreement contains an option to purchase the property at
any time prior to the expiration of the lease for $250 in cash or, at the
lessor's option, 3,300 shares of the Company's stock. Rental expense under this
lease was $12, $12 and $6 for 1999, 1998 and 1997, respectively, which is
included in occupancy expenses.
Remaining minimum rental commitments under this lease for the year ending
December 31, 2000 are $6.
NOTE 7 - DEPOSITS
The aggregate amount of certificates of deposit with balances in excess of one
hundred thousand dollars was approximately $19,513 and $20,798 at December 31,
1999 and 1998, respectively.
At December 31, 1999, the scheduled maturities of certificates of deposit are as
follows:
<TABLE>
<S> <C>
2000 $51,581
2001 13,616
2002 759
2003 955
2004 and thereafter 38
$66,949
</TABLE>
15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 8 - FEDERAL FUNDS PURCHASED
Federal funds purchased generally mature within one to four days from the
transaction date. Information concerning federal funds purchased is summarized
as follows for the years ended December 31:
1999 1998
Average balance during the year $1,366 $ 698
Average interest rate during the year 5.86% 5.99%
Maximum month-end balance during the year $3,675 $2,550
Balance outstanding at year-end -- --
NOTE 9 - SHORT-TERM BORROWINGS
At December 31, 1999 and 1998, short-term borrowings were comprised of direct
investments deposited by the U.S. Treasury of $225 and $86, respectively, and,
in 1999, borrowings of $9,450 from the Federal Home Loan Bank of Seattle bearing
interest at 5.50% and maturing in January 2000.
NOTE 10 - INCOME TAXES
Income taxes are comprised of the following for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Current $ 1,726 $ 1,573 $ 1,564
Deferred (benefit) (34) 17 79
TOTAL INCOME TAXES $ 1,692 $ 1,590 $ 1,643
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities at December 31 are:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
DEFERRED TAX ASSETS
Allowance for credit losses $ 530 $ 537
Deferred compensation 243 118
Unrealized loss on securities available for sale 494 --
TOTAL DEFERRED TAX ASSETS 1,267 655
DEFERRED TAX LIABILITIES
Depreciation 50 111
Unrealized gain on securities available for sale -- 186
Deferred revenue 766 621
TOTAL DEFERRED TAX LIABILITIES 816 918
NET DEFERRED TAX ASSETS (LIABILITIES) $ 451 $ (263)
</TABLE>
(CONTINUED)
16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 10 - INCOME TAXES (CONCLUDED)
The following is a reconciliation between the statutory and effective federal
income tax rate for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
PERCENT PERCENT PERCENT
OF PRE-TAX OF PRE-TAX PRE-TAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
<S> <C> <C> <C> <C> <C> <C>
Income tax at statutory rate $ 1,909 34.0% $ 1,899 34.0% $ 1,874 34.0%
Adjustments resulting from:
Tax-exempt income (261) (4.6) (251) (4.5) (223) (4.0)
Net earnings on life insurance
policies (35) (.6) (28) (.5) (14) (.3)
Non-deductible merger costs 106 1.9 -- -- -- --
Other (27) (.6) (30) (.5) 6 .1
TOTAL INCOME TAX EXPENSE $ 1,692 30.1% $ 1,590 28.5% $ 1,643 29.8%
</TABLE>
NOTE 11 - EMPLOYEE BENEFITS
INCENTIVE COMPENSATION PLAN
The Banks have plans which provide incentive compensation to key employees if
the Banks meet certain performance criteria established by their Boards of
Directors. The cost of these plans was $622, $599 and $564 in 1999, 1998 and
1997, respectively.
401(K) PLANS
Harbor has established a 401(k) profit sharing plan for those employees who meet
the eligibility requirements set forth in the plan. Eligible employees may
contribute up to 15% of their compensation. Matching contributions by the Bank
are at the discretion of the Board of Directors. Harbor contributions totaled
$79, $75 and $66 for 1999, 1998 and 1997, respectively.
Under Pacific's 401(k) deferred contribution plan, all qualified employees may
elect to make contributions pursuant to a salary reduction agreement upon
meeting age and length-of-service requirements. Pacific contributions are made
at the discretion of its Board of Directors. Contributions totaling $16, $15 and
$12 were made to the plan in 1999, 1998 and 1997, respectively.
(CONTINUED)
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 11 - EMPLOYEE BENEFITS (CONCLUDED)
DIRECTOR AND EMPLOYEE DEFERRED COMPENSATION PLANS
Harbor has director and employee deferred compensation plans. Under the terms of
the plans, a director or employee may participate upon approval by the Board.
The participant may then elect to defer a portion of his or her earnings
(directors' fees or salary) as designated at the beginning of each plan year.
Payments begin upon retirement, termination, death or permanent disability, sale
of Harbor, the ten-year anniversary of the participant's participation date, or
at the discretion of Harbor. There are currently two participants in the plans.
Total deferrals plus earnings were $327, $132 and $64 at December 31, 1999, 1998
and 1997, respectively.
In 1997, Pacific's Board adopted two deferred compensation plans for directors.
One, the Director Emeritus Plan, provides retirement income benefits for all
current directors. Benefits will be paid to directors for ten years after their
retirement from the Board, and are accrued over the period to each director's
anticipated retirement date. The second plan, the Director Deferred Compensation
Plan, covers only those directors who have chosen to participate in the plan.
The participating directors have elected to defer the payment of current
directors fees until their retirement from the Board, which amounts, including
an interest factor, are accrued until the director's retirement. Pacific has
purchased life insurance policies on certain directors participating in both
plans which may be used to fund payments to them under these plans. Cash
surrender values on these policies were $2,330 and $2,226 at December 31, 1999
and 1998, respectively. In 1999, the net benefit recorded from these plans,
including the cost of the related life insurance, was $3. In 1998 and 1997, the
net cost of these plans, including the cost of the related life insurance, was
$15 and $34, respectively.
QUALIFIED NON-CONTRIBUTORY DEFINED BENEFIT PLAN
Pacific maintains a non-contributory defined benefit plan covering substantially
all employees. Pacific makes annual contributions to the plan equal to the
amount accrued for pension expenses, which are invested in a group annuity
contract with a life insurance company. Contributions of $33, $2 and $49 were
made in 1999, 1998 and 1997, respectively.
NON-QUALIFIED DEFERRED COMPENSATION PLAN
Pacific has a non-qualified deferred compensation plan to cover selected
employees. Pacific makes annual contributions to the plan; such contributions
totaled $19, $18 and $33 in 1999, 1998 and 1997, respectively. Covered employees
may also contribute to the plan.
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES
The Banks are party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of their customers. These
financial instruments include commitments to extend credit and standby letters
of credit, and involve, to varying degrees, elements of credit risk in excess of
the amount recognized in the balance sheets.
The Banks' exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those instruments.
The Banks use the same credit policies in making commitments and conditional
obligations as they do for on-balance-sheet instruments. A summary of the Banks'
commitments at December 31 is as follows:
1999 1998
Commitments to extend credit $18,573 $16,119
Standby letters of credit 1,795 1,464
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since many
of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Banks' experience has been that approximately 67% of loan commitments is drawn
upon by customers. The Banks evaluate each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Banks upon extension of credit, is based on management's credit evaluation
of the party. Collateral held varies, but may include accounts receivable,
inventory, property and equipment, residential real estate, and income-producing
commercial properties.
Standby letters of credit are conditional commitments issued by the Banks to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
as specified above, and is required in instances where the Banks deems
necessary.
Certain executive officers have entered into employment contracts with the Banks
which provide for contingent payments subject to future events.
The Banks have agreements with commercial banks for lines of credit totaling
$10,200, none of which was used at December 31, 1999. In addition, the Banks
have credit lines with the Federal Home Loan Bank totaling 10% and 20% of assets
for Harbor and Pacific, respectively, $9,450 of which was used at December 31,
1999. These borrowings were collateralized under blanket pledge agreements.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these claims,
if any, will not have a material effect on the financial position of the
Company.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 13 - SIGNIFICANT CONCENTRATIONS OF CREDIT RISK
Most of the Bank's business activity is with customers and governmental entities
located in the State of Washington, including investments in state and municipal
securities. Loans are generally limited by federal and state banking regulations
to 20% of the Banks' shareholders' equity, excluding accumulated other
comprehensive income (loss). As of December 31, 1999, the Banks' loans to
companies in the forest products and hotel/motel industries totaled $12,281 and
$10,513, respectively (net of government loan guarantees). Standby letters of
credit were granted primarily to commercial borrowers. Harbor and Pacific, as a
matter of practice, generally do not extend credit to any single borrower or
group of borrowers in excess of $2 million and $1.5 million, respectively.
NOTE 14 - STOCK OPTIONS
At December 31, 1999, the Company has three stock-based option plans, which are
described below. The Company applies APB Opinion No. 25 and related
interpretations in accounting for these plans. Accordingly, no compensation cost
has been recognized for the plans. Had compensation cost for the Company's stock
option plans been determined based on the fair value at the grant dates for
awards granted since December 31, 1994 under these plans, consistent with the
method of SFAS No. 123, the Company's net income and earnings per share would
have been reduced to these pro forma amounts:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Net income:
As reported $ 3,922 $ 3,994 $ 3,868
Pro forma 3,914 3,988 3,862
Earnings per share:
Basic:
As reported $ 8.01 $ 8.19 $ 7.97
Pro forma 8.00 8.18 7.96
Diluted:
As reported 7.93 8.06 7.92
Pro forma 7.92 8.05 7.91
</TABLE>
The Company's three incentive stock option plans provide for granting incentive
stock options, as defined under current tax laws, to key personnel. Under the
first plan, options are exercisable 90 days from the date of grant. These
options terminate if not exercised within ten years from the date of grant. If
after six years from the date of grant fewer than 20% of the options have been
exercised, they will expire at a rate of 20% annually. Under the second plan,
the options are exercisable one year from the date of grant, at a rate of 10%
annually. Options terminate if not exercised when they become available. Under
the third plan, options become exercisable four years from the grant date. These
options terminate if not exercised between the sixth and the tenth years. Upon
reaching the sixth year from the date of grant, if less than 20% of the options
have been exercised, at least 20% of the options must be exercised within 90
days, and 20% of the options must be exercised every anniversary thereafter.
Under the plans, the Company may grant up to 25,000 shares of its common stock
to certain key employees.
(CONTINUED)
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 14 - STOCK OPTION PLANS (CONCLUDED)
The fair value of each option grant is estimated on the date of grant, based on
the Black-Scholes option-pricing model and using the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1999 1997
<S> <C> <C>
Dividend yield 4.63% 3.82%
Expected life 10 years 10 years
Risk-free interest rate 6.6% 5.6%
</TABLE>
The weighted average fair value of options granted during 1999 and 1997 was
$14.33 and $5.29, respectively.
A summary of the status of the Company's stock option plans as of December 31,
1999, 1998 and 1997 and changes during the
years ending on those dates, is presented below:
<TABLE>
<CAPTION>
1999 1998 1997
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 18,710 $ 65.72 20,388 $ 65.09 16,350 $ 53.23
Granted 5,000 135.00 -- -- 6,888 75.78
Exercised (8,000) 60.00 (1,678) 58.11 (2,850) 22.89
OUTSTANDING AT END OF YEAR 15,710 90.67 18,710 65.72 20,388 65.09
Exercisable at end of year 2,678 -- 500
</TABLE>
The following information summarizes information about stock options outstanding
and exercisable at December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
REMAINING
EXERCISE NUMBER CONTRACTUAL NUMBER
PRICE OUTSTANDING LIFE (YEARS) EXERCISABLE
<S> <C> <C> <C>
$ 60.00 1,500 5 1,500
65.00 3,500 6 --
72.00 1,000 7 --
76.43 4,710 7 1,178
135.00 5,000 10 --
</TABLE>
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 15 - REGULATORY MATTERS
The Company and the Banks are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines on the regulatory framework for prompt corrective action, the Bank
must meet specific capital adequacy guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital
classification is also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Banks to maintain minimum amounts and ratios (set
forth in the table below) of Tier 1 capital (as defined in the regulations) to
total average assets (as defined), and minimum ratios of Tier 1 and total
capital (as defined) to risk-weighted assets (as defined).
As of December 31, 1999, the most recent notification from the Banks' regulator
categorized the Banks as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Banks must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Company and the Banks' actual capital amounts and ratios are also presented
in the table. Management believes, as of December 31, 1999, that the Banks meet
all capital requirements to which they are subject.
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
UNDER PROMPT
CAPITAL ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
<S> <C> <C> <C> <C>
DECEMBER 31, 1999
TIER 1 CAPITAL (TO AVERAGE ASSETS):
Consolidated $22,390 9.28% $ 9,646 4.00% N/A N/A
The Bank of Grays Harbor 12,366 9.11 5,427 4.00 $ 6,784 5.00%
Bank of the Pacific 9,938 9.43 4,217 4.00 5,271 5.00
TIER 1 CAPITAL (TO RISK-WEIGHTED ASSETS):
Consolidated 22,390 12.93 6,929 4.00 N/A N/A
The Bank of Grays Harbor 12,366 12.50 3,956 4.00 5,934 6.00
Bank of the Pacific 9,938 13.37 2,973 4.00 4,459 6.00
TOTAL CAPITAL (TO RISK-WEIGHTED ASSETS):
Consolidated 24,320 14.04 13,857 8.00 N/A N/A
The Bank of Grays Harbor 13,477 13.63 7,911 8.00 9,889 10.00
Bank of the Pacific 10,757 14.47 5,946 8.00 7,432 10.00
</TABLE>
(CONTINUED)
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 15 - REGULATORY MATTERS (CONCLUDED)
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
UNDER PROMPT
CAPITAL ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
TIER 1 CAPITAL (TO AVERAGE ASSETS):
Consolidated $21,117 9.03% $ 9,313 4.00% N/A N/A
The Bank of Grays Harbor 11,569 8.78 5,271 4.00 $ 6,589 5.00%
Bank of the Pacific 9,469 9.37 4,041 4.00 5,051 5.00
TIER 1 CAPITAL (TO RISK-WEIGHTED ASSETS):
Consolidated 21,117 12.63 6,686 4.00 N/A N/A
The Bank of Grays Harbor 11,569 12.17 3,795 4.00 5,693 6.00
Bank of the Pacific 9,469 13.11 2,890 4.00 4,335 6.00
TOTAL CAPITAL (TO RISK-WEIGHTED ASSETS):
Consolidated 22,981 13.75 13,372 8.00 N/A N/A
The Bank of Grays Harbor 12,716 13.40 7,590 8.00 9,488 10.00
Bank of the Pacific 10,186 14.10 5,780 8.00 7,224 10.00
</TABLE>
RESTRICTIONS ON RETAINED EARNINGS
The Banks are restricted from paying dividends to the Company in an amount that
would violate the most restrictive capital requirement shown above. At December
31, 1999, there were no regulatory dividend restrictions on the Banks' retained
earnings.
NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at December 31
are as follows:
<TABLE>
<CAPTION>
1999 1998
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and due from banks,
interest-bearing deposits with
banks, and federal funds sold $ 14,824 $ 14,824 $ 27,618 $ 27,618
Securities available for sale 65,625 65,625 53,125 53,125
Securities held to maturity 1,615 1,615 1,725 1,725
Loans receivable 150,734 149,368 145,416 145,486
FINANCIAL LIABILITIES
Deposits $ 206,139 $ 206,156 $ 210,650 $ 210,888
Other borrowings 9,675 9,675 86 86
</TABLE>
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 17 - EARNINGS PER SHARE DISCLOSURES
Following is information regarding the calculation of basic and diluted earnings
per share for the years indicated.
<TABLE>
<CAPTION>
NET INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1999
Basic earnings per share:
Net income $ 3,922 489,546 $ 8.01
Effect of dilutive securities:
Options -- 4,757 (.08)
Diluted earnings per share:
NET INCOME $ 3,922 494,303 $ 7.93
YEAR ENDED DECEMBER 31, 1998
Basic earnings per share:
Net income $ 3,994 487,583 $ 8.19
Effect of dilutive securities:
Options -- 7,796 (.13)
Diluted earnings per share:
NET INCOME $ 3,994 495,379 $ 8.06
YEAR ENDED DECEMBER 31, 1997
Basic earnings per share:
Net income $ 3,868 485,324 $ 7.97
Effect of dilutive securities:
Options -- 2,932 (.05)
Diluted earnings per share:
NET INCOME $ 3,868 488,256 $ 7.92
</TABLE>
The number of shares shown for "options" is the number of incrementional shares
that would result from the exercise of options and use of the proceeds to
repurchase shares at the average market price during the year.
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 18 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
CONDENSED BALANCE SHEETS - DECEMBER 31
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
ASSETS
Cash $ 1,751 $ 1,021
Investment in the Banks 21,352 21,383
Other assets -- 22
Due from the Banks 1,440 1,410
Federal income tax receivable 34 28
TOTAL ASSETS $ 24,577 $ 23,864
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 3,105 $ 2,379
Due to the Banks 34 --
Shareholders' equity 21,438 21,485
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 24,577 $ 23,894
</TABLE>
CONDENSED STATEMENTS OF INCOME - YEARS ENDED DECEMBER 31
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Dividend income from the Banks $ 3,010 $ 2,450 $ 2,159
Expenses (377) (81) (7)
Equity in undistributed income of subsidiaries 1,289 1,625 1,716
NET INCOME $ 3,922 $ 3,994 $ 3,868
</TABLE>
(CONTINUED)
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Pacific Financial Corporation and Subsidiaries
December 31, 1999 and 1998
NOTE 18 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY (CONCLUDED)
CONDENSED STATEMENTS OF CASH FLOWS - YEARS ENDED DECEMBER 31
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,922 $ 3,994 $ 3,868
Adjustments to reconcile net income to net cash provided:
Equity in undistributed income of subsidiaries (1,289) (1,625) (1,716)
Other - net 20 (62) 521
NET CASH PROVIDED BY OPERATING ACTIVITIES 2,653 2,307 2,673
INVESTING ACTIVITIES
Investment in subsidiary -- (90) (23)
FINANCING ACTIVITIES
Net proceeds from exercise of stock options and bonuses 480 99 67
Dividends paid (2,379) (2,118) (1,894)
Repurchase of common stock (24) -- --
NET CASH USED IN FINANCING ACTIVITIES (1,923) (2,019) (1,827)
NET INCREASE IN CASH 730 198 823
CASH
Beginning of year 1,021 823 --
END OF YEAR $ 1,751 $ 1,021 $ 823
</TABLE>
26
<PAGE>
SUPPLEMENTARY
INFORMATION
<PAGE>
CONSOLIDATED AVERAGE BALANCES AND NET INTEREST INCOME
- --------------------------------------------------------------------------------
(Dollars in Thousands)
Pacific Financial Corporation
Years Ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
INTEREST INTEREST
AVERAGE INCOME AVERAGE AVERAGE INCOME AVERAGE
BALANCE (EXPENSE) RATE BALANCE (EXPENSE) RATE
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Earning assets:
Loans $147,689 $ 14,129* 9.57% $145,493 $ 14,427* 9.92%
Investment securities:
Taxable 51,439 2,987 5.81 31,587 1,925 6.09
Tax-exempt 14,333 1,114* 7.77 14,994 1,172* 7.82
TOTAL INVESTMENT SECURITIES 65,772 4,101 6.24 46,581 3,097 6.65
Federal funds sold and
deposits in banks 10,476 570 5.44 14,760 877 5.94
TOTAL EARNING ASSETS/INTEREST INCOME 223,937 18,800 8.40% 206,834 18,401 8.90%
Cash and due from banks 8,599 6,511
Premises and equipment (net) 3,596 3,786
Other assets 5,303 6,555
Allowance for credit losses (1,922) (1,863)
TOTAL ASSETS $ 239,513 $ 221,823
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Deposits:
Savings and interest-bearing
demand $ 112,452 (3,435) 3.05% $ 103,163 (3,207) 3.11%
Time 65,524 (3,277) 5.00 61,657 (3,379) 5.48
TOTAL DEPOSITS 177,976 (6,712) 3.77 164,820 (6,586) 4.00
Other borrowings 4,091 (212) 5.18 4,505 (266) 5.90
TOTAL INTEREST-BEARING LIABILITIES/
INTEREST EXPENSE 182,067 (6,924) 3.80% 169,325 (6,852) 4.05%
Demand deposits 32,921 28,707
Other liabilities 1,804 2,287
Shareholders' equity 22,721 21,504
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 239,513 $ 221,823
NET INTEREST INCOME $ 11,876 $ 11,549
NET INTEREST INCOME AS A PERCENTAGE
OF AVERAGE EARNING ASSETS
Interest income 8.40% 8.90%
Interest expense 3.10 3.31
NET INTEREST INCOME 5.30% 5.59%
</TABLE>
* TAX EQUIVALENT BASIS
27
<PAGE>
EXHIBIT 10.7
BANK OF THE PACIFIC
INCENTIVE STOCK OPTION PLAN
1. PURPOSE: The purpose of the Bank of the Pacific Incentive Stock Option
Plan (the "Plan") is to encourage the long-term success of Bank of the Pacific
(the "Bank") by: (1) providing a means through which the Bank can attract,
motivate and retain officers and other key employees who can contribute
materially to that success; and (2) encouraging stock ownership by these
employees so that they have a proprietary interest in the Bank's growth and
success. These goals shall be achieved under the Plan by the grant of
stock-based awards ("Incentive Stock Options" ("ISOs"), "Nonqualified Stock
Grants" ("NQGs"), or a combination thereof, (hereinafter collectively referred
to as "Awards") to designated employees under the two methods that compose the
Plan (the "Incentive Stock Option Plan" and the "Nonqualified Stock Grant
Plan").
2. ADMINISTRATION: The Plan shall be administered by an Awards Committee
(the "Committee") of the Board of Directors of the Bank (the "Board"). The
Committee shall at all times consist of at least three members of the Board. The
members of the Committee shall be appointed by the Board and shall serve at the
pleasure of the Board. All members of the Committee shall be "disinterested
persons," within the meaning of regulation 240.16b-3(d)(3) under the Securities
Exchange Act of 1934. A majority of the Committee members shall constitute a
quorum. Any action approved by a majority of the Committee members who are
present during a meeting in which a quorum is present, or any action approved in
writing by all the Committee members, shall be considered actions approved by
the Committee. Subject to the provisions of the Plan described in the following,
the Committee may adopt such rules and regulations pertaining to the
administration of the Plan as it deems proper and necessary. The Committee shall
interpret, construe and implement the provisions of the Plan. All determinations
of the Committee shall be final and conclusive.
3. STOCK SUBJECT TO AWARDS: The shares of stock which may be made subject
to Awards under the Plan shall be shares of the Bank's Common Stock, $2.50 par
value ("Stock"). Awards made under the Plan will not exceed 10% of the
outstanding shares of the Bank (subject to adjustment as provided in Section 9),
and will be authorized and unissued shares or Stock. If an Award is cancelled or
expires for any reason without having been exercised or matured in full, all
shares of Stock covered by such cancelled or expired Award shall be made
available for future Awards.
4. ELIGIBILITY: Officers (including officers who are also directors) and
other key employees of the bank and its subsidiaries, as may be selected from
time to time by the Committee, may be granted Awards pursuant to the Plan. In
general, Awards will be made to those employees who, in the Committee's
judgment, are (or will be) contributors to the long-term success of the Bank
and/or its subsidiaries ("Participants"). However, Awards shall not be granted
to any member of the Committee nor to any individual who is not, at the time of
the Award, an employee of the Bank. The Committee may grant additional Awards to
Participants who have previously received Awards under the Plan.
1
<PAGE>
Initially, it is the intention of the Committee to grant Awards to the
Chief Executive Officer and the Vice President and Cashier.
5. INCENTIVE STOCK OPTION PLAN (THE "ISO PLAN"): Under the ISO Plan, ISOs
meeting the requirements of Internal Revenue Code ("Code") Section 422A to
purchase one or more shares of Stock may be awarded to Participants. Each ISO
shall be evidenced by an Incentive Stock Option Agreement ("ISO Agreement")
between the Bank and the Participant. ISO Agreements shall be in such form or
forms as the Committee shall prescribe from time to time, and need not be
identical to each other. However, all ISO Agreements shall comply with and be
subject to the following terms and conditions:
A. OPTION PRICE: The option price per share of stock subject to an ISO
shall be set by the Committee (based upon a stock evaluation within the
last 12 months by an independent appraiser) and shall in no instance be
less than the fair market value of the Stock ISOs awarded to any otherwise
eligible employee who, at the time the ISO is awarded, owns Stock
possessing more than 10 percent of the total combined voting power of all
classes of stock of the Bank (a "10 percent Shareholder"), the option price
per share shall not be less than 110 percent of fair market value of the
Stock on the date of award.
B. ANNUAL LIMITATION ON AWARD OF ISOS: The aggregate fair market value
of shares of Stock (determined as of the date an ISO is awarded) that may
be awarded (whether under the ISO Plan or under any other plan of the Bank
within the meaning of Code Sections 425(e) and (f), in the first year of
the Plan shall not exceed the sum of one hundred thousand dollars
($100,000). There shall not be any such annual aggregate limitation in
subsequent years.
C. DURATION OF ISOS: No ISO shall be exercisable after the expiration
("Expiration Date") specified by the Committee at the time the ISO is
awarded. The Expiration Date of each ISO shall not be later than the tenth
anniversary (or, or any ISO awarded to a 10 percent shareholder, the fifth
anniversary) of the date of awarding such ISO, but may be any earlier date
established by the Committee. The Expiration Date of each ISO shall be set
forth in the ISO Agreement.
D. EXERCISABILITY OF ISOS: Except as provided in Section 8, ISOs shall
be exercisable only while the Participant of the Bank or an Affiliate of
the Bank. Subject to such restriction, and except for such additional
restrictions as may be imposed by the Committee, any ISO awarded under the
ISO Plan shall be exercisable, in full or in part, at any time or on or
after the first anniversary of the date of award of the ISO that the ISO
shall not become exercisable, in whole or in part, for such additional
period or periods of time as the Committee shall provide. Such additional
restrictions shall be set forth in the ISO Agreement. The Committee may at
any time accelerate the exercisability of outstanding ISOs.
E. SEQUENTIAL EXERCISE OF ISOS: In accordance with Code Section
422A(b)(7), no ISO awarded under the ISO Plan shall be exercisable while
there is still outstanding any Incentive Stock Option which was awarded,
whether or not under the
2
<PAGE>
ISO Plan, to the Participant to purchase Stock (or any stock of the Company
or of any corporation which, at the time of the award of such ISO, was an
Affiliate of the Bank or any such Affiliate) before the awarding of such
ISO under the ISO Plan.
F. METHOD OF EXERCISE OF AN ISO: A Participant holding an exercisable
ISO may exercise it in accordance with its terms, by delivering to the
Secretary of the Bank at its executive offices written notice specifying
the number of shares with respect to which ISO is being exercised, together
with payment in full of the option price of such shares. Such payment shall
be made either (1) in cash or by certified check or bank draft to the order
of the Bank, or (2) at the Committee's discretion, in whole or in part in
any other form, including payment by personal check or by the delivery to
the Bank of shares of Stock previously acquired by the participant, or a
combination of Stock and cash having a total fair market value on the date
of exercise equal to the option price.
G. OTHER CONDITIONS: The Committee may also make the award of an ISO
subject to any other conditions which, in the opinion of the Committee,
should be imposed in order for an ISO to comply with the requirements of
relevant Code sections (including Section 422A) and any applicable
regulations and revenue rulings of the Treasury Department, or which the
Committee deems desirable and which do not disqualify the ISO as an
"incentive stock option" under the Code.
6. THE NONQUALIFIED STOCK GRANT PLAN (THE "NQG PLAN"): Under the NQG Plan,
one or more nonqualified stock grants ("NQGs") which DO NOT meet the
requirements of Code Sections 422 or 422A may be awarded to Participants. Each
NQG so awarded shall be evidenced by a Nonqualified Stock Grant Agreement (the
"NQG Agreement") between the Bank and the Participant. NQG Agreements shall be
in such form or forms as the Committee shall prescribe from time to time, and
need not be identical to each other. However, all NQG Agreements shall be
subject to the following terms and conditions:
A. MATURITY OR DELIVERY OF SHARES PURSUANT TO NQGS: Subject to Section
7 hereof, Stock shall be delivered to a Participant pursuant to an
outstanding NQG only as long as the Participant is an employee of the Bank
or an Affiliate of the Bank. Subject to such restriction, and except for
such additional restrictions as may be imposed by the Committee and set
forth in the NQG Agreement, Stock awarded pursuant to an NQG shall be
delivered to the Participant on anniversaries of the date of award of the
NQG as determined by the Committee. The Committee may at any time
accelerate the delivery of Stock pursuant to an outstanding NQG.
7. TERMINATION OF EMPLOYMENT:
NQGs: Any outstanding NQG shall immediately expire, and no further
stock shall be delivered pursuant to the NQG, at the time of the Participant's
termination of employment with the Bank or an Affiliate of the Bank
("Termination"), regardless of the reason, including death, for Termination.
3
<PAGE>
ISOs: Any outstanding ISO may be exercised after a Participant's
Termination only to the extent that the ISO was exercisable immediately prior to
Termination pursuant to the ISO Agreement, and then only subject to the
following limitations:
A. In the event of a Participant's Termination either: (1) for any
cause (other than those specified in paragraphs 2-4 of this Section 7; (2)
upon discharge by the Bank; or (3) voluntarily on the part of the
Participant prior to Regular Retirement (as defined in paragraph C of this
Section 7); and without the written consent of the Bank, any ISO held by
the Participant and any right thereunder shall immediately terminate and
expire as of the date of Termination (see final paragraph of this Section
7).
B. In the event of a Participant's Termination on account of
disability as defined in Code Section 106(d)(4) ("Disability"), any
theretofore unexercised ISO, to the extent that such ISO was exercisable on
the date of Termination (see final paragraph of this Section 7), shall
remain exercisable according to its terms until the earlier of: (1) six
months after the data of Termination; or (2) the Expiration Date of the
ISO.
C. In the event of a Participant's Termination voluntarily pursuant to
"Regular Retirement" (defined as retirement pursuant to the terms of any
pension, employee benefit or retirement plan maintained by the Bank in
which the Participant participates), an ISO, to the extent such ISO was
exercisable immediately prior to the date of Regular Retirement (see final
paragraph of this Section 7) shall remain exercisable according to its
terms until the earlier of (1) six months; or (2) the Expiration Date of
the ISO.
D. In the event of the death of a Participant while he or she is
employed by the Bank or an Affiliate of the Bank or during any period after
Termination during which an ISO remains exercisable pursuant to the
provisions of paragraphs B or C of this Section 7, any ISO, to the extent
that the ISO was exercisable on the date of the Participant's death, shall
remain exercisable according to its terms by the Participant's estate,
personal representative, heir or beneficiary until the earlier of: (1) six
months after the date of the Participant's death; or (2) the Expiration
Date of the ISO.
The Committee shall determine in each case the effective date of a
Participant's Termination or Regular Retirement ("date of Termination" or "date
of Regular Retirement," respectively). The Committee shall also decide whether
an authorized leave of absence, for military service or otherwise, shall
constitute a Termination. With respect to ISOs only, the Committee in its
discretion may elect to treat a Participant's retirement prior to regular
Retirement (see paragraph A(3) of this Section 7) as Regular Retirement, and may
also, in its discretion, extend the six month period during which an ISO remains
exercisable after the date of Regular Retirement to such longer period as the
Committee shall determine, which longer period shall not exceed three years and
shall in no event be longer than the expiration date set forth in the applicable
ISO Agreement.
8. NONTRANSFERABILITY: No Award made under this Plan shall be assignable or
transferable except, in the case of an ISO, by will or the laws of descent and
distribution.
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<PAGE>
During a Participant's lifetime, an ISO shall be exercisable only by the
Participant (or the Participant's guardian or legal representative).
9. ADJUSTMENTS: Appropriate adjustments in the number of shares of Stock
subject to Awards and in option price per share will be made by the Committee to
give effect to changes made in the number of outstanding shares of Stock
resulting from any recapitalization, reclassification, stock dividend, stock
split, reverse stock split or other similar change.
10. MERGERS, CONSOLIDATIONS, ETC.: In the event that the Board approves a
proposal for a merger or consolidation in which the Bank is not the resulting or
surviving corporation but becomes a subsidiary of another corporation (or in
which the Bank is the resulting or surviving corporation but becomes a
subsidiary of another corporation) or for transfer of all or substantially all
of the assets of the Bank ("Transaction"), the Committee shall notify in writing
each Participant holding an ISO of the proposed Transaction (the "Proposal
Notice"). Such Proposal Notice shall be sent to Participants at least 30 days
prior to the effective date of the proposed Transaction (as fixed by the
Committee) and shall advise the Participant that he or she has the right to
exercise any theretofore unexercised ISO awarded to the Participant, including
those, in any which, pursuant to the terms of the Plan or the relevant ISO
Agreement, have not then otherwise become exercisable. Each Participant, by
written notice to the Bank, may exercise such ISO and, in so exercising, may
condition such exercise upon, and provide that such exercise shall become
effective immediately prior to, the consummation of the Transaction, in which
event such Participant need not make payment for the Stock to be purchased until
five days after written notice by the Bank to the Participant that the
Transaction has been consummated (the "Transaction Notice"). If the Transaction
is consummated, each ISO, to the extent not previously exercised prior to the
consummation of the Transaction, shall terminate and cease being exercisable as
of the effective date of the Transaction unless by the terms of the Agreement
for the Transaction, the surviving corporation or in the event that the Bank is
the surviving corporation but becomes the subsidiary of another corporation, its
parent agrees to assume all of the obligations of the Bank under this Incentive
Stock Option Plan, in which event such Participant may at his option exercise
the ISO at any time up to and including the date upon which the ISO would have
expired had the Transaction not occurred. If the Transaction is abandoned, then
(1) any ISO not exercised shall continue to be exercisable to the extent that
such ISO was exercisable prior to the date of the Proposal Notice, and in
accordance with the other provisions of the Plan and the relevant ISO Agreement,
and (2) to the extent that any ISO not exercised prior to such abandonment shall
become exercisable solely by operation of this Section 10, such exercisability
shall be deemed null, and the exercisability provisions set forth in the Plan
and the relevant ISO Agreement shall be reinstated as of the date of such
abandonment.
Any NQG Agreement in effect immediately prior to the Transaction shall
carry forward as an obligation of the surviving corporation to the same extent
as if the Transaction had not taken place.
11. MISCELLANEOUS:
A. EFFECTIVE DATE AND DURATION: The Plan and the ISO and NQG Plans
contained therein will become effective on the date the Plan is approved by
the Board and
5
<PAGE>
shall terminate on, and no Awards shall be made after, the tenth
anniversary of the Effective Date of the Plan. The provisions of the Plan,
however, shall continue to govern all Awards theretofore made until the
exercise, expiration, or cancellation of such Awards.
B. AMENDMENT AND TERMINATION OF THE PLAN: The board at any time may
terminate the Plan or amend it from time to time in such respect as it
deems desirable; provided that, without the further approval of the holders
of majority of the outstanding Common Stuck, no amendment shall (except
for adjustments pursuant to Section 9): (1) increase the maximum number
of shares of Stock which may be made the subject of Awards under the Plan;
(2) decrease the option price for ISOs; (3) increase the option price for
ISOs; or (4) materially change the eligibility provisions hereof; and
provided further that no termination of or amendment of the Plan shall
adversely affect the rights of a Participant holding an Award
theretofore made, without the consent of such Participant.
C. ISSUANCE OF SHARES - RESTRICTIONS: Subject to the conditions and
restrictions provided in this paragraph C of Section 11, the Bank shall, as
soon as practicable after an ISO has been exercise in whole or in part, or
an NQG has matured so that shares of Stock are deliverable to the
Participant pursuant to the relevant NQG Agreement, deliver to the
Participant, for the appropriate number of shares of Stock.
D. RIGHTS AS SHAREHOLDER AND EMPLOYEE: No participant holding an Award
shall have any rights as a shareholder of the Bank with respect to any
Stock, including the right to vote the Stock, prior to the date of issuance
to him or her of the certificate for such stock. Neither the Plan nor any
Award made under the Plan shall confer upon a Participant any right to
continue in the employment of the Bank.
E. CONSTRUCTION: The Plan and the ISO and NQG Agreements issued
thereunder shall be interpreted and administered under the laws of the
State of Washington.
Approved this _____ day of _____________________________, 1997 by the Board
of Directors of ______________________________.
_________________________________ ________________________________________
Chairman Secretary of the Board
6
<PAGE>
EXHIBIT 10.8
THE BANK OF GRAYS HARBOR
INCENTIVE STOCK OPTION PLAN
(FOR KEY EMPLOYEES)
I. PURPOSE.
The purpose of this Incentive Stock Option Plan (the "Plan") is: (1) to aid
in maintaining, acquiring, and developing strong management through encouraging
the ownership of shares of The Bank of Grays Harbor (the "Bank") by key
employees of the Bank; and (2) to give suitable recognition, in addition to
salaries to such employees abilities and industry which contribute materially to
the success of the Bank's business interests.
II. DEFINITIONS.
In this Plan, except where the context clearly indicates otherwise, the
following definitions apply:
(1) "Board" means the Board of Directors of the Bank.
(2) "Code" means the Internal Revenue Code of 1986, as amended.
(3) "Committee" means the Committee appointed under Article V to
administer the Plan.
(4) "Bank" means The Bank of Grays Harbor, a Washington corporation.
(5) "Key Employees" means any employee of the Bank or of any parent
or subsidiary thereof who is an officer or in a managerial, professional or
other key position. However, the term "Key Employee" does NOT include any
employee (hereinafter called "Shareholder Employee") of the Bank who, at the
time the Bank grants the option, owns more than 10% of the total combined voting
power of all classes of stock of the Bank (or its parent or subsidiary, if
applicable) UNLESS (a) the option price is at least 110% of the Value of the
Share at the time the Bank grants the option and (b) the option is not
exercisable after the expiration of five years from the date it is granted. For
the purposes of this limitation, an employee owns Shares owned directly or
indirectly by or for his brothers and sisters, spouse, ancestors and lineal
descendants; and stock owned directly or indirectly by or for a corporation,
partnership, estate or trust is considered as being owned by or for its
shareholders, partners or beneficiaries.
(6) "Optionee" means a Key Employee whom the Bank grants a stock
option under this Plan.
(7) "Share" means a share of the Bank's $1 par value common stock the
Bank has previously authorized but not issued, or has issued and reacquired.
(8) "Successor Person" means the person or persons whom the
Optionee's rights under an option have passed by will or by the laws of descent
and distribution.
(9) "Value" is the mean between the bid and asked price published by
the National Association of Securities Dealers, Inc. (or registered securities
exchange, if appropriate) of the Shares on the date the Bank grants the option,
or if not available for that day, then the next earliest preceding day on which
the price is available. If the Shares should become listed on a national
registered securities exchange, then the Value is the reported closing price for
the day in question. In all other cases, the Value is the fair market value
determined by the method the Committee deems reasonable. In this regard, the
Committee must consult with the Board in establishing the criteria for valuation
of the Shares.
1
<PAGE>
III. TERM OF PLAN.
This Plan becomes effective upon its adoption by the Board. The Plan
continues in effect for a term of ten years unless sooner terminated
under Article IX. This Plan remains in effect after the term for the
purpose of administration of any option granted pursuant to its
provisions. An option granted during the term will not be adversely
affected by the expiration of the term of this Plan. The Committee
must grant the options within ten years of the date on which the Board
adopts the Plan or the date the shareholders approve the Plan,
whichever is earlier.
IV. SHARES TO BE OPTIONED.
The maximum number of shares which the Bank may option and sell under
this Plan is Twenty Five Thousand (25,000) Shares. If options granted
under this Plan terminate or expire without being wholly exercised,
the Bank may grant new options under the Plan covering the number of
Shares to which such termination or expiration relates.
V. ADMINISTRATION OF THE PLAN.
The Board must appoint a Committee to administer the Plan consisting
of three or more members.
The Committee has the sole right to grant options. The Committee can
conclusively interpret the Plan provisions, and can decide all
questions arising in its application. The Committee can act by general
rule or regulation, or by making individual determinations, or both.
All decisions of the Committee are final and binding on all parties.
VI. OPTIONS.
The Committee may grant one or more options to any Key Employee under
this Plan. Each option granted is subject to the following conditions:
(1) During the Optionee's lifetime, the Optionee may not sell, pledge,
assign or transfer in any manner, an option granted under this Plan. During the
Optionee's lifetime, only the Optionee or his legal representative (in the event
of the Optionee's disability) may exercise an option granted under this Plan.
Any option exercisable after the Optionee's death is exercisable by the
Optionee's Successor Person.
(2) Consistent with the limitations of the Plan, the Committee will
determine the provisions of each option, which need not be identical and which
provisions shall be set forth in the Option Agreement.
(3) The Committee may grant options for a period not exceeding ten
years or five years in the case of a Shareholder Employee.
(4) The Optionee exercises an option when he gives written notice of
such exercise to the Bank at its principal business office and makes full
payment to the Bank for the Shares subject to the notice. Until the issuance of
the Share certificates following exercise, no right to vote or to receive
dividends or any other rights as a shareholder exist with respect to the
optioned Shares notwithstanding the exercise of the option. The Bank will not
make any adjustment for a dividend or other rights for which the record date is
prior to the date it issues the Share certificate. The optionee must make
payment for the Shares with cash (including certified funds or cashier's check),
previously acquired Shares having a fair market value equal to the option price,
or previously acquired Shares having a fair market value less than the option
price, plus cash, as described in the Option Agreement. Upon exercise of an
option and payment of the purchase price, the Bank shall promptly issue the
Shares to the Optionee.
2
<PAGE>
(5) In the event the Optionee during his lifetime terminates
employment with the Bank for any reason, any option or unexercised portion of an
option, which otherwise was exercisable on the date of termination of
employment, will expire unless exercised within a period of three months from
the date his employment terminates, but in no event later than ten years from
the date the Bank granted the option. In the event of the death of the Optionee
during said three month period, the Optionee's Successor Person may exercise the
option to the same extent and during the same period the Optionee could have
exercised the option had the Optionee not died. If the Optionee dies while
employed by the Bank, the Optionee's Successor Person may exercise any option or
unexercised portion of an option which otherwise was exercisable at the time of
the Optionee's death, within six months of the Optionee's death, but in no event
later than ten years from the date the Bank granted the option. The Plan deems
an Optionee's continuous employment as not interrupted by a leave of absence
approved by the Bank.
VII. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION.
Whenever a stock split, stock dividend or other relevant change in
capitalization occurs, the Committee will appropriately adjust; (1)
the number and kind of Shares the Optionee can thereafter purchase,
and the option price per Share, under each option the Committee has
granted which the Optionee has not exercised, and (2) the number of
Shares used in determining whether a particular option is grantable
thereafter.
VIII. ADDITIONAL PROVISIONS APPLICABLE TO OPTIONS AND CERTAIN POWERS OF THE
COMMITTEE.
The Committee, in addition to any other powers granted it under the
Plan, has the power and discretion, consistent with the limitations of
the Plan to:
(1) provide in option agreements:
(a) for an agreement by the Optionee to render services to the
Bank upon such terms and conditions as the agreement specifies.
(b) for restrictions on the transfer, sale, or disposition of the
stock to be issued to the Optionee upon the exercise of his
option.
(c) that any options granted under this Plan are not incentive
stock options, and to provide such options to directors and other
persons who are not Key Employees, as described in Article IX.
(d) for any other conditions not inconsistent with Section 422 of
the Code.
(2) require of any person exercising an option granted under the Plan,
at the time of such exercise, the execution of any paper or the making of any
representation or the giving of any commitment which the Committee, in its
discretion, deems necessary or advisable by reason of the securities laws of the
United States or of any State, whether provided for in the pertinent stock
option or stock option agreement.
(3) amend stock option agreements previously granted and outstanding
under this Plan, but the Committee cannot make any amendment to any agreement
without the consent of the Optionee if such amendment would adversely affect the
Optionee, unless the Committee determines it necessary or advisable to do so in
light of a change to the Code or other law occurring after date of grant. The
Committee cannot make any amendment to any stock option agreement inconsistent
with the Plan or Section 422 of the Code.
(4) grant options after the date the Board adopts the Plan, but before
shareholder approval, provided the options granted are specifically contingent
upon shareholder approval.
3
<PAGE>
IX. POWER TO GRANT NONQUALIFIED OPTIONS.
The Committee may grant options to directors or other persons who are
not Key Employees. Such options are not incentive stock options but
are nonqualified options, and may be granted on such terms as the
Committee may establish. Such terms may or may not be consistent with
the Plan; provided that the term of the Plan and the total number of
Shares optioned hereunder may not exceed the limits of Articles III
and IV.
IX. POWER TO AMEND OR TERMINATE THE PLAN.
The Board may terminate this Plan at any time, or amend or modify the
Plan in such respects as it deems advisable in light (i) of any
addition to or change in the Code or in the regulations issued
thereunder, or any federal or state securities law or other law or
regulation, which change occurs after the effective date of the Plan
and by its terms applies to the Plan; or (ii) in any other
circumstance; provided if the amendment would adversely affect the
Employee, the Employee must consent.
In addition, the Board cannot:
(1) Increase the maximum number of Shares the Bank may effectively
option, otherwise than through the making of an adjustment pursuant to Article
VII; not,
(2) Change the class of employees eligible for the option.
X. SHAREHOLDER APPROVAL.
The Board must submit this Plan for approval and ratification by a
vote of the holders of a majority of the Shares of stock of the Bank
entitled to vote thereon, or such other percentage of approval as may
be required by applicable law.
_______________________________
THE BANK OF GRAYS HARBOR
_______________________________
By: ROBERT J. WORRELL
Its: President
Effective Date as Adopted by the Board:
Date Approved by the Shareholders:
4
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the use in this Form 10-K of our report, dated January
28, 2000, on the consolidated financial statements of Pacific Financial
Corporation and Subsidiaries.
/s/ KNIGHT VALE & GREGORY PLLC
Tacoma, Washington
March 24, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 13,080
<INT-BEARING-DEPOSITS> 1,744
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 65,625
<INVESTMENTS-CARRYING> 1,615
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<LOANS> 152,664
<ALLOWANCE> 1,930
<TOTAL-ASSETS> 242,189
<DEPOSITS> 206,139
<SHORT-TERM> 9,675
<LIABILITIES-OTHER> 4,937
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0
0
<COMMON> 497
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<TOTAL-LIABILITIES-AND-EQUITY> 242,189
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<INCOME-PRETAX> 5,614
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<EXTRAORDINARY> 0
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<LOANS-NON> 175
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