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OREGON PACIFIC BANCORP - Quarter Report: 2006 March (Form 10-Q)

Oregon Pacific Bancorp 10-Q 3-31-2006
FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the quarterly period ended March 31, 2006

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to___________   

OREGON PACIFIC BANCORP
(Exact name of Registrant as specified in its charter)


 
Oregon
  
71-0918151
  
 
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)
  

1355 Highway 101
Florence, Oregon 97439
(Address of principal executive offices)

(541) 997-7121
(Issuer’s telephone number)

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 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes      x  No     ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “Accelerated Filer and Large Accelerated Filer” in Rule 12b-2 of the Exchange Act. (check one):    Large Accelerated Filer     ¨     Accelerated Filer     ¨     Non-accelerated Filer    x
 
  Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes    ¨  No     x

The number of shares outstanding of the issuer’s Common Stock, no par value, as of April 30, 2006, was 2,175,842.
 


OREGON PACIFIC BANCORP

INDEX

Part I
Financial Information
  
       
 
Item 1.
Financial statements
 
       
   
3
   
4-5
   
6
   
7
   
8-11
     
 
 
Item 2.
12-17
     
 
 
Item 3.
17
       
 
Item 4.
17-18
       
Part II
Other Information
  
       
 
Item 1.
18
       
 
Item 1A.
18
       
 
Item 2.
19
       
 
Item 3.
19
       
 
Item 4.
19
       
 
Item 5.
19
       
 
Item 6.
19
       
 
20
 
Certifications of Chief Executive Officer and Chief Financial Officer
21-23
 
2

PART 1.
FINANCIAL INFORMATION

Item 1.     Financial statements

OREGON PACIFIC BANCORP
CONSOLIDATED BALANCE SHEETS
(Unaudited)

   
MARCH 31,
  
DECEMBER 31,
  
ASSETS
  
2006
  
2005
  
           
Cash and cash equivalents
  
$
7,994,975
  
$
5,018,838
  
Interest-bearing deposits in banks
    
10,653,911
   
5,916,224
 
Available-for-sale securities, at fair value
    
11,329,919
   
11,643,557
 
Restricted equity securities
    
1,023,100
   
1,023,100
 
Loans held-for-sale
    
1,454,222
   
1,350,810
 
Loans, net of allowance for loan losses and deferred fees
    
119,704,215
   
117,985,801
 
Premises & equipment, net
   
5,265,582
   
5,232,814
 
Intangible assets, net
    
439,300
   
-
 
Accrued interest and other assets
    
2,347,617
   
2,269,861
 
               
Total assets
  
$
160,212,841
  
$
150,441,005
  
               
LIABILITIES AND STOCKHOLDERS' EQUITY
              
               
Deposits:
              
Demand deposits
  
$
35,401,037
  
$
29,668,703
  
Interest-bearing demand deposits
    
42,024,063
   
40,468,295
 
Savings deposits
    
18,068,325
   
18,433,466
 
Time certificate accounts:
              
$100,000 or more
    
16,727,498
   
15,709,566
 
Other time certificate accounts
    
17,121,090
   
17,049,226
 
               
Total deposits
    
129,342,013
   
121,329,256
 
               
Federal Home Loan Bank borrowings and other debt
    
12,921,056
   
11,412,806
 
Floating rate Junior Subordinated Deferrable Interest
              
Debentures (Trust Preferred Securities)
    
4,124,000
   
4,124,000
 
Deferred compensation liability
    
1,939,032
   
1,865,781
 
Accrued interest and other liabilities
    
1,248,364
   
1,445,931
 
               
Total liabilities
    
149,574,465
   
140,177,774
 
               
Stockholders' equity
              
Common stock, no par value, 10,000,000 shares authorized with 2,174,230 and 2,166,006 issued and outstanding at March 31, 2006 and
             
December 31, 2005, respectively
    
4,940,095
   
4,858,728
 
Undivided profits
    
5,706,531
   
5,376,065
 
Accumulated other comprehensive (loss) income, net of tax
    
(8,250
)
  
28,438
 
               
Total stockholders' equity
    
10,638,376
   
10,263,231
 
               
Total liabilities and stockholders' equity
  
$
160,212,841
  
$
150,441,005
  

See accompanying notes

3

OREGON PACIFIC BANCORP
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)

 
  
 Three Months Ended March 31,
  
   
 2006
  
2005
  
            
INTEREST INCOME
           
Interest and fees on loans
  
$
2,557,547
  
$
2,354,305
  
Interest on investment securities:
              
U.S. Teasuries and agencies
    
36,798
   
58,969
 
State and political subdivisions
    
75,224
   
80,812
 
Corporate and other investments
    
8,474
   
28,143
 
Interest on deposits in banks
    
105,955
   
15,025
 
               
Total interest income
    
2,783,998
   
2,537,254
 
               
INTEREST EXPENSE
              
Interest-bearing demand deposits
    
222,786
   
113,598
 
Savings deposits
    
25,154
   
24,350
 
Time deposits
    
280,412
   
133,451
 
Other borrowings
    
207,029
   
171,677
 
               
Total interest expense
    
735,381
   
443,076
 
               
Net interest income before provision for loan losses
    
2,048,617
   
2,094,178
 
               
PROVISION FOR LOAN LOSSES
    
26,000
   
170,000
 
               
Net interest income after provision for loan losses
    
2,022,617
   
1,924,178
 
               
NONINTEREST INCOME
              
Service charges and fees
    
250,393
   
232,134
 
Trust fee income
    
159,043
   
145,804
 
Mortgage loan sales and servicing fees, net
    
125,924
   
161,949
 
Investment sales commissions
    
91,288
   
27,893
 
Other income
    
34,046
   
97,758
 
               
Total noninterest income
    
660,694
   
665,538
 
 
4

OREGON PACIFIC BANCORP
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)
(continued)

 
  
 Three Months Ended March 31,
  
   
 2006
  
2005
  
            
NONINTEREST EXPENSE
           
Salaries and benefits
    
1,231,546
   
1,115,417
 
Occupancy
    
228,280
   
208,914
 
Supplies
    
40,160
   
47,034
 
Postage and freight
    
20,871
   
21,017
 
Outside services
    
168,154
   
173,871
 
Advertising
    
14,476
   
20,799
 
Loan collection expense
    
19,685
   
13,848
 
Securities and trust department expenses
    
57,349
   
37,969
 
Other expenses
    
190,387
   
156,304
 
               
Total noninterest expense
    
1,970,908
   
1,795,173
 
               
INCOME BEFORE INCOME TAXES
    
712,403
   
794,543
 
               
PROVISION FOR INCOME TAXES
    
251,821
   
309,083
 
               
NET INCOME
    
460,582
   
485,460
 
               
OTHER COMPREHENSIVE INCOME
              
Unrealized loss on available-for-sale securities, net of tax
    
(36,688
)
  
(133,710
)
               
COMPREHENSIVE INCOME
  
$
423,894
  
$
351,750
  
               
EARNINGS PER SHARE OF COMMON STOCK
              
Basic earnings per share
  
$
0.21
  
$
0.23
  
Diluted earnings per share
  
$
0.21
  
$
0.23
  
               
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
              
Basic
    
2,170,890
   
2,147,719
 
Diluted
    
2,180,781
   
2,151,674
 

See accompanying notes

5

OREGON PACIFIC BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

               
Accumulated
      
               
Other
  
Total
  
   
Common Stock
  
Undivided
  
Comprehensive
  
Stockholders'
  
   
Shares
  
Amount
  
Profits
  
Income
  
Equity
  
                       
Balance, December 31, 2004
    
2,148,616
 
$
4,698,162
  
$
3,983,420
  
$
210,715
  
$
8,892,297
  
                                 
Shares acquired in stock repurchase plan
    
(4,300
)
  
(31,610
)
  
-
   
-
   
(31,610
)
                                 
Sale of nonregistered stock
    
1,081
   
11,003
   
-
   
-
   
11,003
 
                                 
Exercise of stock options
    
1,538
   
9,997
   
-
   
-
   
9,997
 
                                 
Cash dividends paid
    
-
   
-
   
(301,551
)
  
-
   
(301,551
)
                                 
Dividends reinvested in stock
    
19,071
   
171,176
   
(171,176
)
  
-
   
-
 
                                 
Net income and comprehensive income
    
-
   
-
   
1,865,372
   
(182,277
)
  
1,683,095
 
                                 
Balance, December 31, 2005
    
2,166,006
 
$
4,858,728
  
$
5,376,065
  
$
28,438
  
$
10,263,231
  
                                 
Bonuses paid in stock for 2005
    
1,686
   
20,000
   
-
   
-
   
20,000
 
                                 
Exercise of stock options
    
2,600
   
12,506
   
-
   
-
   
12,506
 
                                 
Stock-based compensation
    
-
   
3,812
   
-
   
-
   
3,812
 
                                 
Cash dividends paid
    
-
   
-
   
(85,067
)
  
-
   
(85,067
)
                                 
Dividends reinvested in stock
    
3,938
   
45,049
   
(45,049
)
  
-
   
-
 
                                 
Net income and comprehensive income
    
-
   
-
   
460,582
   
(36,688
)
  
423,894
 
                                 
Balance, March 31, 2006 (Unaudited)
    
2,174,230
 
$
4,940,095
  
$
5,706,531
  
$
(8,250
)
$
10,638,376
  

See accompanying notes

6

OREGON PACIFIC BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Three Months Ended March 31,
  
   
2006
  
2005
  
           
CASH FLOWS FROM OPERATING ACTIVITIES
          
Net income
  
$
460,582
  
$
485,460
  
Adjustments to reconcile net income to net cash from operating activities:
              
Depreciation and amortization
    
145,234
   
117,523
 
Provision for loan losses
    
26,000
   
170,000
 
Federal Home Loan Bank stock dividends
    
-
   
(3,000
)
Stock-based compensation
    
3,812
   
-
 
Net change in mortgage loans held-for-sale
    
(103,412
)
  
(146,631
)
Net increase in accrued interest and other assets
    
(53,296
)
  
(17,532
)
Net (decrease) increase in accrued interest and other liabilities
    
(124,316
)
  
69,923
 
               
Net cash from operating activities
    
354,604
   
675,743
 
               
CASH FLOWS FROM INVESTING ACTIVITIES
              
Proceeds from sales and maturities of available-for-sale securities
    
250,000
   
189,200
 
Net increase in interest-bearing deposits in banks
    
(4,737,687
)
  
(206,601
)
Loans originated, net of principal repayments
    
(1,744,414
)
  
(2,050,885
)
Purchase of premises and equipment
    
(154,812
)
  
(50,554
)
Purchase of brokerage firm
    
(460,000
)
  
-
 
               
Net cash from investing activities
    
(6,846,913
)
  
(2,118,840
)
               
CASH FLOWS FROM FINANCING ACTIVITIES
              
Net increase in demand and savings deposit accounts
    
6,922,961
   
392,945
 
Net increase (decrease) in time deposits
    
1,089,796
   
(580,505
)
Proceeds from Federal Home Loan Bank borrowings
    
1,522,000
   
1,700,000
 
Repayment of Federal Home Loan Bank borrowings
    
(13,750
)
  
(13,750
)
Shares acquired in stock repurchase plan
    
-
   
(31,609
)
Proceeds from exercise of common stock options
    
12,506
   
-
 
Proceeds for issuance of common stock
    
-
   
1,003
 
Stock bonuses granted
    
20,000
   
-
 
Cash dividends paid
    
(85,067
)
  
(66,866
)
               
Net cash from financing activities
    
9,468,446
   
1,401,218
 
               
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
2,976,137
   
(41,879
)
               
CASH AND CASH EQUIVALENTS, beginning of period
  
$
5,018,838
  
$
4,341,385
  
               
CASH AND CASH EQUIVALENTS, end of period
  
$
7,994,975
  
$
4,299,506
  
               
SCHEDULE OF NONCASH ACTIVITIES
              
Stock dividends reinvested
  
$
45,049
  
$
39,745
  
               
Change in fair value of AFS securities, net of tax
  
$
(36,688
)
$
(133,710
)
 
See accompanying notes

7

Oregon Pacific Bancorp and Subsidiary
Notes to Financial Statements
March 31, 2006
(Unaudited)

Note 1 - Organization and Basis of Presentation
 
The unaudited interim consolidated financial statements include the accounts of Oregon Pacific Bancorp (“Bancorp”), an Oregon corporation and a registered financial holding company, and its wholly-owned subsidiary Oregon Pacific Banking Co. (the “Bank”), after elimination of intercompany transactions and balances. Substantially all activity of Bancorp is conducted through its banking subsidiary.

Oregon Pacific Bancorp, an Oregon Corporation and financial holding company, became the holding company of Oregon Pacific Banking Co. (collectively, the “Company”) effective January 1, 2003 through a Plan of Share Exchange approved by Bank shareholders on December 19, 2002. The Bank is a state-chartered institution authorized to provide banking services by the State of Oregon, from its headquarters in Florence, Oregon. Full-service banking products are offered to the Bank’s customers who live primarily in Lane, Douglas, and Coos counties and on the central Oregon coast. In December 2003, Bancorp formed Oregon Pacific Statutory Trust I, a wholly-owned Connecticut statutory business trust, for purposes of issuing guaranteed undivided beneficial interests in Junior Subordinated Deferrable Interest Debentures. The Bank is subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.

In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts and balances for the periods presented. Actual results could differ from those estimated. Additionally, the results of operations for the three months ended March 31, 2006 are not necessarily indicative of results to be anticipated for the year ending December 31, 2006. The interim financial statements should be read in conjunction with the audited financial statements, including the notes thereto, contained in the Company’s 2005 Annual Report to Shareholders.

The unaudited consolidated interim financial statements have been prepared in conformity with accounting principals generally accepted in the United States of America and industry practice. Certain information in footnote disclosures normally included in financial statements prepared in accordance with accounting principals generally accepted in the United States of America and industry practice have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission.

Reclassifications - Certain reclassifications have been made to the 2005 financial statements to conform to current year presentations.

8
 
Note 2 - Securities Available-for-Sale

The following table presents the fair value of investments with continuous unrealized losses for less than or more than 12 months as of March 31, 2006.
   
Amortized Cost
  
Gross Unrealized Gains
  
Gross Unrealized Losses Less than 12 Months
  
Gross Unrealized Losses More than 12 Months
  
Estimated Fair Value
  
March 31, 2006:
                      
                       
U.S. Treasury and agencies
  
$
4,000,000
  
$
-
  
$
-
  
$
(87,812
)
$
3,912,188
  
State and political subdivisions
    
6,884,658
   
79,218
   
(6,365
)
  
(7,537
)
  
6,949,974
 
Corporate notes
    
459,011
   
8,746
   
-
   
-
   
467,757
 
                                 
   
$
11,343,669
  
$
87,964
  
$
(6,365
)
$
(95,349
)
$
11,329,919
  
                                 
December 31, 2005:
                                
U.S. Treasury and agencies
  
$
4,000,000
  
$
-
  
$
(12,500
)
$
(63,125
)
$
3,924,375
  
State and political subdivisions
    
6,884,782
   
123,997
   
(8,861
)
  
(6,304
)
  
6,993,614
 
Corporate notes
    
711,378
   
14,328
   
(138
)
  
-
   
725,568
 
                                 
   
$
11,596,160
  
$
138,325
  
$
(21,499
)
$
(69,429
)
$
11,643,557
  

For the securities exhibiting unrealized losses, that is, they currently have fair values less than amortized costs, the Bank has evaluated these securities and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The following information was also considered in determining that the impairments are not other-than-temporary. U.S. Government agencies securities have minimal credit risk as they play a vital role in the nation’s financial markets. State and political subdivisions and corporate securities have a credit rating of at least investment grade by one of the nationally recognized rating agencies. The decline in value is not related to any company or industry-specific event and the Bank anticipates full recovery of amortized costs with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment.


Note 3 - Loans and Allowance for Loan Losses

The composition of the loan portfolio was as follows as of the dates presented:
 
   
MAR. 31, 2006
  
DEC. 31, 2005
  
           
Real estate
  
$
19,167,010
  
$
18,583,333
  
Commercial
    
95,062,483
   
94,138,523
 
Installment
    
7,779,285
   
7,541,900
 
Overdrafts
    
49,488
   
72,495
 
               
Total Loans
    
122,058,266
   
120,336,251
 
Less allowance for loan losses
    
(1,884,185
)
  
(1,858,185
)
Less deferred loan fees
   
(469,866
)
  
(492,265
)
Loans, net of allowance for loan losses and deferred loan fees
  
$
119,704,215
  
$
117,985,801
  
 
9

Changes in the allowance for loan losses were as follows for the three-months ended:
   
MAR. 31, 2006
  
MAR. 31, 2005
  
           
Balance, beginning of period
  
$
1,858,185
  
$
1,640,060
  
Provision for loan losses
    
26,000
   
170,000
 
Loans charged off
    
-
   
(1,480
)
Loan recoveries
    
-
   
460
 
               
Balance, end of period
  
$
1,884,185
  
$
1,809,040
  

It is the policy of the Bank to place loans on nonaccrual status whenever the collection of all or a part of the principal is in doubt. Loans placed on nonaccrual status may or may not be contractually past due at the time of such determination, and may or may not be secured by collateral. Loans in the amount of $115,000 and $356,000 were on nonaccrual status at March 31, 2006 and December 31, 2005.

The Bank had no loans past due 90 days or more on which it continued to accrue interest at either March 31, 2006 or December 31, 2005.


Note 4 - Earnings per Share of Common Stock

Basic earnings per share excludes dilution and is computed by dividing net income by the weighted average common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if common shares were issued pursuant to the exercise of options under stock option plans. Weighted average shares outstanding consist of common shares outstanding and common stock equivalents attributable to outstanding stock options.


Note 5 - Stock-based compensation

Prior to January 1, 2006, the Company’s stock option plans were accounted for under the recognition and measurement provisions of APB Opinion No. 25 (Opinion 25), Accounting for Stock Issued to Employees, and related interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation (as amended by SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure) (collectively SFAS 123). No stock-based employee compensation cost was recognized in the Company’s Statements of Operations through December 31, 2005, as all options granted to employees under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payment (SFAS 123(R)), using the modified- prospective-transition method. Under that transition method, compensation cost recognized in 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). As of January 1, 2006, 20,205 stock options were not fully vested.

The fair value of each option grant on the date of grant is estimated using the Black-Scholes option pricing model based on a weighted average volatility of 15.2%, expected life of options of three to five and one-half years, weighted average risk free interest rate of 4.7%, and a dividend yield of 2% grants during first quarter 2006. The fair value of options granted during the quarter ended March 31, 2006 ranged from $1.60 to $2.23. 
 
As a result of adopting SFAS 123(R) on January 1, 2006, the Company’s earnings before income taxes for the three months ended March 31, 2006, was approximately $3,800 lower than if it had continued to be accounted for as share-based compensation under Opinion 25. As of March 31, 2006, the Company had 32,991 nonvested options outstanding and there was $32,600 of total unrecognized compensation cost related to these nonvested options. This cost is expected to be recognized on a straight-line basis, over the vesting periods, through December 31, 2011.

10

On March 16, 2006 the Board of Directors of the Company modified the vesting period of all incentive stock options granted after 2002 and allowed for accelerated vesting when an employee reaches retirement age and ceases continuous service. Under SFAS 123(R), grants issued subsequent to adoption of SFAS 123(R) which are subject to such an accelerated vesting upon the recipient’s attainment of retirement age, are expensed over the shorter of the time to retirement age or the vesting schedule in accordance with the grant. Thus the vesting period can be less than the plan’s five-year vesting period depending on the age of the grantee. 

There were 13,082 options granted and 2,600 options exercised during the quarter ended March 31, 2006. The following table summarizes information about the stock options outstanding at March 31, 2006:
 
   
Exercise Price
  
Number Outstanding
  
Remaining Contractual Life (years)
  
Options Exercisable
  
                   
   
$
4.81
    
2,597
   
4.8
    
2,597
 
   
$
6.20
    
1,612
   
4.5
    
161
 
   
$
7.25
    
17,242
   
6.0
    
-
 
   
$
7.40
    
1,351
   
5.0
    
135
 
   
$
11.85
    
13,082
   
7.0
    
-
 
                           
Total
    
35,884
         
2,893
 
Weighted Average Per Share Price
  
$
8.71
              

The following table illustrates the effect on net income and income per share for the periods ended March 31, 2005, if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

   
3 Months Ended March 31, 2005
  
       
Net earnings, as reported
  
$
485,460
  
Deduct: Total stock-based employee compensation expense determined under the fair value-based method for all awards, net of related tax effects
    
(1,212
)
         
Pro forma net earnings
  
$
484,248
  
         
Basic earnings per common share:
        
As reported
  
$
0.23
  
Pro forma
  
$
0.23
  
         
Diluted earnings per common share:
        
As reported
  
$
0.23
  
Pro forma
  
$
0.23
  
 
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for March 31, 2005:

   
2005
  
       
Dividend yield
    
2.44
%
Expected life (years)
    
7.5
 
Expected volatility
    
14.39
%
Risk-free rate
    
4.50
%
 
11

Note 6 - Business Combinations 

On January 03, 2006, the Bank acquired all of the assets of Coast Investment Advisors, Inc., the local Florence branch of LPL Financial Services, Inc.  As a result of the acquisition, the Bank recorded $460,000 in intangible assets, which consist of a customer list and a non-compete agreement, which are amortized on a straight-line basis over the estimated lives of the asset, both of which are 60 months. The amortization of the non-compete agreement will begin at the end of a three-year employment contract. This acquisition was consistent with the Bank’s strategy to grow the Trust and Investment Department and provided an opportunity to increase the customer base in this area.

The aggregate purchase price was $462,000, which included cash of $140,000 and an unsecured Note Payable of $322,000. Interest on the note payable is 7% and paid monthly, while principal payments are made in three equal and annual installments, with the final payment due in February 2009. No liabilities or obligations were assumed in the transaction.


Note 7 - Accounting Pronouncements
 
In March 2006, the Financial Accounting Standards Board issued FAS No. 156, Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140, which changes the accounting for all loan servicing rights  which are recorded as the result of selling a loan where the seller undertakes an obligation to service the loan, usually in exchange for compensation. FAS 156 amends current accounting guidance by permitting the servicing right to be recorded initially at fair value and also permits the subsequent reporting of these assets at fair value. FAS 156 is effective beginning January 1, 2007. Management does not expect the adoption of this standard to have a material impact on the Company’s financial statements.
 

Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains a number of forward looking statements about our anticipated business, operations, financial performance and cash flows. Statements in this report that relate to future plans, events and circumstances are provided to describe management's intentions and expectations based on currently available information, and readers should not construe these statements as assurances or guarantees. As with any predictions, these statements are inherently difficult to make with any degree of assurance, and actual results may differ materially and adversely from management's expectations described herein. Likewise, management's plans described in this report may not come to pass because unforeseen events may force management to deviate from its expressed intentions. Forward-looking statements often can be identified by the use of predictive or prospective terms such as "expect," "anticipate," "believe," "plan," "intend," and words of similar construction or meaning. Some of the events or circumstances that may cause our actual results to deviate from management's expectations include the impact of competition and local and regional economic factors upon our customer base, our deposits and our loan portfolio; economic and regulatory limits on our ability to grow our assets and manage our business; customer acceptance of our products; interest rate fluctuations that may adversely impact our revenues and expenses; and the impact of impairment charges upon our intangible and other assets. Other factors that may adversely impact our performance are discussed in this report as well as other disclosures we make from time to time in our filings with the Securities and Exchange Commission or other federal agencies. Readers also should note that forward-looking statements expressed in this report are made as of the date of this report, and management cannot undertake to update those statements to reflect future events or circumstances.


Critical Accounting Policies and Estimates

On an ongoing basis, management evaluates the estimates used, including the adequacy of the allowance for loan losses and the recorded value of the mortgage servicing asset. Estimates are based upon historical experience, current economic conditions, and other factors that management considers reasonable under the circumstances. These estimates result in judgments regarding the carrying values of assets and liabilities when these values are not readily available from other sources as well as assessing and identifying the accounting treatments of commitments and contingencies.

12
 
The allowance for loan losses is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible based upon evaluations of the collectibility of loans and prior loan loss experience. Management also attempts to ensure that the overall allowance appropriately reflects a margin for the imprecision in an estimation process and evaluates factors such as the trend in the loan growth and the percentage of change, the level of geographic and/or industry concentrations, competitive issues that impact the loan underwriting or structure, and economic conditions. The increase in the allowance primarily relates to loan growth since March 31, 2005. While management believes that the allowance for loan losses is sufficient to absorb losses inherent in the loan portfolio and credit commitments outstanding based on the best information available, the assessment cannot be determined with precision and may not necessarily be indicative of future losses.

The Company recognizes as assets the rights to service mortgage loans for others, known as MSRs. MSRs are capitalized based on the relative fair value of the servicing right and the mortgage loan on the date the mortgage loan is sold and amortized over the life of the loan. Utilizing assumptions about factors such as discount rates, mortgage loan prepayment speeds, market trends and industry demand, an estimate of the fair value of the Company’s capitalized MSRs is performed quarterly by management. Since valuation is determined using discounted cash flow models, the primary risk inherent in MSRs is the impact of prepayment speeds on the estimated life of the servicing revenue stream. The use of different estimates or assumptions could produce a different fair value. At March 31, 2006, the Company’s mortgage servicing asset was $811,000 and the related loan balances serviced by the Company for others totaled $98.2 million.


Overview

Oregon Pacific Bancorp ("Bancorp"), an Oregon corporation and financial bank holding company, is the holding company of Oregon Pacific Banking Co. (the "Bank") (collectively, the “Company”). The Company is headquartered in Florence, Oregon.

The Bank is an Oregon banking corporation organized under the Oregon Bank Act on December 17, 1979. The Bank is a full-service commercial bank that provides a broad range of depository and lending services to commercial enterprises, governmental entities and individuals. Full-service banking products are offered to the Bank’s customers from its four branches who live primarily in Lane, Douglas, and Coos counties and on the central Oregon coast. Additional financial services provided by the Bank include trust and asset management services and investment and brokerage services. The Bank is subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.

The Company has a two-tiered corporate structure. At the holding company level the affairs of Bancorp, the sole owner of the Bank, are overseen by a Board of Directors elected by the shareholders of the Company. The business of the Bank is overseen by the Bank’s Board of Directors selected by Bancorp’s Board. Currently the respective members of the Board of Directors of the Bank and of Bancorp are identical.

The Company reported net income of $461,000, or $.21 per basic share, for the three months ended March 31, 2006. This compares to Bank income of $485,000, or $.23 per basic share, for the same three month period in the prior year. 2005 income includes an interest payment for a 2004 principal recovery of a previously charged off loan and a repayment of certain Bank costs that increased net income per share by $.07.


Financial Condition

Total assets at March 31, 2006 were $160,213,000 compared to $150,441,000 at December 31, 2005, an increase of $9,772,000 (6.1%). The increase was due primarily to increased interest-bearing deposits in banks ($4.74 million) and new loans ($1.72 million) funded by increases in demand deposits ($5.73 million) and interest-bearing demand deposits ($1.56 million).

13

March 31, 2006 stockholders’ equity was $10,638,000, an increase of $375,000 from December 31, 2005. This change resulted from consolidated net income partially offset by cash dividends paid ($85,000).

The net loan portfolio at March 31, 2006 increased $1.8 million to $119.7 million compared to $117.9 million at December 31, 2005 and increased $9.1 million from March 31, 2005 when the portfolio was $110.6 million. See Note 3 of the financial statements for a breakdown of the type of loans.

Borrowings from the Federal Home Loan Bank at March 31, 2006 were $12.6 million compared to $11.4 million at December 31, 2005 and $12.8 million at March 31, 2005. The Bank borrowed $1.2 million during the first quarter of 2006 to match-fund a fixed rate loan. The new borrowings averaged 5.08% and the average rate on all borrowings is 4.23%. The Company also has an obligation to pay interest and, at maturity, principal on the “trust preferred securities” issued by Oregon Pacific Statutory Trust I and $322,000 from its January acquisition.

As a result of the acquisition of the local LPL Financial Services brokerage in January 2006, the Company recorded $460,000 of intangible assets. The Company had no intangible assets at December 31, 2005.


Results of Operations

Net interest income

Net interest income is the Bank’s primary source of revenue. Net interest income is the difference between interest income earned from loans and the investment portfolio, and interest expense paid on customer deposits and debt. Changes in net interest income result from changes in volume and changes in rate. Volume refers to the dollar level of interest earning assets and interest bearing liabilities. Rate refers to the underlying yields on assets and costs of liabilities.

Net interest income on a tax-equivalent basis was $2,050,000 for the quarter ended March 31, 2006 compared to $1,758,000 which excludes the one-time interest payment (discussed above) for the same period in 2005 (see Table below). The $292,000 increase was due to increases in both the volume and rates of loans partially offset by an increase in the cost of funds and a small increase in the volume of time certificates. The increase in interest income of $584,000 was primarily due to a $173,000 increase from the increase in average loans outstanding of $9,748,000 from the same period one year ago and a $408,000 increase in average rates earned resulting from the rising interest rate environment over the past few years. The effective rate on interest-bearing liabilities for the quarter was 2.69% compared to 1.77% for the same period in 2005 which reflect rising interest rates and a shift of depositors to more time certificates.

Average Balances and Average Rates Earned and Paid. The following table shows average balances and interest income or interest expense, with the resulting average yield or rates by category of average earning asset or interest-bearing liability:

14
 
   
Three Months Ended Mar 31, 2006
  
Three Months Ended Mar 31, 2005
  
Increase (Decrease)
  
       
Interest
  
Average
      
Interest
  
Average
              
   
Average
  
Income or
  
Yield or
  
Average
  
Income or
  
Yield or
  
Due to change in
  
Net
  
(dollars in thousands)
  
Balance
  
Expense
  
Rates
  
Balance
  
Expense
  
Rates
  
Volume
  
Rate
  
Change
  
Interest-earning assets:
                                      
Loans (2)(3)
  
$
121,100
  
$
2,558
    
8.45
%
$
111,352
  
$
1,977
    
7.10
%
$
173
  
$
408
  
$
581
  
Investment securities
                                                        
Taxable securities
    
5,631
   
48
   
3.41
%
  
8,716
   
89
   
4.08
%
  
(32
)
  
(9
)
  
(41
)
Nontaxable securities (1)
    
6,785
   
73
   
4.30
%
  
7,321
   
120
   
6.54
%
  
(9
)
  
(38
)
  
(47
)
Interest-earning balances duefrom banks
    
9,655
   
106
   
4.39
%
  
2,557
   
15
   
2.35
%
  
42
   
49
   
91
 
Total interest-earning assets
    
143,171
   
2,785
   
7.78
%
  
129,946
   
2,201
   
6.77
%
  
174
   
410
   
584
 
                                                         
Cash and due from banks
    
4,774
               
4,215
                               
Premises and equipment, net
    
5,239
               
5,173
                               
Other real estate
    
0
               
0
                               
Loan loss allowance
    
(1,872
)
              
(1,720
)
                              
Other assets
    
4,476
               
3,371
                               
                                                         
Total assets
  
$
155,788
              
$
140,985
                                
                                                         
Interest-bearing liabilities:
                                                        
Interest-bearing checking and savings accounts
  
$
59,102
  
$
248
    
1.68
%
$
60,716
  
$
138
    
0.91
%
$
(4
)
$
114
  
$
110
  
Time deposit and IRA accounts
    
33,324
   
280
   
3.36
%
  
23,173
   
133
   
2.30
%
  
58
   
89
   
147
 
Borrowed funds
    
16,706
   
207
   
4.96
%
  
16,132
   
172
   
4.26
%
  
6
   
29
   
35
 
Total interest-bearing liabilities
    
109,132
   
735
   
2.69
%
  
100,021
   
443
   
1.77
%
  
60
   
232
   
292
 
Noninterest-bearing deposits
    
32,774
               
29,452
                               
Other liabilities
    
3,645
               
2,510
                               
Total liabilities
    
145,551
               
131,983
                               
Shareholders’ equity
    
10,237
               
9,002
                               
                                                         
Total liabilities and share- holders’ equity
  
$
155,788
              
$
140,985
                                
                                                         
Net interest income
        
$
2,050
              
$
1,758
        
$
114
  
$
178
  
$
292
  
                                                         
Net interest spread
                
5.09
%
              
5.00
%
                  
                                                         
Net interest expense to average earning assets
                
2.05
%
              
1.36
%
                  
                                                         
Net interest margin
                
5.73
%
              
5.41
%
                  
____________
(1)
Tax-exempt income has been adjusted to a tax-equivalent basis at 34%.
(2)
Nonaccrual loans are included in the average balance.
(3)
2005 excludes one-time interest repayment of $377,000 for loan charged off in 1998 and recovered in 2004.
 
15
 
Provision for Loan Losses

A provision of $26,000 was recorded for the three months ended March 31, 2006 compared to $170,000 in the same period in 2005. The allowance for loan losses at March 31, 2006 was 1.5% of gross loans, the same as December 31, 2005. Management is satisfied that the reserve is adequate for probable loan losses in the loan portfolio at March 31, 2006. Management’s assessment of the adequacy of the allowance for loan loss is based on a number of factors including current delinquent and non-performing loans, past loan loss experience, evaluation of customers’ financial strength, and economic trends impacting areas and customers served by the Bank. The allowance is based on estimates, and actual losses may vary from those currently estimated.

Noninterest Income

Noninterest income decreased $5,000 or 0.7% for the three months ended March 31, 2006 as compared to the same period in 2005.
 
   
Three months ended
          
   
March 31,
          
   
2006
  
2005
  
$ Change
  
% Change
  
                   
Service charges and fees
  
$
250,393
  
$
232,134
  
$
18,259
    
7.9
%
Trust fee income
    
159,043
   
145,804
 
$
13,239
    
9.1
%
Mortgage loan sales and servicing fees, net
    
125,924
   
161,949
 
$
(36,025
)
  
-22.2
%
Investment sales commissions
    
91,288
   
27,893
 
$
63,395
    
227.3
%
Other income
    
34,046
   
97,758
 
$
(63,712
)
  
-65.2
%
   
$
660,694
  
$
665,538
  
$
(4,844
)
  
-0.7
%

The decrease was the result of the a decrease of “other income” ($64,000) due to a recovery of Bank expenses as mentioned above in 2005 and decreased mortgage loan sales ($36,000) partially offset by an increase in Investment Department commissions subsequent to the acquisition of the brokerage in January as discussed in Note 6 ($69,000).

Noninterest Expense

Noninterest expense increased $176,000 or 9.8% for the three months ended March 31, 2006 from the same period one year ago.

   
Three months ended
          
   
March 31,
          
   
2006
  
2005
  
$ Change
  
% Change
  
                   
Salaries and benefits
  
$
1,231,546
  
$
1,115,417
  
$
116,129
    
10.4
%
Occupancy expense
    
228,280
   
208,914
 
$
19,366
    
9.3
%
Outside services
    
168,154
   
173,871
 
$
(5,717
)
  
-3.3
%
Securities and trust department expenses
    
57,349
   
37,969
 
$
19,380
    
51.0
%
Other expenses
    
285,579
   
259,002
 
$
26,577
    
10.3
%
   
$
1,970,908
  
$
1,795,173
  
$
175,735
    
9.8
%

Most of the increase is attributable to eight new full-time equivalent staff, three of whom were a part of the brokerage acquisition ($116,000) and resulting additional expenses for the Investment Department ($19,000).

Provision for Income Taxes

The provision for income taxes at both March 31, 2006 and 2005 remained consistent with expected statutory rates adjusted for anticipated permanent differences arising primarily from nontaxable income earned on municipal security investments and timing differences associated with the tax treatment of bad debt.

16

Liquidity and Capital Resources

Liquidity management involves the ability to meet cash flow requirements. The Bank’s major sources of liquidity are customer deposits, calls and maturities of investment securities, the use of borrowing arrangements through the Federal Home Loan Bank of Seattle, and net cash provided by operating activities. Sales of the Bank’s investment portfolio are another source of funds, if needed. The investment portfolio is of high quality and is highly marketable although a gain or loss would be realized if the market value of securities sold were not equal to their adjusted book value at the date of sale.
 
The Bank maintains liquidity levels adequate to fund loan commitments, investment opportunities, deposit withdrawals and other financial commitments. The Bank's liquidity position increased significantly during the quarter ended March 31, 2006 as deposit growth exceeded the loan growth volume. As a result, during the quarter, the loan-to-deposit ratio loosened and fell slightly to 94% at March 31, 2006. Liquidity that is deemed to be temporary excess cash may be invested as interest-earning deposits with the FHLB or time certificates at other financial institutions increased during the quarter. As of March 31, 2006, the Bank had $10.7 million in such funds compared to $5.9 million at December 31, 2005. Management believes its liquidity planning will adequately provide the funds necessary to enable the Bank to fund loan commitments and meet customer withdrawals of deposits in the normal course of business.
 
For purposes of determining a bank’s deposit insurance assessment, the FDIC has issued regulations that define a “well capitalized” bank as one with a leverage ratio of 5% or more and a total risk-based ratio of 10% or more. At March 31, 2006, the Bank’s leverage and total risk-based ratios were 9.30% and 12.34% respectively, which exceed the well-capitalized threshold. 
 
 
Item 3.     Quantitive and Qualitive Disclosures about Market Risk
 
Market risk is the risk of loss from adverse changes in market prices and rates. The Bank’s market risk arises principally from interest rate risk in its lending, deposit taking, and borrowing activities. A sudden and substantial increase in interest rates could adversely impact the Company’s earnings, to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis.

Management actively monitors and manages its interest rate risk exposure. Although the Bank manages other risks, such as credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be a significant market risk which could have the largest material effect on the Bank’s financial condition and results of operations.

Through the Bank’s Asset/Liability Management Committee (“ALCO”), which is comprised of senior management, the Bank monitors the level and general mix of earning assets and interest-bearing liabilities, with special attention to those assets and liabilities which are rate-sensitive. The primary objective of ALCO is managing the Company’s assets and liabilities in a manner that balances profitability, interest rate risk, and various other risks including liquidity.  ALCO operates under policies and within risk limits prescribed by, reviewed and approved by the Board of Directors. The Bank’s strategy has included the funding of certain fixed rate loans with medium term borrowed funds in order to mitigate a margin squeeze should interest rates rise. There have been no significant changes in the Company’s market risk exposure since December 31, 2005.


Item 4.     Controls and Procedures

(a)
The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures as of March 31, 2006. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer each concludes that as of March 31, 2006, the Company maintained effective disclosure controls and procedures in all material respects, including those to ensure that information required to be disclosed in reports filed or submitted with the SEC is recorded, processed, and reported within the time periods specified by the SEC, and is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow for timely decision regarding required disclosure.
 
17

(b)
Changes in Internal Controls: In the quarter ended March 31, 2006, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls.

Disclosure Controls and Internal Controls. Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (SEC) rules and forms. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, as appropriate to allow timely decisions regarding required disclosure. Internal Controls are procedures which are designed with the objective of providing reasonable assurance that (1) transactions are properly authorized; (2) assets are safeguarded against unauthorized or improper use; and (3) transactions are properly recorded and reported, all to permit the preparation of financial statement in conformity with accounting principles generally accepted in the United States of America.
 
Limitations on the Effectiveness of Controls. The Company’s management does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.


PART II.
OTHER INFORMATION

Item 1.
Legal proceedings.

As of the date of filing this Form 10-Q neither Bancorp nor the Bank was a party to any material legal proceedings. Further, management is not aware of any threatened or pending lawsuits or other proceedings against the Company which, if determined adversely, would have a material effect on the business or its financial position. Bancorp or the Bank may from time to time become a party to litigation in the ordinary course of business, such as debt collection litigation or through an appearance as a creditor in a bankruptcy case.

Item 1A.
Risk factors.

There has not been any material change in the risk factors disclosure from that contained in the Company’s 2005 10-K for the fiscal year ended December 31, 2005.
 
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Item 2.
Unregistered sales of equity securities and use of proceeds.

In August 2005 the Board of Directors approved the Bancorp Amended Dividend Reinvestment Plan that permits the direct purchase of additional shares of Bancorp Common Stock for cash in addition to the automatic reinvestment of cash dividends. During 2005, 1,081 shares were sold at an average price of $10.18 per share as part of the new Plan. No such purchases were made in the first quarter of 2006.

Item 3.
Defaults upon senior securities.

None.

Item 4.
Submission of matters to a vote of security holders.

None.

Item 5.
Other information.

None.

Item 6.
Exhibits and reports on Form 8-K.

(a)
Exhibits.

The following documents are filed as part of this Form 10-Q as required by Item 601 of Regulation S-K:

 
3.1
Articles of Incorporation of Oregon Pacific Bancorp (incorporated herein by reference to Exhibit 3(i) to Oregon Pacific Bancorp’s Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 31, 2003).

 
3.2
Bylaws of Oregon Pacific Bancorp (incorporated herein by reference to Exhibit 3(i) to Oregon Pacific Bancorp’s Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 31, 2003).

 
10.1
2003 Stock Incentive Plan (incorporated by reference to Exhibit 1 to Oregon Pacific Bancorp’s Form DEF 14A filed with the Securities and Exchange Commission on March 25, 2003).

 
10.2
Oregon Pacific Banking Co. Deferred Compensation and Incentive Plan (incorporated herein by reference to Exhibit 10.2 to Oregon Pacific Bancorp’s Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission on March 30, 2004).

 
Certification of Chief Executive Officer pursuant to rule 13a-14(a) or Rule 15d-14(a) and Section 302(a) of the Sarbanes-Oxley Act of 2002.**

 
Certification of Chief Financial Officer pursuant to rule 13a-14(a) or Rule 15d-14(a) and Section 302(a) of the Sarbanes-Oxley Act of 2002.**
 
 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **
 
_________________ 
** Filed herewith.


(b)
On February 10, 2006 a Form 8-K was filed under items 2.02 and 9.01 announcing 2005 fourth quarter and year earnings.
 
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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto, duly authorized, in the City of Florence, State of Oregon, on May 12, 2006.

 
OREGON PACIFIC BANCORP
     
     
 
By:
/s/ Thomas K. Grove
     
   
Thomas K. Grove
   
President, Chief Executive Officer And Director (Chief Executive Officer)
     
     
 
By:
/s/ Joanne Forsberg
     
   
Joanne Forsberg
   
Chief Financial Officer and Secretary (Principal Financial Officer)
 
 
 
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