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PCBK > SEC Filings for PCBK > Form 10-Q on 8-Aug-2013All Recent SEC Filings




Quarterly Report

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

The following discussion is intended to provide a more comprehensive review of the Company's operating results and financial condition than can be obtained from reading the Consolidated Financial Statements alone. The discussion should be read in conjunction with the financial statements and the notes included later in this report. Please refer also to our Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in the Company's 2012 Form 10-K. All dollar amounts, except share and per share data, are expressed in thousands of dollars.

In addition to historical information, this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements regarding projected results for third quarter 2013 and full year 2013, the expected interest rate environment and its impact on our business, loan yields, net interest margin, expectations regarding nonperforming assets, expected cash flows from the securities portfolio, expectations regarding the Company's securities portfolio and the sale of securities, their value and yields, capital levels and dividends, the outcome of legal proceedings, the 2013 provision for loan losses, management's plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as "expects," "anticipates," "intends," "plans," "believes," "should," "projects," "seeks," "estimates" or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations in the forward-looking statements, including those set forth in this report, and our other reports filed with the SEC:

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

The local housing or real estate market could decline.

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

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

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

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

Competition among financial institutions could increase significantly.

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

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

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

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

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

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

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

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

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

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

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Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Part I, Item 1A "Risk Factors" in the Company's 2012 Form 10-K and Part II, Item 1A, "Risk Factors" in this report and the other risks described in this report and include risks and uncertainties described or referred to in Part I, Item 1 "Business" under the captions "Competition" and "Supervision and Regulation" of the Company's 2012 Form 10-K and Part II, Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this report. Please take into account that forward-looking statements speak only as of the date of this report or documents incorporated by reference. The Company does not undertake any obligation to publicly correct or update any forward-looking statement whether as a result of new information, future events or otherwise.


We follow accounting standards set by the Financial Accounting Standards Board, commonly referred to as the "FASB." The FASB sets generally accepted accounting principles ("GAAP") that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in this report are to the "FASB Accounting Standards Codification," sometimes referred to as the "Codification" or "ASC." The FASB finalized the Codification effective for periods ending on or after September 15, 2009. Prior FASB Statements, Interpretations, Positions, EITF consensuses, and AICPA Statements of Position are no longer being issued by the FASB. The Codification does not change how the Company accounts for its transactions or the nature of related disclosures made. However, when referring to guidance issued by the FASB, the Company refers to topics in the ASC rather than the specific FASB statement. We have updated references to GAAP in this report to reflect the guidance in the Codification.

The SEC defines "critical accounting policies" as those that require the application of management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements in the Company's 2012 Form 10-K. Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements in the Company's 2012 Form 10-K should be considered critical under the SEC definition:

Nonaccrual Loans

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

Allowance for Loan Losses and Reserve for Unfunded Commitments

The allowance for loan losses on outstanding loans is classified as a contra-asset account offsetting outstanding loans, and the allowance for unfunded commitments is classified as an "other" liability on the balance sheet. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balances of the allowance for loan losses for outstanding loans and unfunded commitments are maintained at an amount management believes will be adequate to absorb known and inherent losses in the loan portfolio and commitments to loan funds. The appropriate balance of the allowance for loan losses is determined by applying loss factors to the credit exposure from outstanding loans and unfunded loan commitments. Estimated loss factors are based on subjective measurements, including management's assessment of the internal risk classifications, changes in the nature of the loan portfolios, industry concentrations, and the impact of current local, regional, and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company's consolidated financial statements, results of operations or liquidity.

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Troubled Debt Restructurings

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

Goodwill and Intangible Assets

At June 30, 2013, the Company had $23,740 in goodwill and other intangible assets. In accordance with financial accounting standards, assets with indefinite lives are no longer amortized, but instead are periodically tested for impairment. Management performs an impairment analysis of its goodwill and intangible assets with indefinite lives at least annually and has determined that there was no impairment as of December 31, 2012.

Share-based Compensation

Consistent with the provisions of FASB ASC 718, Stock Compensation, a revision to the previously issued guidance on accounting for stock options and other forms of equity-based compensation, we recognize expense for the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees' requisite service period (generally the vesting period). The requisite service period may be subject to performance conditions. The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model. Management assumptions utilized at the time of grant impact the fair value of the option calculated under the Black-Scholes methodology, and ultimately, the expense that will be recognized over the life of the option. Additional information is included in Note 1 of the Notes to Consolidated Financial Statements in Item 8 of the Company's 2012 Form 10-K.

Fair Value Measurements

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

Recent Accounting Pronouncements

In January 2013, the FASB issued Accounting Standards Update No. 2013-01, "Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities." ASU No. 2013-01 clarifies that ASU No. 2011-11 applies only to derivatives, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or subject to an enforceable master netting arrangement or similar agreement. Entities with other types of financial assets and financial liabilities subject to a master netting arrangement or similar agreement are no longer subject to the disclosure requirements in ASU No. 2011-11. The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013. The adoption of ASU No. 2013-01 did not have a material impact on the Company's consolidated financial statements.

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In February 2013, the FASB issued Accounting Standards Update No. 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." ASU No. 2013-02 requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and to present either on the face of the statement where net income is presented, or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2012. The adoption of ASU No. 2013-02 did not have a material impact on the Company's consolidated financial statements.

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                                          For the three months ended June 30,                  For the six months ended June 30,
                                        2013               2012           % Change          2013               2012           % Change

Net income                          $       3,724       $     3,117           19.47 %    $     6,174        $     5,832            5.86 %
Operating revenue(1)                $      15,051       $    13,992            7.57 %    $    29,707        $    28,056            5.88 %

Earnings per share
Basic                               $        0.21       $      0.17           23.53 %    $      0.35        $      0.32            9.37 %
Diluted                             $        0.21       $      0.17           23.53 %    $      0.34        $      0.32            6.25 %

Assets, period-end                  $   1,431,074       $ 1,310,084            9.24 %
Gross loans, period-end             $     960,433       $   826,788           16.16 %
Core deposits, period end(2)        $     958,741       $   851,781           12.56 %
Deposits, period-end                $   1,070,628       $   949,950           12.70 %

Return on average assets(3)                  1.04 %            0.97 %                           0.87 %             0.91 %
Return on average equity(3)                  8.19 %            6.94 %                           6.81 %             6.51 %
Return on average tangible
equity(3)(4)                                 9.42 %            7.92 %                           7.82 %             7.42 %

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

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

(3) Amounts annualized.

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

The Company earned $3,724 in second quarter 2013, compared to $3,117 in second quarter 2012. The improvement in net income was primarily due to an increase in operating revenue of $1,059 or 7.57% and a lower provision for loan losses. The increase in operating revenue was primarily centered in net interest income, which accounted for $1,017 of the total improvement in operating revenue. Improvement in net interest income was primarily due to increased volumes of earnings assets, primarily loans, due both to organic growth and the acquisition of Century Bank, which closed on February 1, 2013. The lower provision for loan losses was due to overall improvement in the credit quality of the loan portfolio, reductions in classified and nonperforming assets, and lower net charge offs during second quarter 2013 when compared to the same quarter last year.

During second quarter 2013, the Company continued to experience organic growth in outstanding loans. Outstanding loans at June 30, 2013, were $960,433 up $9,605 over the prior quarter end. Outstanding loans at June 30, 2013, were up $89,176 over December 31, 2012. Excluding loans acquired in the Century Bank transaction, organic loan growth during the first six months of 2013 was approximately $35,600 and represented an annualized growth rate of 8.20%. Outstanding core deposits at June 30, 2013, were $958,741, and relatively unchanged from first quarter 2013.

Year-to-date June 30, 2013, net income was $6,174, up $342 or 5.86% over the same period last year. Current year income was negatively impacted by $1,246 of merger expenses related to the Century Bank acquisition, which were booked during the first quarter 2013. Excluding the merger related expenses, net income was $7,009, up $1,117 or 20.18% over the same period last year due to increased operating revenues and a lower provision for loan losses.

Reconciliation of non-GAAP financial information

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

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

                                               June 30,          December 31,         June 30,
                                                 2013                2012               2012
Total shareholders' equity                     $ 178,929        $      183,381        $ 180,589
Goodwill                                         (22,945 )             (22,031 )        (22,031 )
Core deposit intangible assets                      (795 )                  -               (92 )

Tangible shareholders' equity (non-GAAP)       $ 155,189        $      161,350        $ 158,466

Book value per share                           $   10.00        $        10.28        $   10.00
Tangible book value per share (non-GAAP)       $    8.68        $         9.05        $    8.77

Year-to-date return on average equity               6.81 %                6.97 %           6.51 %
Year-to-date return on average tangible
equity (non-GAAP)                                   7.82 %                7.94 %           7.42 %

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


Net Interest Income

Net interest income is the primary source of the Company's revenue. Net interest income is the difference between interest income derived from earning assets (principally loans) and interest expense associated with interest-bearing liabilities (principally deposits). The volume and mix of earning assets and funding sources, market rates of interest, demand for loans, and the availability of deposits affect net interest income.

The net interest margin for the second quarter 2013 was 4.20%, down 9 basis points from the first quarter 2013 net interest margin of 4.29%, and down 11 basis points from the 4.31% reported for second quarter 2012. The decrease in the linked-quarter margin was primarily attributable to a 10 basis point decline in the yield on earning assets, while the Company's cost of funds was unchanged. The decline in earning asset yields was centered in the loan portfolio, where the yields declined 14 basis points in second quarter 2013 when compared to first quarter 2013. The decline in loan yields was the result of the continued low interest rate environment and competitive pricing on new loan production. During the second quarter 2013, the Company recognized accretion of $336 on loans acquired in the Century Bank transaction, which added 11 basis points to the current quarter net interest margin. That compares to accretion of $231 recognized in first quarter 2013 that added 7 basis points to the net interest margin.

The Company's cost of interest-bearing core deposits and wholesale funding remained virtually unchanged in second quarter 2013 at 0.55% when compared to first quarter 2013 at 0.54%. The cost of interest-bearing core deposits was down 1 basis point on a linked-quarter basis. However, the cost of wholesale funding increased 2 basis points in second quarter 2013 when compared to the prior quarter. The increase in the cost of wholesale funding was centered in non-core time deposits and trust preferred. During the second quarter 2013, the Company continued to opportunistically issue long-term callable brokered time deposits with five and ten-year maturities in order to partially mitigate its liability sensitive position. In addition, on April 22, 2013, the Company executed an interest rate swap on $8,000 of its trust preferred securities, swapping a variable rate priced at

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LIBOR plus 135 basis points or approximately 1.67% for a fixed rate of 2.73% for seven years. This strategy also helped mitigate the Company's liability position, but increased the cost of trust preferred securities to 2.67% in second quarter 2013, compared to 1.67% in first quarter 2013. With the increase in market interest rates that occurred during the last 45 days of the second quarter 2013, the trust preferred swap had an increase of $351 in its fair value during the current quarter.

The prolonged historically low interest rate environment and highly competitive pricing on new and existing loans is expected to continue to erode loan yields over time. The accretion of interest income on loans acquired in the Century Bank transaction will mitigate some of the erosion in loan yields. In addition, the recent increase in long-term market interest rates and steepening of the yield curve may also mitigate erosion of loan yields, but pricing on new loans remains highly competitive. Earning asset yields may also benefit from the recent increase in market interest rates due to anticipated higher yields on the mortgage-back section of the Company's securities portfolio. The increase in market interest rates is expected to slow down refinancing and prepayment speeds on mortgage-backed securities, which in turn will slow the amortization of premiums paid on securities, thus increasing the yield on this element of the portfolio. Overall, the Company expects some stabilization in the net interest margin over the remainder of 2013.

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The following table presents condensed balance sheet information, together with interest income and yields on average interest earning assets, and interest . . .

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