10-Q 1 bhb10qsep2011.htm BHB 10-Q September 2011

 

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

FORM 10-Q

(Mark One)
  X      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011

OR

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

Commission File Number: 001-13349

BAR HARBOR BANKSHARES
(Exact name of registrant as specified in its charter)

Maine

01-0393663

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification Number)

PO Box 400

82 Main Street, Bar Harbor, ME

04609-0400

(Address of principal executive offices)

(Zip Code)

(207) 288-3314
(Registrant's telephone number, including area code)

Inapplicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES   x    NO ___

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). YES   x    NO ___

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and smaller reporting company" in Rule 12b-2 of the Exchange Act: Large accelerated filer ___ Accelerated filer   x    Non-accelerated filer (do not check if a smaller reporting company) ___  Smaller reporting company ___

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): YES: ___ NO:   x  

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date:

Class of Common Stock

Number of Shares Outstanding – November 1, 2011

$2.00 Par Value

3,885,607

 

TABLE OF CONTENTS

Page No.

PART I

FINANCIAL INFORMATION

Item 1.

Interim Financial Statements (unaudited):

Consolidated Balance Sheets at September 30, 2011, and December 31, 2010

3

Consolidated Statements of Income for the three and nine months ended September 30, 2011 and 2010

4

Consolidated Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2011 and 2010

5

Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010

6

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2011 and 2010

7

Notes to Consolidated Interim Financial Statements

8-31

Item 2.

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

31-59

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

59-62

Item 4.

Controls and Procedures

62

PART II

OTHER INFORMATION

Item 1.

Legal Proceedings

62

Item 1A.

Risk Factors

62

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

63

Item 3.

Defaults Upon Senior Securities

63

Item 4.

(Removed and Reserved)

63

Item 5.

Other Information

63

Item 6.

Exhibits

63

Signatures

63

Exhibit Index

64

Exhibits

 

PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2011 AND DECEMBER 31, 2010
(Dollars in thousands, except per share data)
(unaudited)

September 30,
2011

December 31,
2010

Assets
     Cash and cash equivalents     $       8,546     $     12,815
     Securities available for sale, at fair value          388,415          357,882
     Federal Home Loan Bank stock            16,068            16,068
     Loans          714,218          700,670
     Allowance for loan losses             (8,153)             (8,500)
     Loans, net of allowance for loan losses          706,065          692,170
     Premises and equipment, net            14,830            13,505
     Goodwill              3,158              3,158
     Bank owned life insurance              7,309              7,112
     Other assets            11,641            15,223
TOTAL ASSETS     $1,156,032     $1,117,933
Liabilities
     Deposits:
          Demand and other non-interest bearing deposits     $     72,269     $     60,350
          NOW accounts            95,165            82,656
          Savings and money market deposits          219,681          211,748
          Time deposits          374,979          353,574
               Total deposits          762,094          708,328
     Short-term borrowings          126,492          119,880
     Long-term advances from Federal Home Loan Bank          139,470          175,134
     Junior subordinated debentures              5,000              5,000
     Other liabilities              5,803              5,983
TOTAL LIABILITIES       1,038,859       1,014,325
Shareholders' equity
     Capital stock, par value $2.00; authorized 10,000,000 shares;
          issued 4,525,635 shares at September 30, 2011 and December 31, 2010              9,051              9,051
     Surplus            26,488            26,165
     Retained earnings            84,900            80,379
     Accumulated other comprehensive income:
          Prior service cost and unamortized net actuarial losses on employee
               benefit plans, net of tax of ($28) and ($29), at September 30, 2011 and
               December 31, 2010, respectively
                (54)                 (56)
          Net unrealized apprciation on securities available for sale, net of tax
               of $3,713 and $445, at September 30, 2011 and December 31, 2010,
               respectively
             7,207                 865
          Portion of OTTI attributable to non-credit losses, net of tax of ($90) and ($270),
               at September 30, 2011and December 31, 2010, respectively
               (174)                (525)
          Total accumulated other comprehensive (loss) income              6,979                 284
          Less: cost of 636,451 and 702,690 shares of treasury stock at September 30, 2011
               and December 31, 2010, respectively
          (10,245)           (12,271)
TOTAL SHAREHOLDERS' EQUITY          117,173          103,608
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY     $1,156,032     $1,117,933

The accompanying notes are an integral part of these unaudited consolidated interim financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
(Dollars in thousands, except per share data)
(unaudited)

Three Months Ended
September 30,

Nine Months Ended
September 30,

2011

2010

2011

2010

Interest and dividend income:
     Interest and fees on loans        $8,783        $ 8,781        $26,087        $26,158
     Interest on securities          3,926           4,098          12,192          12,280
     Dividend on FHLB stock               11               ---                 35                ---
Total interest and dividend income        12,720         12,879          38,314          38,438
Interest expense:
     Deposits          2,202           2,499            6,606            7,450
     Short-term borrowings               55                72               199               209
         1,759           2,362            5,847            6,980
Total interest expense          4,016           4,933          12,652          14,639
Net interest income          8,704           7,946          25,662          23,799
     Provision for loan losses             750              450            1,850            1,500
Net interest income after provision for loan losses          7,954           7,496          23,812          22,299
Non-interest income:
     Trust and other financial services             746              800            2,261            2,136
     Service charges on deposit accounts             372              365               997            1,051
     Mortgage banking activities                 5                  4                 43                 73
     Credit and debit card service charges and fees             361              318               940               844
     Net securities gains             993              618            2,313            1,975
     Total other-than-temporary impairment ("OTTI") losses            (743)             (211)           (1,897)              (751)
     Non-credit portion of OTTI losses (before taxes) (1)             171                ---               171                 ---
     Net OTTI losses recognized in earnings            (572)             (211)           (1,726)              (751)
     Other operating income             159              171               453               442
Total non-interest income          2,064           2,065            5,281            5,770
Non-interest expense:
     Salaries and employee benefits          3,267           3,001           9,334             8,863
     Occupancy expense             350              317           1,153             1,026
     Furniture and equipment expense             416              397           1,261             1,168
     Credit and debit card expenses               87                74              232                221
     FDIC insurance assessments             242              267              870                797
     Other operating expense          1,322           1,462           4,131             4,040
Total non-interest expense          5,684           5,518         16,981           16,115
Income before income taxes          4,334           4,043         12,112          11,954
Income taxes          1,324           1,173           3,460            3,321
Net income          3,010           2,870           8,652            8,633
Preferred stock dividends and accretion of discount              ---               ---                ---              653
Net income available to common shareholders        $3,010        $ 2,870        $ 8,652        $ 7,980
Per Common Share Data:
     Basic earnings per share        $  0.78        $  0.76        $   2.25        $   2.12
     Diluted earnings per share        $  0.77        $  0.75        $   2.23        $   2.09

(1) Included in other comprehensive loss, net of tax

The accompanying notes are an integral part of these unaudited consolidated interim financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
(Dollars in thousands, except per share data)
(unaudited)

Capital
Stock

Preferred
Stock

Surplus

Retained
Earnings

Accumulated
Other
Comprehensive
income (loss)

Treasury
Stock

Total
Shareholders'
Equity

Balance December 31, 2009     $8,887    $18,358   $24,360         $75,001      $      573 $(13,665)      $113,514
Net income           ---            ---           ---             8,633                --- ---            8,633
Total other comprehensive income           ---           ---           ---                 ---           3,912 ---            3,912
Dividend declared:
     Common stock ($0.78 per share)           ---           ---           ---           (2,945)                ---

---

         (2,945)
     Preferred stock           ---           ---           ---              (138)                ---

---

            (138)
Issuance of common stock
     (82,021 shares)
         164           ---       1,777                ---                ---

---

           1,941
Purchase of preferred stock
     (18,751 shares)
          ---    (18,873)         (279)                ---                ---

---

       (19,152)
Stock options exercised
     (31,477 shares), including
     related tax effects
          ---           ---              4                (297)                --- 841              548
Recognition of stock based
     compensation expense
          ---           ---            93                ---                ---

---

               93
Accretion of discount           ---          515           ---               (515)                ---

---

---
Balance September 30, 2010     $9,051    $     ---   $25,955         $79,739      $   4,485 $(12,824)      $106,406

Capital
Stock

Surplus

Retained
Earnings

Accumulated
Other
Comprehensive
income (loss)

Treasury
Stock

Total
Shareholders'
Equity

Balance December 31, 2010     $9,051    $26,165   $80,379         $     284      $(12,271)      $103,608
Net income           ---           ---       8,652                ---                ---            8,652
Total other comprehensive income           ---           ---           ---             6,695                ---            6,695
Dividend declared:
Common stock
     ($0.815 per share)
          ---           ---      (3,142)                ---                ---          (3,142)
Purchase of treasury stock 
     (10,794 shares)
          ---           ---           ---                ---             (304)             (304)
Stock options exercised
     (77,033 shares), including
     related tax effects
          ---           246        (989)                ---           2,330            1,587
Recognition of stock based
     compensation expense
          ---             77           ---                ---                ---                 77
Balance September 30, 2011     $9,051    $26,488   $84,900         $  6,979      $(10,245)      $117,173

The accompanying notes are an integral part of these unaudited consolidated interim financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
(Dollars in thousands)
(unaudited)

2011

2010

Cash flows from operating activities:
     Net income     $    8,652     $    8,633
     Adjustments to reconcile net income to net cash provided by operating activities:
     Depreciation and amortization of premises and equipment              891              760
     Provision for loan losses           1,850           1,500
     Net securities gains          (2,313)         (1,975)
     Other-than-temporary impairment           1,726              751
     Net amortization of bond premiums and discounts           1,039              733
     Recognition of stock based expense                77                93
     Proceeds from sale of mortgages               ---              846
     Origination of mortgage loans held for sale               ---             (829)
     Net gain on sale of mortgage loans held for sale               ---               (17)
     Net change in other assets              785             (675)
     Net change in other liabilities             (183)                  5
     Net cash provided by operating activities         12,524           9,825
Cash flows from investing activities:
     Purchases of securities available for sale      (113,677)      (131,940)
     Proceeds from maturities, calls and principal paydowns of mortgage-backed securities         52,377         86,560
     Proceeds from sales of securities available for sale         40,457         29,959
     Net loans made to customers        (16,705)        (12,249)
     Proceeds from sale of other real estate owned              116              854
     Capital expenditures         (2,216)          (2,299)
     Net cash used in investing activities       (39,648)        (29,115)
Cash flows from financing activities:
     Net increase in deposits        53,766          57,700
     Net (decrease) increase in securities sold under repurchase agreements and
          fed funds purchased
           (750)          17,376
     Paydown of Federal Reserve borrowings               ---         (20,000)
     Proceeds from Federal Home Loan Bank advances        26,000          19,000
     Repayments of Federal Home Loan Bank advances       (54,302)         (36,018)
     Proceeds from issuance of common stock               ---            1,941
     Purchases of preferred stock and warrants               ---         (19,152)
     Purchases of treasury stock            (304)                ---
     Proceeds from stock option exercises, including excess tax benefits          1,587               548
     Payments of dividends         (3,142)           (3,083)
     Net cash provided by financing activities        22,855          18,312
Net decrease in cash and cash equivalents         (4,269)             (978)
Cash and cash equivalents at beginning of period        12,815           9,832
Cash and cash equivalents at end of period     $   8,546     $    8,854
Supplemental disclosures of cash flow information:
     Cash paid during the period for:
          Interest     $ 12,923     $ 14,782
          Income taxes          3,077          3,940
Schedule of noncash investing activities:
     Transfers from loans to other real estate owned     $      960     $       92

The accompanying notes are an integral part of these unaudited consolidated interim financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
(Dollars in thousands)
(unaudited)

Three Months Ended
September 30,

2011

2010

Net income      $  3,010      $  2,870
Other comprehensive income:
     Net unrealized appreciation on securities available for sale,
          net of tax of $2,096 and $741, respectively
         4,068          1,438
     Less reclassification adjustment for net gains related to securities
          available for sale included in net income,
          net of tax of $338 and $210, respectively
          (657)           (408)
     Add other-than-temporary impairment adjustment,
          net of tax of $252 and $72, respectively
           490            140
Less non-credit portion of other-than-temporary impairment losses,
     net of tax of $58 and $0, respectively
          (113)              ---
     Net unrealized depreciation and other amounts for interest rate derivatives,
          net of tax of $0 and $58, respectively
             ---          (112)
     Amortization of actuarial gain for supplemental executive retirement plan,
          net of related tax of $0 and $1, respectively
                1               1
Total other comprehensive income          3,789         1,059
Total comprehensive income      $  6,799      $ 3,929

Nine Months Ended
September 30,

2011

2010

Net income      $  8,652      $  8,633
Other comprehensive income:
     Net unrealized appreciation on securities available for sale,
          net of tax of $3,648 and $2,621, respectively
         7,082          5,088
Less reclassification adjustment for net gains related to securities
     available for sale included in net income,
     net of tax of $787 and $672, respectively
        (1,528)         (1,304)
     Add other-than-temporary impairment adjustment,
          net of tax of $645 and $256, respectively
         1,252              496
     Less non-credit portion of other-than-temporary impairment losses,
          net of tax of $58 and $0, respectively
           (113)               ---
      Net unrealized depreciation and other amounts for interest rate derivatives,
           net of tax of $0 and $192, respectively
             ---            (372)
      Amortization of actuarial gain for supplemental executive retirement plan,
          net of related tax of $1 and $2, respectively
                2                 4
                Total other comprehensive income          6,695          3,912
Total comprehensive income      $15,347      $12,545

 

The accompanying notes are an integral part of these unaudited consolidated interim financial statements

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Dollars in thousands, except share data)
(unaudited)

Note 1: Basis of Presentation

The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All inter-company transactions have been eliminated in consolidation. Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation. The net income reported for the three and nine months ended September 30, 2011, is not necessarily indicative of the results that may be expected for the year ending December 31, 2011, or any other interim periods.

The consolidated balance sheet at December 31, 2010, has been derived from audited consolidated financial statements at that date. The accompanying unaudited interim consolidated financial statements have been prepared in accordance with United States ("U.S.") generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X (17 CFR Part 210). Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, and notes thereto.

Note 2: Management’s Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting 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 loan losses, other-than-temporary impairments on securities, income tax estimates, and the valuation of intangible assets.

Allowance for Loan Losses: The allowance for loan losses (the "allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance is available to absorb losses on loans and is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the loan portfolio, given past and present conditions. The allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged-off, and is decreased by loans charged-off as uncollectible.

Arriving at an appropriate level of allowance involves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated regularly based on review of loans, with particular emphasis on non-performing or other loans that management believes warrant special consideration. The ongoing evaluation process includes a formal analysis, which considers among other factors: the character and size of the loan portfolio, business and economic conditions, real estate market conditions, collateral values, changes in product offerings or loan terms, changes in underwriting and/or collection policies, loan growth, previous charge-off experience, delinquency trends, non-performing loan trends, the performance of individual loans in relation to contract terms, and estimated fair values of collateral.

The allowance consists of allowances established for specific loans including impaired loans; allowances for pools of loans based on historical charge-offs by loan types; and supplemental allowances that adjust historical loss experience to reflect current economic conditions, industry specific risks, and other observable data.

While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.

Other-Than-Temporary Impairments on Investment Securities: One of the significant estimates relating to securities is the evaluation of other-than-temporary impairment. If a decline in the fair value of a security is judged to be other-than-temporary, and management does not intend to sell the security and believes it is more-likely-than-not the Company will not be required to sell the security prior to recovery of cost or amortized cost, the portion of the total impairment attributable to the credit loss is recognized in earnings, and the remaining difference between the security’s amortized cost basis and its fair value is included in other comprehensive income.

For impaired available for sale debt securities that management intends to sell, or where management believes it is more-likely-than-not that the Company will be required to sell, an other-than-temporary impairment charge is recognized in earnings equal to the difference between fair value and cost or amortized cost basis of the security. The fair value of the other-than-temporarily impaired security becomes its new cost basis.

The evaluation of securities for impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of securities should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses. The Company has a security monitoring process that identifies securities that, due to certain characteristics, as described below, are subjected to an enhanced analysis on a quarterly basis.

Securities that are in an unrealized loss position, are reviewed at least quarterly to determine if an other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. The primary factors considered in evaluating whether a decline in value of securities is other-than-temporary include: (a) the cause of the impairment; (b) the financial condition, credit rating and future prospects of the issuer; (c) whether the debtor is current on contractually obligated interest and principal payments; (d) the volatility of the securities’ fair value; (e) performance indicators of the underlying assets in the security including default rates, delinquency rates, percentage of non-performing assets, loan to collateral value ratios, conditional payment rates, third party guarantees, current levels of subordination, vintage, and geographic concentration and; (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of the receipt of all principal and interest due.

In addition, for securitized financial assets with contractual cash flows, such as private label mortgage-backed securities, the Company periodically updates its best estimate of cash flows over the life of the security. The Company’s best estimate of cash flows is based upon assumptions consistent with the current economic environment, similar to those the Company believes market participants would use. If the fair value of a securitized financial asset is less than its cost or amortized cost and there has been an adverse change in timing or amount of anticipated future cash flows since the last revised estimate to the extent that the Company does not expect to receive the entire amount of future contractual principal and interest, an other-than-temporary impairment charge is recognized in earnings representing the estimated credit loss if management does not intend to sell the security and believes it is more-likely-than-not the Company will not be required to sell the security prior to recovery of cost or amortized cost. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third party sources along with certain assumptions and judgments regarding the future performance of the underlying collateral. In addition, projections of expected future cash flows may change based upon new information regarding the performance of the underlying collateral.

Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information indicates that it is more-likely-than-not that deferred tax assets will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. As of September 30, 2011 and December 31, 2010, there was no valuation allowance for deferred tax assets. Deferred tax assets are included in other assets on the consolidated balance sheet.

Goodwill and Identifiable Intangible Assets: In connection with acquisitions, the Company generally records as assets on its consolidated financial statements both goodwill and identifiable intangible assets, such as core deposit intangibles.

The Company evaluates whether the carrying value of its goodwill has become impaired, in which case the value is reduced through a charge to its earnings. Goodwill is evaluated for impairment at least annually, or upon a triggering event using certain fair value techniques. The Company’s annual measurement date is December 31. Goodwill impairment testing is performed at the segment (or "reporting unit") level. Goodwill is assigned to reporting units at the date the goodwill is initially recorded. Once goodwill has been assigned to the reporting units, it no longer retains its association with a particular acquisition, and all of the activities within a reporting unit, whether acquired or organically grown, are available to support the value of the goodwill.

The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each unit’s fair value to its carrying value including goodwill. If the fair value of a reporting unit exceeds its carrying value, applicable goodwill is considered not to be impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is to measure the amount of impairment. At September 30, 2011, there was no indication of impairment that led us to believe we needed to perform a two-step test.

At September 30, 2011 and December 31, 2010, the Company did not have any identifiable intangible assets on its consolidated balance sheet.

Any changes in the estimates used by the Company to determine the carrying value of its goodwill, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company’s consolidated results of operations.

Note 3: Earnings Per Share

Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company, such as the Company’s dilutive stock options.

The following is a reconciliation of basic and diluted earnings per share for the three and nine months ended September 30, 2011 and 2010:

Three Months Ended
September 30,

Nine Months Ended
September 30,

2011

2010

2011

2010

Net income     $      3,010     $      2,870    $      8,652    $      8,633
Preferred stock dividends and accretion of discount                 ---                 --- ---               653
Net income available to common shareholders     $      3,010     $      2,870    $      8,652    $      7,980
Weighted average common shares outstanding
     Basic      3,876,647      3,783,036     3,853,030     3,771,903
     Effect of dilutive employee stock options           12,610           46,313          21,660          49,725
     Diluted      3,889,257      3,829,349     3,874,690     3,821,628
Anti-dilutive options excluded from
     earnings per share calculation
         129,030          167,642        127,030        154,324
Per Common Share Data:
     Basic earnings per share     $        0.78     $        0.76    $        2.25    $        2.12
     Diluted earnings per share     $        0.77     $        0.75    $        2.23    $        2.09

Note 4: Securities Available For Sale

The following tables summarize the securities available for sale portfolio as of September 30, 2011 and December 31, 2010:

September 30, 2011

Available for Sale:

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair Value

Obligations of US Government sponsored enterprises      $    1,000      $       27      $     ---      $   1,027
Mortgage-backed securities:
     US Government-sponsored enterprises        232,369        10,209           220        242,358
     US Government agency          70,890          2,294             82          73,102
     Private label          15,175             589        1,532          14,232
Obligations of states and political subdivisions thereof          58,325          1,963        2,592          57,696
     Total      $377,759      $15,082      $4,426      $388,415

 

December 31, 2010

Available for Sale:

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair Value

Obligations of US Government sponsored enterprises      $    1,000      $      34      $     ---      $    1,034
Mortgage-backed securities:
     US Government-sponsored enterprises        217,319         7,812           578        224,553
     US Government agency          56,083         1,216           356          56,943
     Private label          22,720            311        2,201          20,830
Obligations of states and political subdivisions thereof          60,245            327        6,050          54,522
     Total      $357,367      $ 9,700      $9,185      $357,882

Securities Maturity Distribution: The following table summarizes the maturity distribution of the amortized cost and estimated fair value of securities available for sale as of September 30, 2011. Actual maturities may differ from the final maturities noted below because issuers may have the right to prepay or call certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers have the right to prepay.

Securities Available for Sale

Amortized
Cost

Estimated
Fair Value

Due after one year through five years         $    1,421         $    1,461
Due after five years through ten years             18,375             18,995
Due after ten years           357,963           367,959
        $377,759         $388,415

Securities Impairment: As a part of the Company’s ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired ("OTTI").

For the three months ended September 30, 2011, the Company recorded total OTTI losses of $743 (before taxes), related to nine, available for sale, 1-4 family, private-label mortgage-backed securities ("MBS"), all but two of which the Company had previously determined were other-than-temporarily impaired. Of the $743 in total OTTI losses, $572 (before taxes) represented estimated credit losses on the collateral underlying the securities, while $171 (before taxes) represented unrealized losses for the same securities resulting from factors other than credit. The $572 in estimated credit losses were recorded in earnings (before taxes), with the $171 non-credit portion of the unrealized losses recorded within accumulated other comprehensive income. The additional credit losses principally reflect an increase in the future loss severity estimates resulting from depressed real estate markets, a weak economy and extended foreclosure timelines that affect the expected performance of the mortgage loans underlying these securities.

For the nine months ended September 30, 2011, the Company recorded total OTTI losses of $1,897 (before taxes), related to fourteen, available for sale, 1-4 family, private-label MBS", all but three of which the Company had previously determined was other-than-temporarily impaired. Of the $1,897 in total OTTI losses, $1,726 (before taxes) represented estimated credit losses on the collateral underlying the securities, while $171 (before taxes) represented unrealized losses for the same securities resulting from factors other than credit. The $1,726 in estimated credit losses were recorded in earnings (before taxes), with the $171 non-credit portion of the unrealized losses recorded within accumulated other comprehensive income. The additional credit losses principally reflected an increase in the future loss severity estimates resulting from depressed real estate markets, a weak economy and extended foreclosure timelines that affect the expected performance of the mortgage loans underlying these securities.

The OTTI losses recognized in earnings during the three and nine months ended September 30, 2011 represented management’s best estimate of credit losses inherent in the securities based on discounted, bond-specific future cash flow projections using assumptions about cash flows associated with the pools of mortgage loans underlying each security. In estimating those cash flows the Company takes a variety of factors into consideration including, but not limited to, loan level credit characteristics, current delinquency and non-performing loan rates, current levels of subordination and credit support, recent default rates and future constant default rate estimates, original and current loan to collateral value ratios, recent collateral loss severities and future collateral loss severity estimates, recent and historical conditional prepayment rates and future conditional prepayment rate assumptions, and other estimates of future collateral performance.

 Despite some rising levels of delinquencies, defaults and losses in the underlying residential mortgage loan collateral, given credit enhancements resulting from the structures of the individual securities, the Company currently expects that it will recover the amortized cost basis of its private label mortgage-backed securities and has therefore concluded that such securities were not other-than-temporarily impaired as of that date. Nevertheless, given recent market conditions, it is possible that adverse changes in repayment performance and fair value could occur in future periods that could impact the Company’s current best estimates.

The following table displays the beginning balance of OTTI related to historical credit losses on debt securities held by the Company at the beginning of the current reporting period, as well as changes in credit losses recognized in pre-tax earnings for the three and nine months ending September 30, 2011 and 2010.

2011

2010

Estimated credit losses as of June 30,          $4,527          $3,015
Additions for credit losses for securities on which
     OTTI has been previously recognized
               503               211
Additions for credit losses for securities on which
     OTTI has not been previously recognized
                 69                 ---
Estimated credit losses as of September 30,           $5,099          $3,226

2011

2010

Estimated credit losses as of prior year-end           $3,373         $2,475
Additions for credit losses for securities on which
     OTTI has been previously recognized
            1,313              751
Additions for credit losses for securities on which
     OTTI has not been previously recognized
               413               ---
Estimated credit losses as of September 30,           $5,099          $3,226

Upon initial impairment of a security, total OTTI losses represent the excess of the amortized cost over the fair value. For subsequent impairments of the same security, total OTTI losses represent additional credit losses and or declines in fair value subsequent to the previously recorded OTTI losses, if applicable. Unrealized OTTI losses recognized in accumulated other comprehensive income ("OCI") represent the non-credit component of OTTI losses on debt securities. Net impairment losses recognized in earnings represent the credit component of OTTI losses on debt securities.

As of September 30, 2011, the Company held sixteen private-label MBS (debt securities) with a total amortized cost (i.e. carrying value) of $5,799 where OTTI losses have been historically recognized in pre-tax earnings (dating back to the fourth quarter of 2008). For nine of these securities, the Company recognized credit losses in excess of the unrealized losses in accumulated OCI, creating an unrealized gain of $369, net of tax, as included in accumulated OCI as of September 30, 2011. For the remaining seven securities, the total OTTI losses included in accumulated OCI amounted to $543, net of tax, as of September 30, 2011. As of September 30, 2011, the total net unrealized losses included in accumulated OCI for securities held where OTTI has been historically recognized in pre-tax earnings amounted to $174, net of tax, compared with $525 at December 31, 2010.

As of September 30, 2011, based on a review of each of the remaining securities in the securities portfolio, the Company concluded that it expects to recover its amortized cost basis for such securities. This conclusion was based on the issuers’ continued satisfaction of the securities obligations in accordance with their contractual terms and the expectation that they will continue to do so through the maturity of the security, the expectation that the Company will receive the entire amount of future contractual cash flows, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence. Accordingly, the Company concluded that the declines in the values of those securities were temporary and that any additional other-than-temporary impairment charges were not appropriate at September 30, 2011. As of that date, the Company did not intend to sell nor anticipated that it would more-likely-than-not be required to sell any of its impaired securities, that is, where fair value is less than the cost basis of the security.

The following table summarizes the fair value of securities with continuous unrealized losses for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer as of September 30, 2011 and December 31, 2010. All securities referenced are debt securities. At September 30, 2011, and December 31, 2010, the Company did not hold any common stock or other equity securities in its securities portfolio.

September 30, 2011

Less than 12 months

12 months or longer

Total

Estimated
Fair
Value

Number of
Investments

Unrealized
Losses

Estimated
Fair
Value

Number of
Investments

Unrealized
Losses

Estimated
Fair
Value

Number of
Investments

Unrealized
Losses

Description of Securities:
Mortgage-backed securities:
     US Government-sponsored
          enterprises
    $12,942               14        $    220      $       20               1        $     ---   $   12,962            15      $   220
     US Government agency       13,378               14                82               62               3               ---         13,440            17             82
     Private label         1,449                 6                67          7,692             26          1,465           9,141            32        1,532
Obligations of states and
     political subdivisions
     thereof
        6,245                 8               87        13,048             60          2,505         19,293            68        2,592
Total     $34,014               42        $   456      $20,822             90        $3,970    $  54,836          132      $4,426
December 31, 2010

Less than 12 months

12 months or longer

Total

Estimated
Fair
Value

Number of
Investments

Unrealized
Losses

Estimated
Fair
Value

Number of
Investments

Unrealized
Losses

Estimated
Fair
Value

Number of
Investments

Unrealized
Losses

Description of Securities:
Mortgage-backed securities:
     US Government-sponsored
          enterprises
     $34,940               37        $   578      $       20               1        $     ---   $   34,960            38      $   578
     US Government agency        27,966               25             353             270               9                 3        28,236            34           356
      Private label               51                 1                 1        13,361             38          2,200         13,412            39        2,201
Obligations of states and
     Political subdivisions
     thereof
      23,223               54          1,635        11,951             59          4,415         35,174          113        6,050
Total     $86,180             117        $2,567      $25,602           107        $6,618    $111,782          224      $9,185

For securities with unrealized losses, the following information was considered in determining that the impairments were not other-than-temporary:

  • Mortgage-backed securities issued by U.S. Government-sponsored enterprises: As of September 30, 2011, the total unrealized losses on these securities amounted to $220, compared with $578 at December 31, 2010. All of these securities were credit rated "AA" by the major credit rating agencies. Company management believes these securities have minimal credit risk, as these Government-sponsored enterprises play a vital role in the nation’s financial markets. Management’s analysis indicates that the unrealized losses at September 30, 2011 were attributed to changes in current market yields and pricing spreads for similar securities since the date the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at September 30, 2011.

  • Mortgage-backed securities issued by U.S. Government agencies: As of September 30, 2011, the total unrealized losses on these securities amounted to $82, compared with $356 at December 31, 2010. All of these securities were credit rated "AA" by the major credit rating agencies. Management’s analysis indicates that these securities bear little or no credit risk because they are backed by the full faith and credit of the United States. The Company attributes the unrealized losses at September 30, 2011 to changes in current market yields and pricing spreads for similar securities since the date the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at September 30, 2011.

  • Private label mortgage-backed securities: As of September 30, 2011, the total unrealized losses on the Bank’s private label mortgage-backed securities amounted to $1,532, compared with $2,201 at December 31, 2010. The Company attributes the unrealized losses at September 30, 2011 to the current illiquid market for non-agency mortgage-backed securities, a seriously depressed and still declining housing market, significantly elevated levels of home foreclosures, risk-related market pricing discounts for non-agency mortgage-backed securities and credit rating downgrades on certain private label mortgage-backed securities owned by the Company. Based upon the foregoing considerations and the expectation that the Company will receive all of the future cash flows related to amortized cost on these securities, the Company does not consider there to be any additional other-than-temporary impairment with respect to these securities at September 30, 2011.

  • Obligations of states of the U.S. and political subdivisions thereof: As of September 30, 2011, the total unrealized losses on the Bank’s municipal securities amounted to $2,592, compared with $6,050 at December 31, 2010. The Bank’s municipal securities primarily consist of general obligation bonds and to a lesser extent, revenue bonds. General obligation bonds carry less risk, as they are supported by the full faith, credit and taxing authority of the issuing government and in the cases of school districts, are supported by state aid. Revenue bonds are generally backed by municipal revenue streams generated through user fees or lease payments associated with specific municipal projects that have been financed. At September 30, 2011, all municipal bond issuers were current on contractually obligated interest and principal payments. At September 30, 2011, the Bank’s municipal bond portfolio did not contain any below investment grade securities as reported by major credit rating agencies.

The Company attributes the unrealized losses at September 30, 2011, to changes in prevailing market yields and pricing spreads since the date the underlying securities were purchased, driven in part by current media attention and market concerns about the prolonged recovery from economic recession and the impact it might have on the future financial stability of municipalities throughout the country. Accordingly, the Company does not consider these municipal securities to be other-than-temporarily impaired at September 30, 2011.

At September 30, 2011, the Company had no intent to sell nor believed it is more-likely-than-not that it would be required to sell any of its impaired securities as identified and discussed immediately above, and therefore did not consider these securities to be other-than-temporarily impaired as of that date.

Securities Gains and Losses: The following table summarizes realized gains and losses and other-than-temporary impairment losses on securities available for sale for the three and nine months ended September 30, 2011 and 2010.

Proceeds
from Sale of
Securities
Available
for Sale

Realized
Gains

Realized
Losses

Other
Than
Temporary
Impairment
Losses

Net

Three months ended September 30,

2011

         $17,984

$ 993

$ ---

        $   572     $    421

2010

         $  6,743

$ 618

$ ---

        $   211     $    407
Nine months ended September 30,

2011

         $40,457

$2,313

$ ---

        $1,726      $   587

2010

         $29,959

$1,975

$ ---

        $   751      $1,224

Note 5: Loans and Allowance for Loan Losses

Loans are carried at the principal amounts outstanding adjusted by partial charge-offs and net deferred loan origination costs or fees.

Interest on loans is accrued and credited to income based on the principal amount of loans outstanding. Residential real estate and home equity loans are generally placed on non-accrual status when reaching 90 days past due, or in process of foreclosure, or sooner if judged appropriate by management. Consumer loans are generally placed on non-accrual status when reaching 90 days or more past due, or sooner if judged appropriate by management. Secured consumer loans are written down to realizable value and unsecured consumer loans are charged-off upon reaching 120 days past due. Commercial real estate loans and commercial business loans that are 90 days or more past due are generally placed on non-accrual status, unless secured by sufficient cash or other assets immediately convertible to cash, and the loan is in the process of collection. Commercial real estate and commercial business loans may be placed on non-accrual status prior to the 90 days delinquency date if considered appropriate by management. When a loan has been placed on non-accrual status, previously accrued and uncollected interest is reversed against interest on loans. A loan can be returned to accrual status when principal is reasonably assured and the loan has performed for a period of time, generally six months.

Commercial real estate and commercial business loans are considered impaired when it becomes probable the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status and collateral value. In considering loans for evaluation of impairment, management generally excludes smaller balance, homogeneous loans: residential mortgage loans, home equity loans, and all consumer loans, unless such loans were restructured in a troubled debt restructuring. These loans are collectively evaluated for risk of loss.

When a loan is classified as non-accrual or impaired, any payments received are typically applied to reduce the principal balance of the loan. In situations where the Company reasonably believes there is no longer doubt regarding the ultimate collectability of principal on a non-accrual or impaired loan, subsequent interest payments received are recorded as interest income on the cash basis in accordance with the contractual terms. For the three and nine months ended September 30, 2011 and 2010, the Company did not recognize any interest income on impaired loans using a cash-basis method of accounting during the time within those periods that the loans were impaired.

Loan origination and commitment fees and direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loans’ yield, using the level yield method over the estimated lives of the related loans.

The Company’s lending activities are principally conducted in downeast and midcoast Maine. The following table summarizes the composition of the loan portfolio as of September 30, 2011 and December 31, 2010:

LOAN PORTFOLIO SUMMARY

September 30,
2011

December 31,
2010

Commercial real estate mortgages           $252,153         $260,357
Commercial and industrial               84,921             80,765
Commercial construction and land development               33,294             32,114
Agricultural and other loans to farmers               24,914             24,359
     Total commercial loans             395,282           397,595
Residential real estate mortgages             231,062           231,434
Home equity loans               54,501             54,289
Consumer loans               24,085               4,417
     Total consumer loans             309,648           290,140
Tax exempt loans                 8,632             12,126
Deferred origination costs, net                    656                  809
Total loans             714,218           700,670
Allowance for loan losses                (8,153)              (8,500)
Total loans net of allowance for loan losses           $706,065         $692,170

Loan Origination/Risk Management: The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. The Company’s board of directors reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the board with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing loans and potential problem loans. The Company seeks to diversify the loan portfolio as a means of managing risk associated with fluctuations in economic conditions.

Commercial Real Estate Mortgages: The Bank’s commercial real estate mortgage loans are collateralized by liens on real estate, typically have variable interest rates (or five year or less fixed rates) and amortize over a 15 to 20 year period. These loans are underwritten primarily as cash flow loans and secondarily as loans secured by real estate. Payments on loans secured by such properties are largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Accordingly, repayment of these loans may be subject to adverse economic conditions to a greater extent than other types of loans. The Company seeks to minimize these risks in a variety of ways, including giving careful consideration to the property’s operating history, future operating projections, current and projected occupancy, location and physical condition in connection with underwriting these loans. The underwriting analysis also includes credit verification, analysis of global cash flows, appraisals and a review of the financial condition of the borrower. Reflecting the Bank’s business region, at September 30, 2011 approximately 36.3% of the commercial real estate mortgage portfolio is represented by loans to the lodging industry. The Bank underwrites lodging industry loans as operating businesses, lending primarily to seasonal establishments with stabilized cash flows.

Commercial and Industrial Loans: Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitability, and prudently expand its business. In nearly all cases, commercial and industrial loans are made in the Bank’s market areas and are underwritten on the basis of the borrower’s ability to service the debt from income. As a general practice, the Bank takes as collateral a lien on any available real estate, equipment or other assets owned by the borrower and obtains a personal guaranty of the borrower or principal. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets. In general, commercial and industrial loans involve more credit risk than residential mortgage loans and commercial mortgage loans and, therefore, usually yield a higher return. The increased risk in commercial and industrial loans is principally due to the type of collateral securing these loans. The increased risk also derives from the expectation that commercial and industrial loans generally will be serviced principally from the operations of the business, and, if not successful, these loans are secured only by tangible, non-real estate collateral. As a result of these additional complexities, variables and risks, commercial and industrial loans generally require more thorough underwriting and servicing than other types of loans.

Construction and Land Development Loans: The Company makes loans to finance the construction of residential and, to a lesser extent, non-residential properties. Construction loans generally are collateralized by first liens on real estate and have floating interest rates. The Company conducts periodic inspections, either directly or through an agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described immediately above are also used in the Company’s construction lending activities. These underwriting guidelines apply both to loans for which repayment is largely or entirely dependent upon the project-specific economics, and loans to borrowers who demonstrate an ability to repay regardless of the time frame for development and/or sellout of the specific project. The Construction loans involve additional risks attributable to the fact that loan funds are advanced against a project under construction and the project is of uncertain value prior to its completion. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. In many cases the success of the project can also depend upon the financial support/strength of the borrower. If the Company is forced to foreclose on a project prior to completion, there is no assurance that the Company will be able to recover the entire unpaid portion of the loan. In addition, the Company may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. While the Company has underwriting procedures designed to identify what it believes to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above.

Residential Real Estate Mortgages: The Company originates first-lien, adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a single family residential property. These loans are principally collateralized by owner-occupied properties, substantially all of which are located in the Company’s market area, and are amortized over 10 to 30 years. All residential real estate loans were originated by the Company. From time to time the Company will sell longer term low rate, residential mortgage loans to the Federal Home Loan Mortgage Corporation ("FHLMC") with servicing rights retained. This practice allows the Company to better manage interest rate risk and liquidity risk. In an effort to manage risk of loss and strengthen secondary market liquidity opportunities, management typically uses secondary market underwriting, appraisal, and servicing guidelines for all loans, including those held in its portfolio. Loans on one-to-four-family residential real estate are mostly originated in amounts of no more than 80% of appraised value or have private mortgage insurance. Mortgage title insurance and hazard insurance are required. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through more stringent underwriting and periodic site inspections, including inspections at standard intervals.

Home Equity Loans: The Company originates home equity lines of credit and second mortgage loans which are secured by a second [junior] lien position on one-to-four-family residential real estate. These loans carry a higher risk than first mortgage residential loans as they are in a second position relating to collateral. Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal cash flows. A security interest, with title insurance when necessary, is taken in the underlying real estate.

Non-performing Loans: the following table sets forth information regarding non-accruing loans and accruing loans 90 days or more overdue at September 30, 2011 and December 31, 2010.

TOTAL NON-PERFORMING LOANS

September 30,
2011

December 31,
2010

Commercial real estate mortgages            $ 3,568         $ 3,572
Commercial and industrial loans               1,242               778
Commercial construction and land development               3,447            5,899
Agricultural and other loans to farmers                  118               254
     Total commercial loans               8,375           10,503
Residential real estate mortgages               3,522            3,022
Home equity loans                  409               146
Consumer loans                  126                ---
     Total consumer loans               4,057            3,168
Total non-accrual loans             12,432           13,671
Accruing loans contractually past due 90 days or more                    39                    6
      Total non-performing loans           $12,471         $13,677
Allowance for loan losses to non-performing loans

65%

62%

Non-performing loans to total loans

1.75%

1.95%

Allowance to total loans

1.14%

1.21%

At September 30, 2011, total other real estate owned consisted of ten properties with a total carrying value of $1,500, compared to four properties with a total carrying value of $656 at December 31, 2010.

Troubled Debt Restructurings: During the nine months ended September 30, 2011, the Company did not have any troubled debt restructurings ("TDRs") in its loan portfolio.  In accordance with the guidance clarified by ASU 2011-02, "A Creditors Determination of Whether a Restructuring is a Troubled Debt Restructuring," the Company reviews all loan modifications to determine whether such modifications constitute a TDR. In evaluating whether a restructuring is a TDR the Company must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the borrower is experiencing financial difficulties.

Past due loans: Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The following tables set forth information regarding past due loans at September 30, 2011 and December 31, 2010. Amounts shown exclude deferred loan origination fees and costs.

September 30, 2011

30-59 Days
Past Due

60-89
Days
Past Due

90 Days
or Greater

Total
Past Due

Current

Total
Loans

>90 Days Past Due and Accruing

Commercial real estate mortgages     $1,549       $155      $2,369     $ 4,073   $248,080   $252,153           $---
Commercial and industrial          242           ---        1,077        1,319       83,602       84,921             34
Commercial construction and
     land development
           ---           ---        3,447        3,447       29,847       33,294             ---
Agricultural and other loans to farmers          541           37             38           616       24,298       24,914             ---
Residential real estate mortgages          688         340        2,091        3,119     227,943     231,062             ---
Home equity            80           ---           409           489       54,012       54,501             ---
Consumer loans          110         157           117           384       23,701       24,085               5
Tax exempt           ---           ---            ---             ---         8,632         8,632             ---
Total     $3,210       $689      $9,548    $13,447   $700,115   $713,562           $39

 

December 31, 2010

30-59 Days
Past Due

60-89
Days
Past Due

90 Days
or Greater

Total
Past Due

Current

Total
Loans

>90 Days Past
Due and Accruing

Commercial real estate mortgages

    $   374

      $   663

     $2,833

  $  3,870

$256,487

$260,357

        $ 2

Commercial and industrial

           37

               5

          483

         525

80,240

80,765

         ---

Commercial construction and
     land development

           ---

            ---

          704

         704

31,410

32,114

         ---

Agricultural and other loans to farmers

           85

             48

            90

         223

24,136

24,359

         ---

Residential real estate mortgages

      2,117

           290

       2,376

      4,783

226,651

231,434

            4

Home equity

           68

             32

            68

         168

54,121

54,289

         ---

Consumer loans

           34

             16

           ---

           50

4,367

4,417

         ---

Tax exempt

           ---

             ---

           ---

          ---

12,126

12,126

         ---

Total

    $2,715

      $1,054

     $6,554

  $10,323

$689,538

$699,861

        $ 6

Impaired Loans: Impaired loans are commercial and commercial real estate loans for which the Company believes it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement, as well as all loans restructured in a troubled debt restructuring, if any. Allowances for losses on impaired loans are determined by the lower of the present value of the expected cash flows related to the loan, using the original contractual interest rate, and its recorded value, or in the case of collateral dependant loans, the lower of the fair value of the collateral, less costs to dispose, and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral less cost to sell.

Details of impaired loans as of September 30, 2011 and December 31, 2010 follows:

For the period ended September 30

For the three months ended September 30

For the nine months ended September 30

2011

Recorded
Investment

Unpaid
Principal
Balance

Related
Allowance

Average
Recorded
Investment

Interest
Recorded

Average
Recorded
Investment

Interest
Recorded

With no related allowance:

Commercial real estate mortgages      $1,839    $   1,839       $ ---      $1,740       $---     $1,199       $---
Commercial and industrial           901           971          ---           972         ---          638        ---
Commercial construction and development        3,447        5,348          ---           334         ---          264        ---
Agricultural and other loans to farmers           118           118          ---           176         ---          210        ---
Subtotal      $6,305    $  8,276       $ ---      $3,222       $---     $2,311       $---

With an allowance:

Commercial real estate mortgages      $1,729    $   1,729       $579      $1,304       $---     $2,075       $---
Commercial and industrial           341           341         279           341         ---          453        ---
Commercial construction and development            ---            ---          ---        4,608         ---       4,735        ---
Agricultural and other loans to farmers            ---            ---          ---            ---         ---            ---         ---
Subtotal      $2,070    $  2,070       $858      $6,253       $---     $7,263       $---
Total      $8,375    $10,346       $858      $9,475      $---     $9,574       $---

 

 

2010

For the period ended December 31

Recorded
Investment

Unpaid
Principal
Balance

Related
Allowance

With no related allowance:

Commercial real estate mortgages

   $     764

    $     764

      $    ---

Commercial and industrial

          240

           240

            ---

Commercial construction and
     land development

          225

           225

            ---

Agricultural and other loans to farmers

          254

           254

            ---

Subtotal

   $  1,483

    $  1,483

      $    ---

With an allowance:

Commercial real estate mortgages

   $  2,808

    $  2,808

      $    591

Commercial and industrial

          538

           725

            159

Commercial construction and
     Land development

       5,674

        5,841

           577

Agricultural and other loans to farmers

           ---

            ---

            ---

Subtotal

   $  9,020

    $  9,374

      $1,327

Total

   $10,503

    $10,857

      $1,327

The average recorded investment in impaired loans for the three and nine month periods ended September 30, 2010 were $5,564 and $5,964, respectively.

Credit Quality Indicators/Classified Loans: In monitoring the credit quality of the portfolio, management applies a credit quality indicator ("risk rating") to each category of commercial loans. These credit quality indicators range from one through nine, with a higher number correlating to increasing risk of loss. These ratings are used as inputs to the calculation of the allowance for loan losses. Loans rated 1 through 5 are consistent with the regulators’ "Pass" ratings, and are generally allocated a lesser percentage allocation in the allowance for loan losses than loans rated from 6 through 9.

The Bank classifies commercial and commercial real estate loans which are considered to be of lesser quality as substandard, doubtful, or loss. The Bank considers a commercial or commercial real estate loan substandard when it contains a well defined weakness that jeopardizes the collection of a loan’s contractual principal and interest. Such a well defined weakness may include inadequate borrower cash flow, weak or inadequate collateral protection, and/or weak or inadequate guarantor support.

Loans that the Bank classifies as doubtful have all of the weaknesses inherent in those loans that are classified as substandard but also have the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is high but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans. The entire amount of the loan might not be classified as doubtful when collection of a specific portion appears highly probable. Loans are generally not classified doubtful for an extended period of time (i.e., over a year).

Loans that the Bank classifies as loss are those considered uncollectible and of such little value that their continuance as an asset is not warranted and the uncollectible amounts are charged off. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. Losses are taken in the period in which they surface as uncollectible.

 Loans that do not expose the Bank to risk sufficient to warrant classification in one of the aforementioned categories, but have some potential weaknesses, are designated special mention. A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. This might include loans which the lending officer may be unable to supervise properly because of: lack of expertise, inadequate loan agreement, the poor condition of or lack of control over collateral, failure to obtain proper documentation or any other deviations from prudent lending practices. Economic or market conditions which may, in the future, affect the obligor may warrant special mention of the asset. Loans for which an adverse trend in the borrower's operations or an imbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized may be included in this classification. Special mention assets are not adversely classified and do not expose an institution to sufficient risks to warrant classification.

The following tables summarize the commercial loan portfolio as of September 30, 2011 and December 31, 2010 by credit quality indicator. Credit quality indicators are reassessed for each applicable commercial loan at least annually, or upon receipt and analysis of the borrower’s financial statements, when applicable. Consumer loans, which principally consist of residential mortgage loans, are not rated, but are evaluated for credit quality after origination based on delinquency status (see past due loan aging table above).

 

September 30, 2011

Commercial real estate mortgages

Commercial and
industrial

Commercial construction
and land development

Agricultural
and other
loans
to farmers

Total

Pass       $224,602       $73,563          $26,304         $23,587     $348,056
Other Assets Especially Mentioned           21,246           8,737              2,782                866         33,631
Substandard             6,305           2,621              4,208                461         13,595
Doubtful                 ---               ---                  ---                 ---               ---
Loss                 ---               ---                  ---                 ---               ---
     Total       $252,153       $84,921          $33,294         $24,914     $395,282

 

December 31, 2010

 

Commercial
real estate
mortgages

 

Commercial
and
industrial

Commercial
construction
and land
development

Agricultural
and other
loans
to farmers

 

Total

Pass

      $228,554

      $69,566

         $24,661

        $ 22,735

    $345,516

Other Assets Especially Mentioned

          25,898

          8,231

                794

             1,066

        35,989

Substandard

            5,905

          2,968

             6,659

                558

        16,090

Doubtful

                ---

              ---

                 ---

                 ---

              ---

Loss

                ---

              ---

                 ---

                 ---

              ---

     Total

      $260,357

      $80,765

         $32,114

        $24,359

    $397,595

Allowance for Loan Losses: The allowance for loan losses (the "allowance") is a reserve established through a provision for loan losses (the "provision") charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to provide for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, "Receivables" and allowance allocations calculated in accordance with ASC Topic 450, "Contingencies." Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance is designed to account for credit deterioration as it occurs. The provision reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company’s allowance for loan losses consists of three principal elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company.

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship level for all commercial loans. When a loan has a classification of 7 or higher, the Company analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other observable considerations.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool, net of any loans for which reserves are already established. The Company’s pools of similar loans include similarly risk-graded groups of, commercial real estate loans, commercial and industrial loans, consumer real estate loans and consumer and other loans.

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the bank’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. The results are then used to determine an appropriate general valuation allowance.

Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off based on regulatory requirements.

A summary of activity in the allowance for loan losses for the nine months ended September 30, 2011 and 2010 follows:

ALLOWANCE FOR LOAN LOSSES
SUMMARY OF LOAN LOSS EXPERIENCE
NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

2011

2010

Balance at beginning of period

$ 8,500

$ 7,814

Charge offs:
Commercial real estate mortgages              99           374
Commercial and industrial              48             93
Commercial construction and land development         1,993           167
Agricultural and other loans to farmers             ---             ---
Residential real estate mortgages            178           160
Consumer loans              30             90
Home equity loans              56           100
Tax exempt loans             ---             ---
     Total charge-offs         2,404           984
Recoveries:
Commercial real estate mortgages                7               1
Commercial and industrial loans              81               2
Commercial construction and land development             ---            ---
Agricultural and other loans to farmers              45               3
Residential real estate mortgages              40           105
Consumer loans              34             58
Home equity loans              ---             41
Tax exempt loans              ---            ---
     Total recoveries             207           210
Net charge-offs          2,197           774
Provision charged to operations          1,850         1,500
  
Balance at end of period    $    8,153    $   8,540
  
Average loans outstanding during period    $718,633    $677,829
  
Annualized net charge-offs to average loans outstanding

0.41%

0.15%

The following table details activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2011. The table also provides details regarding the Company’s recorded investment in loans related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

Three Months Ended September 30, 2011

Commercial Real Estate

Commercial
and
Industrial

Commercial Construction and land development

Agricultural

Residential
Real Estate

Consumer

Home

Equity

Tax Exempt

Total

Beginning Balance     $ 3,699      $  1,618 $ 1,655     $      347   $    1,436   $     304   $    330   $    146 $      9,535
Charged Off            ---             (42) (1,993)              ---           (101)            (2)          (56)          ---       (2,194)
Recoveries               6                2 ---              ---              40           14           ---          ---             62
Provision           277              (81) 738             (17)             (75)          (42)          (10)          (40)           750
Ending Balance     $ 3,982     $   1,497      $ 400     $     330   $    1,300   $     274   $     264   $    106 $     8,153

Nine Months Ended September 30, 2011

Commercial Real Estate

Commercial
and
Industrial

Commercial Construction
and land development

Agricultural

Residential
Real
Estate

Consumer

Home Equity

Tax
Exempt

Total

Beginning Balance     $    4,260     $  1,237      $     999     $     223   $    1,322   $      73   $    276   $   110 $     8,500
Charged Off               (99)             (48)         (1,993)              ---           (178)          (30)          (56)          ---      (2,404)
Recoveries                  7              81              ---              45              40            34           ---          ---          207
Provision             (186)            227          1,394              62            116          197            44           (4)       1,850
Ending Balance     $    3,982     $  1,497      $     400     $     330   $    1,300   $     274   $     264   $    106 $    8,153
of which:
Amount for loans
     individually
     evaluated for
     impairment
    $       579     $     279      $       ---     $      ---   $       ---   $      ---   $      ---   $      --- $        858
Amount for loans
     collectively
     evaluated for
     impairment
    $    3,403     $  1,218      $     400     $     330   $    1,300   $     274   $     264   $    106 $    7,295
Loans individually
     evaluated for
     impairment
    $    3,568     $  1,242      $  3,447     $     118   $       ---   $      ---   $      ---   $      --- $    8,375
Loans collectively
     evaluated for
     impairment
    $248,585     $83,679      $29,847     $24,796   $231,062   $24,085   $54,501   $8,632 $705,187

 

 

December 31, 2010

Commercial Real Estate

Commercial and
Industrial

Commercial Construction and Land Development

Agricultural

Residential Real Estate

Consumer

Home Equity

Tax
Exempt

Total

Ending Balance

$ 4,260

$ 1,237

$ 999

$ 223

$ 1,322

$ 73

$276

$ 110

$ 8,500

of which:

Amount for loans
     individually
     evaluated

for impairment

$ 591

$ 159

$ 577

$ ---

$ ---

$ ---

$ ---

$ ---

$ 1,327

Amount for loans
     collectively
     evaluated
     for impairment

$ 3,669

$ 1,078

$ 422

$ 223

$1,322

$ 73

$276

$ 110

$ 7,173

Loans individually
     evaluated for
     impairment

$ 3,572

$ 778

$ 5,899

$ 254

$ ---

$ ---

$ ---

$ ---

$ 10,503

Loans collectively
     evaluated for
     impairment

$256,785

$79,987

$26,215

$ 24,105

$ 231,434

$ 4,417

$54,289

$12,126

$689,358

Loan concentrations: Because of the Company’s proximity to Acadia National Park, a large part of the economic activity in the Bank’s area is generated from the hospitality business associated with tourism. At September 30, 2011 and December 31, 2010, loans to the lodging industry amounted to approximately $91,444 and $86,142, respectively.

Note 6: Retirement Benefit Plans

The Company has non-qualified supplemental executive retirement agreements with certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations.

The Company also has supplemental executive retirement agreements with certain current executive officers. These agreements provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or upon a change of control.

The following table summarizes the net periodic benefit costs for the three and nine months ended September 30, 2011 and 2010:

Supplemental Executive
Retirement Plans

Three Months Ended September 30,

2011

2010

Service cost         $  12         $  48
Interest cost             47             47
Amortization of actuarial loss               1               1
     Net periodic benefit cost         $  60         $  96

Supplemental Executive
Retirement Plans

Nine Months Ended September 30,

2011

2010

Service cost         $  36         $141
Interest cost           142           142
Amortization of actuarial loss               3               5
     Net periodic benefit cost         $181         $288

The Company is expected to recognize $239 of expense for the foregoing plans for the year ended December 31, 2011. The Company is expected to contribute $205 to the foregoing plans in 2011. As of September 30, 2011, the Company had contributed $152.

Note 7: Commitments and Contingent Liabilities

The Company’s wholly owned subsidiary, Bar Harbor Bank & Trust (the "Bank"), is a party to financial instruments in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit.

Commitments to originate loans, including unused lines of credit, are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. 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 Bank uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the borrower.

The Bank guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are primarily issued in support of third party debt or obligations. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet instruments. Exposure to credit loss in the event of non-performance by the counter-party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. Typically, these standby letters of credit have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements.

The following table summarizes the contractual amounts of commitments and contingent liabilities as of September 30, 2011 and December 31, 2010:

September 30,
2011

December 31,
2010

Commitments to originate loans         $27,673         $24,112
Unused lines of credit         $89,953         $91,753
Un-advanced portions of construction loans         $  8,705         $11,215
Standby letters of credit         $     717         $     750

As of September 30, 2011 and December 31, 2010, the fair value of the standby letters of credit was not significant to the Company’s consolidated financial statements.

Note 8: Fair Value Measurements

The Company measures 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. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.

The Company’s fair value measurements employ valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the servicing capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The Company uses a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets (Level 1 measurements) for identical assets or liabilities and the lowest priority to unobservable inputs (Level 3 measurements). The fair value hierarchy is as follows:

  • Level 1 – Valuation is based on unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

  • Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and model-based techniques for which all significant assumptions are observable in the market.

  • Level 3 – Valuation is principally generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates that market participants would use in pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques.

The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

The most significant instruments that the Company values are securities, all of which fall into Level 2 in the fair value hierarchy. The securities in the available for sale portfolio are priced by independent providers. In obtaining such valuation information from third parties, the Company has evaluated their valuation methodologies used to develop the fair values in order to determine whether valuations are appropriately placed within the fair value hierarchy and whether the valuations are representative of an exit price in the Company’s principal markets. The Company’s principal markets for its securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in those markets. Additionally, the Company periodically tests the reasonableness of the prices provided by these third parties by obtaining fair values from other independent providers and by obtaining desk bids from a variety of institutional brokers.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

  • Securities Available for Sale: All securities and major categories of securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from independent pricing providers. The fair value measurements used by the pricing providers consider observable data that may include dealer quotes, market maker quotes and live trading systems. If quoted prices are not readily available, fair values are determined using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as market pricing spreads, credit information, callable features, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, default rates, and the securities’ terms and conditions, among other things.

The foregoing valuation methodologies may produce fair value calculations that may not be fully indicative of net realizable value or reflective of future fair values. While Company management believes these valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

The following tables summarize financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

September 30, 2011

Level 1
Inputs

Level 2
Inputs

Level 3
Inputs

Total Fair Value

Securities available for sale:
     Obligations of US Government-
          sponsored enterprises
$ ---     $    1,027 $ ---     $    1,027
     Mortgage-backed securities:
          US Government-sponsored enterprises $ ---     $242,358 $ ---     $242,358
          US Government agencies $ ---     $  73,102 $ ---     $  73,102
          Private label $ ---     $  14,232 $ ---     $  14,232
     Obligations of states and political
          subdivisions thereof
$ ---     $  57,696 $ ---     $  57,696

December 31, 2010

Level
Inputs

Level 2
Inputs

Level 3
Inputs

Total Fair Value

Securities available for sale:
     Obligations of US Government-
          sponsored enterprises
$ ---      $ 1,034 $ ---     $    1,034
     Mortgage-backed securities:
          US Government-sponsored enterprises $ ---     $224,553 $ ---     $224,553
          US Government agencies $ ---     $  56,943 $ ---     $  56,943
          Private label $ ---     $  20,830 $ ---     $  20,830
     Obligations of states and political
          subdivisions thereof
$ ---     $  54,522 $ ---     $  54,522

The following table summarizes financial assets and financial liabilities measured at fair value during the quarter, on a non-recurring basis as of September 30, 2011, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.

Principal
Balance
as of 9/30/11

Level 1
Inputs

Level 2
Inputs

Level 3
Inputs

Fair Value
as of 9/30/11

Mortgage servicing rights            $   138 $ ---          $138       $    ---           $   190
Collateral dependent impaired loans            $1,729 $ ---          $ ---       $1,729           $1,150

The following table summarizes financial assets and financial liabilities measured at fair value on a non-recurring basis as of December 31, 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.

Principal
Balance
as of 12/31/10

Level 1 Inputs

Level 2
Inputs

Level 3 Inputs

Fair Value
as of 12/31/10

Mortgage servicing rights

           $    210

$ ---

         $210

      $    ---

          $   262

Collateral dependent impaired loans

           $1,782

$ ---

         $ ---

      $1,782

          $1,448

The Company had total collateral dependent impaired loans with a carrying value of approximately $2,877 and $3,044, which had specific reserves included in the allowance of $579 and $334, at September 30, 2011, and December 31, 2010, respectively.

Note 9: Fair Value of Financial Instruments

The Company discloses fair value information about financial instruments for which it is practicable to estimate fair value. Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and relevant market information. Where available, quoted market prices are used. In other cases, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties and are significantly affected by the assumptions used and judgments made regarding risk characteristics of various financial instruments, discount rates, estimates of future cash flows, future expected loss experience and other factors. Changes in assumptions could significantly affect these estimates. Derived fair value estimates cannot be substantiated by comparison to independent markets and, in certain cases, could not be realized in an immediate sale of the instrument.

Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Accordingly, the aggregate fair value amounts presented do not purport to represent the underlying market value of the Company.

The following describes the methods and significant assumptions used by the Company in estimating the fair values of significant financial instruments:

Cash and Cash Equivalents: For cash and cash equivalents, including cash and due from banks and other short-term investments with maturities of 90 days or less, the carrying amounts reported on the consolidated balance sheet approximate fair values.

Loans: For variable rate loans that re-price frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of other loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits: The fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is based on the discounted value of contractual cash flows, applying interest rates currently being offered on wholesale funding products of similar maturities. The fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of alternative forms of funding ("deposit base intangibles").

Borrowings: For borrowings that mature or re-price in 90 days or less, carrying value approximates fair value. The fair value of the Company’s remaining borrowings is estimated by using discounted cash flows based on current rates available for similar types of borrowing arrangements taking into account any optionality.

Accrued Interest Receivable and Payable: The carrying amounts of accrued interest receivable and payable approximate their fair values.

Off-Balance Sheet Financial Instruments: The Company’s off-balance sheet instruments consist of loan commitments and standby letters of credit. Fair values for standby letters of credit and loan commitments were insignificant.

A summary of the carrying values and estimated fair values of the Company’s significant financial instruments at September 30, 2011, and December 31, 2010, follows:

September 30, 2011

December 31, 2010

Carrying
Value

Fair
Value

Carrying
Value

Fair
Value

Financial assets:
     Cash and cash equivalents

    $    8,546

    $    8,546     $  12,815     $  12,815
     Loans, net

    $706,065

    $715,508     $692,170     $696,515
     Interest receivable

    $    4,226

    $    4,226     $    4,159     $    4,159
     Securities, available for sale

    $388,415

    $388,415     $357,882     $357,882
Financial liabilities:
     Deposits (with no stated maturity)

    $387,115

    $387,115     $354,754     $354,754
     Time deposits

    $374,979

    $384,264     $353,574     $361,481
     Borrowings

    $270,962

    $280,153     $300,014     $309,561
     Interest payable

    $       807

    $       807     $     1,078     $    1,078

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis, which follows, focuses on the factors affecting the Company’s consolidated results of operations for the three and nine months ended September 30, 2011 and 2010, and financial condition at September 30, 2011, and December 31, 2010, and where appropriate, factors that may affect future financial performance. The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this report on Form 10-Q.

Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation.

Unless otherwise noted, all dollars are expressed in thousands except share data.

Use of Non-GAAP Financial Measures: Certain information discussed below is presented on a fully taxable equivalent basis. Specifically, included in interest income in the third quarter 2011 and 2010 was $743 and $836, respectively, of tax-exempt interest income from certain investment securities and loans. For the nine months ended September 30, 2011 and 2010, the amount of tax-exempt income included in interest income was $2,312 and $2,591, respectively.

An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income totals discussed in certain sections of this Management’s Discussion and Analysis, representing tax equivalent adjustments of $359 and $396 in the third quarter of 2011 and 2010, respectively, and $1,113 and $1,228 for the nine months ended September 30, 2011 and 2010, respectively, which increased net interest income accordingly. The analysis of net interest income tables included in this report on Form 10-Q provide a reconciliation of tax equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.

Management believes the disclosure of tax equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from their earning asset portfolios. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices.

FORWARD LOOKING STATEMENTS DISCLAIMER

Certain statements, as well as certain other discussions contained in this quarterly report on Form 10-Q, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. You can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.

Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operation, financial condition, and the business of the Company which are subject to change based on the impact of various factors that could cause actual results to differ materially from those projected or suggested due to certain risks and uncertainties. Those factors include but are not limited to:

(i)

The Company's success is dependent to a significant extent upon general economic conditions in Maine, and Maine's ability to attract new business, as well as factors that affect tourism, a major source of economic activity in the Company’s immediate market areas;

(ii)

The Company's earnings depend to a great extent on the level of net interest income (the difference between interest income earned on loans and investments and the interest expense paid on deposits and borrowings) generated by the Company’s wholly-owned banking subsidiary, Bar Harbor Bank & Trust (the "Bank"), and thus the Company’s results of operations may be adversely affected by increases or decreases in interest rates;

(iii)

The banking business is highly competitive and the profitability of the Company depends on the Bank's ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and non-traditional institutions, such as credit unions and finance companies;

(iv)

A significant portion of the Bank's loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other intangible factors which are considered in making commercial loans and, accordingly, the Company's profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions;

(v)

A significant delay in, or inability to execute strategic initiatives designed to increase revenues and or control expenses;

(vi)

The potential need to adapt to changes in information technology systems, on which the Company is highly dependent, could present operational issues or require significant capital spending;

(vii)

Significant changes in the Company’s internal controls, or internal control failures;

(viii)

Acts or threats of terrorism and actions taken by the United States or other governments as a result of such threats, including military action, could further adversely affect business and economic conditions in the United States generally and in the Company’s markets, which could have an adverse effect on the Company’s financial performance and that of borrowers and on the financial markets and the price of the Company’s common stock;

(ix)

Significant changes in the extensive laws, regulations, and policies governing bank holding companies and their subsidiaries could alter the Company's business environment or affect its operations;

(x)

Changes in general, national, international, regional or local economic conditions and credit markets which are less favorable than those anticipated by Company management that could impact the Company's securities portfolio, quality of credits, or the overall demand for the Company's products or services; and

(xi)

The Company’s success in managing the risks involved in all of the foregoing matters.

You should carefully review all of these factors as well as the risk factors set forth in Item 1A. Risk Factors contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. There may be other risk factors that could cause differences from those anticipated by management.

The forward-looking statements contained herein represent the Company's judgment as of the date of this quarterly report on Form 10-Q and the Company cautions readers not to place undue reliance on such statements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the succeeding discussion, or elsewhere in this quarterly report on Form 10-Q, except to the extent required by federal securities laws.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of its December 31, 2010, report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s financial performance is reported.

Management’s discussion and analysis of the Company’s financial condition and results of operations are based on the Consolidated Financial Statements, which are prepared in accordance with U.S. generally accepted accounting principles. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management evaluates its estimates on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from management’s estimates and assumptions under different assumptions or conditions. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, other than temporary impairment on securities, income tax estimates, and the evaluation of intangible assets. The use of these estimates is more fully described in Part I, Item 1, Note 2 of the consolidated financial statements in this quarterly report on Form 10-Q.

SUMMARY FINANCIAL RESULTS

For the three months ended September 30, 2011 the Company reported net income available to common shareholders of $3,010, compared with $2,870 in the third quarter of 2010, representing an increase of $140, or 4.9%. The Company’s diluted earnings per share amounted to $0.77 for the quarter compared with $0.75 in the third quarter of 2010, representing an increase of $0.02, or 2.7%.

The Company’s annualized return on average shareholders’ equity ("ROE") amounted to 10.45% for the quarter, compared with 10.81% in the third quarter of 2010. The Company’s third quarter return on average assets ("ROA") amounted to 1.04%, unchanged compared with the third quarter of 2010.

For the nine months ended September 30, 2011, the Company’s net income available to common shareholders amounted to $8,652, compared with $7,980 for the same period in 2010, representing an increase of $672, or 8.4%. Diluted earnings per share amounted to $2.23 for the nine months ended September 30, 2011, compared with $2.09 for the same period in 2010, representing an increase of $0.14, or 6.7%.

For the nine months ended September 30, 2011, the Company’s ROE amounted to 10.60%, compared with 10.94% for the same period in 2010. The Company’s ROA amounted to 1.01%, compared with 1.07% for the first nine months of 2010.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the principal component of the Company's income stream and represents the difference or spread between interest generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in market interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.

Total Net Interest Income: For the three months ended September 30, 2011, net interest income on a tax equivalent basis amounted to $9,063, compared with $8,342 in the third quarter of 2010, representing an increase of $721, or 8.6%. As more fully discussed below, the increase in third quarter 2011 tax-equivalent net interest income compared with the third quarter of 2010 was principally attributed to average earning asset growth of $57,720, combined with a nine basis point improvement in the net interest margin.

For the nine months ended September 30, 2011, net interest income on a tax-equivalent basis amounted to $26,775, compared with $25,027 for the same period in 2010, representing an increase of $1,748, or 7.0%. As more fully discussed below, the increase in net interest income was principally attributed to average earning asset growth of $69,319, or 6.7%, and to a lesser extent a one basis point improvement in the tax-equivalent net interest margin.

Factors contributing to the changes in net interest income and the net interest margin are more fully enumerated in the following discussion and analysis.

Net Interest Income Analysis: The following tables summarize the Company’s average balance sheets and components of net interest income, including a reconciliation of tax equivalent adjustments, for the three and nine months ended September 30, 2011 and 2010:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
SEPTEMBER 30, 2011 AND 2010

2011

2010

Average
Balance

Interest

Weighted
Average
Rate

Average
Balance

Interest

Weighted
Average
Rate

Interest Earning Assets:
Loans (1,3)    $    723,219       $ 8,813

4.83%

  $   681,646      $ 8,824

5.14%

Securities (2,3)         368,579          4,255

4.58%

      349,992         4,449

5.04%

Federal Home Loan Bank stock           16,068               11

0.27%

        16,068              ---

0.00%

Fed funds sold, money market funds, and time
     deposits with other banks                538              ---

0.00%

          2,978               2

0.27%

     Total Earning Assets      1,108,404        13,079

4.68%

    1,050,684       13,275

5.01%

Non-Interest Earning Assets:
Cash and due from banks             8,974            8,226
Allowance for loan losses            (9,698)           (8,611)
Other assets (2)           44,719          43,072
     Total Assets    $1,152,399   $1,093,371
Interest Bearing Liabilities:
Deposits    $    687,541       $ 2,202

1.27%

  $    635,884      $ 2,499

1.56%

Borrowings         279,903          1,814

2.57%

       284,968         2,434

3.39%

     Total Interest Bearing Liabilities         967,444          4,016

1.65%

       920,852         4,933

2.13%

Rate Spread

3.03%

2.88%

Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits           65,455          61,869
Other liabilities             5,202            5,288
     Total Liabilities      1,038,101        988,009
Shareholders' equity         114,298        105,362
     Total Liabilities and Shareholders' Equity    $1,152,399   $1,093,371
Net interest income and net interest margin (3)          9,063

3.24%

        8,342

3.15%

Less: Tax Equivalent adjustment            (359)           (396)
     Net Interest Income       $ 8,704

3.12%

     $ 7,946

3.00%

 

(1)  For purposes of these computations, non-accrual loans are included in average loans.
(2)  For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3)  For purposes of these computations, interest income, net interest income and net interest margin are reported on a tax equivalent basis.

 

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
NINE MONTHS ENDED
SEPTEMBER 30, 2011 AND 2010

2011

2010

Average
Balance

Interest

Weighted
Average
Rate

Average
Balance

Interest

Weighted
Average
Rate

Interest Earning Assets:
Loans (1,3)    $   718,633     $26,188

4.87%

   $    677,829       $26,288

5.19%

Securities (2,3)        373,335       13,204

4.73%

        343,857         13,376

5.20%

Federal Home Loan Bank stock          16,068              35

0.29%

          16,068               ---

0.00%

Fed funds sold, money market funds, and time
     deposits with other banks               182             ---

0.00%

           1,145                  2

0.23%

     Total Earning Assets     1,108,218       39,427

4.76%

    1,038,899         39,666

5.10%

Non-Interest Earning Assets:
Cash and due from banks             7,540             6,514
Allowance for loan losses            (9,313)            (8,384)
Other assets (2)           41,474           40,902
     Total Assets    $1,147,919    $1,077,931
Interest Bearing Liabilities:
Deposits    $    674,400      $ 6,606

1.31%

   $    625,848       $   7,450

1.59%

Borrowings         300,036         6,046

2.69%

        287,085            7,189

3.35%

     Total Interest Bearing Liabilities         974,436       12,652

1.74%

        912,933          14,639

2.14%

Rate Spread

3.02%

2.96%

Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits           59,270           54,258
Other liabilities             5,112             5,228
     Total Liabilities      1,038,818         972,419
Shareholders' equity         109,101         105,512
     Total Liabilities and Shareholders' Equity    $1,147,919    $1,077,931
Net interest income and net interest margin (3)       26,775

3.23%

         25,027

3.22%

Less: Tax Equivalent adjustment        (1,113)          (1,228)
     Net Interest Income     $25,662

3.10%

      $23,799

3.06%

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, net interest income and net interest margin is reported on a tax equivalent basis.

Net Interest Margin: The net interest margin, expressed on a tax equivalent basis, represents the difference between interest and dividends earned on interest-earning assets and interest paid to depositors and other creditors, expressed as a percentage of average earning assets.

The net interest margin is determined by dividing tax equivalent net interest income by average interest-earning assets. The interest rate spread represents the difference between the average tax equivalent yield earned on interest earning-assets and the average rate paid on interest bearing liabilities. The net interest margin is generally higher than the interest rate spread due to the additional income earned on those assets funded by non-interest bearing liabilities, primarily demand deposits and shareholders’ equity.

For the three months ended September 30, 2011, the tax equivalent net interest margin amounted to 3.24%, compared with 3.15% in the third quarter of 2010, representing an improvement of nine basis points. As more fully discussed below, the increase in the net interest margin from the third quarter of 2010 was principally attributed to the weighted average cost of funds, which declined 15 basis points more than the weighted average earning asset yield. This improvement was partially offset by proportionately lower levels of tax-exempt interest income during the quarter ended September 30, 2011, compared with the same quarter in 2010.

For the nine months ended September 30, 2011, the tax-equivalent net interest margin amounted to 3.23%, compared with 3.22% for the same period in 2010, representing an improvement of one basis point. The improved net interest margin was principally attributed to the weighted average cost of funds, which declined six basis points more than the weighted average earning asset yield. This improvement was partially offset by proportionately lower levels of tax-exempt interest income during the first nine months of 2011, compared with the same period in 2010.

The following table summarizes the net interest margin components, on a quarterly basis, over the past two years. Factors contributing to the changes in the net interest margin are further enumerated in the following discussion and analysis.

NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED

WEIGHTED AVERAGE RATES

2011

2010

2009

Quarter:

3

2

1

4

3

2

1

4

3

Interest Earning Assets:
Loans (1,3)

4.83%

4.86%

4.93%

5.00%

5.14%

5.20%

5.22%

5.16%

5.27%

Securities (2,3)

4.58%

4.78%

4.79%

4.73%

5.04%

4.93%

5.64%

5.70%

5.90%

Federal Home Loan Bank stock

0.27%

0.30%

0.30%

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Fed Funds sold, money market funds,
     and time deposits with other banks

0.00%

0.00%

0.00%

0.00%

0.27%

0.00%

0.00%

0.00%

1.33%

   Total Earning Assets

4.68%

4.77%

4.81%

4.83%

5.01%

5.03%

5.28%

5.26%

5.40%

Interest Bearing Liabilities:
Demand and other non-interest
     bearing deposits

1.27%

1.30%

1.36%

1.50%

1.56%

1.57%

1.64%

1.73%

1.79%

Borrowings

2.57%

2.69%

2.81%

3.22%

3.39%

3.24%

3.42%

3.34%

3.19%

   Total Interest Bearing Liabilities

1.65%

1.74%

1.82%

2.03%

2.13%

2.10%

2.21%

2.27%

2.29%

Rate Spread

3.03%

3.03%

2.99%

2.80%

2.88%

2.93%

3.07%

2.99%

3.11%

Net Interest Margin (3)

3.24%

3.23%

3.21%

3.06%

3.15%

3.17%

3.34%

3.27%

3.38%

Net Interest Margin without
     Tax Equivalent Adjustments

3.12%

3.09%

3.07%

2.92%

3.00%

3.01%

3.18%

3.10%

3.23%

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3) For purposes of these computations, interest income, net interest income and net interest margin are reported on a tax equivalent basis.

For the three and nine months ended September 30, 2011, the weighted average yield on average earning assets amounted to 4.68% and 4.76%, compared with 5.01% and 5.10% for the same periods in 2010, representing declines of 33 and 34 basis points, respectively. These declines principally reflected the origination and competitive re-pricing of certain commercial loans, residential mortgage loan refinancing activity, and the replacement of cash flows from the securities portfolio during a period of historically low interest rates.

For the three and nine months ended September 30, 2011, the weighted average cost of interest bearing liabilities amounted to 1.65% and 1.74%, compared with 2.13% and 2.14% for the same periods in 2010, representing declines of 48 and 40 basis points, respectively. These declines principally reflected both the ongoing re-pricing of maturing time deposits and borrowings, as well as the gathering of certain deposits and borrowings in a historically low interest rate environment.

Interest and Dividend Income: For the three months ended September 30, 2011, total interest and dividend income on a tax-equivalent basis amounted to $13,079, compared with $13,275 in the third quarter of 2010, representing a decline of $196, or 1.5%. The decline in interest and dividend income was principally attributed to a 33 basis point decline in the weighted average earning asset yield, largely offset by average earning asset growth of $57,720, or 5.5%.

For the quarter ended September 30, 2011, tax-equivalent interest income from the securities portfolio amounted to $4,255, representing a decline of $194, or 4.4%, compared with the third quarter of 2010. The decline in interest income from securities was principally attributed to a 46 basis point decline in the weighted average securities portfolio yield to 4.58%, but was largely offset by average securities portfolio growth of $18,587, or 5.3%, compared with the third quarter of 2010. The decline in the weighted average securities yield was largely attributed to the ongoing replacement of moderately accelerated portfolio cash flows in a historically low interest rate environment, combined with incremental securities purchases at prevailing low market yields. Accelerated cash flows were principally attributed to increased securitized loan refinancing activity and credit defaults.

For the quarter ended September 30, 2011, tax-equivalent interest income from the loan portfolio amounted to $8,813, representing a decline of $11 compared with the third quarter of 2010. While the average loan portfolio increased $41,573 or 6.1%, the impact of this increase was more than offset by a 31 basis point decline in the weighted average yield on the loan portfolio to 4.83%, compared with the third quarter of 2010. The decline in yield principally reflected the origination and competitive re-pricing of certain commercial loans, as well as elevated levels of residential mortgage loan refinancing activity during a period of historically low interest rates.

For the nine months ended September 30, 2011, total tax-equivalent interest and dividend income amounted to $39,427, compared with $39,666 for the same period in 2010, representing a decline of $239, or 0.6%. The decline in interest and dividend income was principally attributed to a 34 basis point decline in the weighted average earning asset yield, largely offset by earning asset growth of $69,319, or 6.7%.

For the nine months ended September 30, 2011, tax-equivalent interest income from the securities portfolio amounted to $13,204, representing a decline of $172, or 1.3%, compared with the same period in 2010. The decline in interest income from securities was principally attributed to a 47 basis point decline in the weighted average securities portfolio yield to 4.73%, largely offset by average portfolio growth of $29,478, or 8.6%. As more fully discussed immediately above, the decline in the weighted average securities yield was largely attributed to the ongoing replacement of accelerated portfolio cash flows in a historically low interest rate environment, incremental securities purchases at low prevailing market yields, as well as the previously reported portfolio cash flow impact of the cumulative Fannie Mae and Freddie Mac securitized loan buyouts in 2010.

For the nine months ended September 30, 2011, tax-equivalent interest income from the loan portfolio amounted to $26,188, representing a decline of $100 compared with the same period in 2010. While the average loan portfolio increased $40,804 or 6.0%, the impact of this increase was more than offset by a 32 basis point decline in the weighted average yield on the loan portfolio to 4.87%. The decline in yield principally reflected the origination and competitive re-pricing of certain commercial loans, as well as elevated levels of residential mortgage loan refinancing activity during a period of historically low interest rates.

Interest Expense: For the three months ended September 30, 2011, total interest expense amounted to $4,016, compared with $4,933 in the third quarter of 2010, representing a decline of $917, or 18.6%. The decline in interest expense was principally attributed to a 48 basis point decline in the weighted average cost of interest bearing liabilities, the impact of which was partially offset by a $46,592 or 5.1% increase in total average interest bearing liabilities, compared with the third quarter of 2010.

The decline in the third quarter weighted average cost of interest bearing liabilities compared with the same quarter in 2010 was principally attributed to prevailing, historically low short-term and long-term market interest rates, with maturing time deposits and borrowings being added or replaced at a lower cost and other interest bearing deposits re-pricing into the lower interest rate environment. For the three months ended September 30, 2011, the total weighted average cost of interest bearing liabilities amounted to 1.65%, compared with 2.13% for the same quarter in 2010, representing a decline of 48 basis points. The weighted average cost of interest bearing deposits declined 29 basis points to 1.27%, compared with the third quarter of 2010, while the weighted average cost of borrowed funds declined 82 basis points to 2.57%.

For the nine months ended September 30, 2011, total interest expense amounted to $12,652, compared with $14,639 for the same period in 2010, representing a decline of $1,987, or 13.6%. The decline in interest expense was principally attributed to a 40 basis point decline in the weighted average cost of interest bearing liabilities, the impact of which was partially offset by a $61,503 or 6.7% increase in total average interest bearing liabilities, compared with the nine months ended September 30, 2010.

The decline in the weighted average cost of interest bearing liabilities for the nine months ended September 30, 2011 compared with the same period in 2010 was principally attributed to prevailing, historically low short-term and long-term market interest rates, with maturing time deposits and borrowings being added or replaced at a lower cost and other interest bearing deposits re-pricing into the lower interest rate environment. For the nine months ended September 30, 2011, the total weighted average cost of interest bearing liabilities amounted to 1.74%, compared with 2.14% for the same period in 2010, representing a decline of 40 basis points. The weighted average cost of interest bearing deposits declined 28 basis points to 1.31%, while the weighted average cost of borrowed funds declined 66 basis points to 2.69%.

Rate/Volume Analysis: The following tables set forth a summary analysis of the relative impact on net interest income of changes in the average volume of interest earning assets and interest bearing liabilities, and changes in average rates on such assets and liabilities. The income from tax-exempt assets has been adjusted to a fully tax equivalent basis, thereby allowing uniform comparisons to be made. Because of the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes to volume or rate. For presentation purposes, changes which are not solely due to volume changes or rate changes have been allocated to these categories in proportion to the relationships of the absolute dollar amounts of the change in each. 

 ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
INCREASES (DECREASES) DUE TO:

Average
Volume

Average
Rate

Total
Change

Loans (1,3)        $530    $     (541)       $   (11)
Securities (2,3)          237 (431)          (194)
Investment in Federal Home Loan Bank stock           --- 11              11
Fed funds sold, money market funds, and time
     deposits with other banks             (2)             ---              (2)
TOTAL EARNING ASSETS        $765    $   (961)       $(196)
Interest bearing deposits           203           (500)          (297)
Borrowings            (43)           (577)          (620)
TOTAL INTEREST BEARING LIABILITIES        $160    $(1,077)       $(917)
NET CHANGE IN NET INTEREST INCOME        $605    $    116       $ 721

(1)  For purposes of these computations, non-accrual loans are included in average loans.
(2)  For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3)  For purposes of these computations, net interest income and net interest margin are reported on a tax equivalent basis.

 

ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
INCREASES (DECREASES) DUE TO:

Average
Volume

Average
Rate

Total
Change

Loans (1,3)     $1,921       $(2,021)     $   (100)
Securities (2,3)       1,164         (1,336)          (172)
Investment in Federal Home Loan Bank stock            ---               35             35
Fed funds sold, money market funds, and time
     deposits with other banks             (2)              ---               (2)
TOTAL EARNING ASSETS     $3,083       $(3,322)     $   (239)
Interest bearing deposits           579           (1,423)            (844)
Borrowings           324           (1,467)         (1,143)
TOTAL INTEREST BEARING LIABILITIES     $   903       $(2,890)     $(1,987)
NET CHANGE IN NET INTEREST INCOME     $2,180       $   (432)     $ 1,748

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, net interest income and net interest margin is reported on a tax equivalent basis.

Provision for Loan Losses

The provision for loan losses (the "provision) reflects the amount necessary to maintain the allowance for loan losses at a level that, in management’s judgment, is appropriate for the amount of inherent risk of probable loss in the Bank’s current loan portfolio.

The credit quality of the Bank’s loan portfolio remained relatively stable during the three and nine months ended September 30, 2011. During the first half of 2011 the Bank experienced a low level of loss experience, with total net loan charge offs amounting to $65, or annualized net charge offs to average loans outstanding amounting to 0.02% of total average loans outstanding. And, while still at elevated levels, the Bank’s non-performing loans were down slightly from December 31, 2010.

For the three months ended September 30, 2011, the Bank recorded a provision of $750, compared with $450 in the third quarter of 2010, representing an increase of $300, or 66.7%. The provision recorded in the third quarter was principally attributed to a $1,872 charge-off of a real estate development loan to a local, non-profit, housing authority in support of an affordable housing project, of which $1,200 had already been allocated for in the Bank’s allowance for loan losses in prior reporting periods. During the third quarter the Bank obtained current appraisals for this housing project and, based on revised prospects for future cash flows and other considerations, classified this loan as collateral dependent and recorded it at fair value in the Company’s financial statements. This loan became a problem loan for the Bank in 2009 when the local town reconsidered a previously approved bond issuance that failed to gain voter support. That, combined with a depressed real estate market and declining real estate values over the past few years, ultimately led to the charge off of $1,872. Failure to realize expected cash flows during the third quarter of 2011 resulted in the revised future cash flows mentioned above.

For the nine months ended September 30, 2011, the Bank recorded a provision of $1,850, compared with $1,500 for the same period in 2010, representing an increase of $350, or 23.3%. The increase in the provision was largely attributed to an affordable housing project loan discussed immediately above. For the nine months ended September 30, 2011, total net loan charge-offs amounted to $2,197 of which $1,872, or 85.2%, was attributed to an affordable housing project loan.

The overall credit quality of the Bank’s loan portfolio remained relatively stable during the three and nine months ended September 30, 2011. At September 30, 2011, total non-performing loans stood at $12,471, representing an improvement of 8.8%, compared with December 31, 2010. In addition to non-performing loans the Bank has loans that are 30-89 days delinquent, which at September 30, 2011 totaled $3,242, representing an improvement of 13.5% compared with December 31, 2010. The Bank also identifies potential problem commercial loans, which at September 30, 2011 totaled $4,830, representing an improvement of 0.7% compared with December 31, 2010.

Refer below to Item 2 of this Part I, Financial Condition, Loans, Non-Performing Loans, Potential Problem Loans and Allowance for Loan Losses, in this report on Form 10-Q for further discussion and analysis related to the provision for loan losses.

Non-interest Income

For the three months ended September 30, 2011, total non-interest income amounted to $2,064, compared with $2,065 for the same quarter in 2010, representing a decline of $1 or 0.0%.

For the nine months ended September 30, 2011, total non-interest income amounted to $5,281, compared with $5,770 for the same period in 2010, representing a decline of $489, or 8.5%. The year-to-date decline in non-interest income was principally attributed to a $637 decline in securities gains net of OTTI losses, as more fully discussed immediately below.

Total third quarter securities gains net of OTTI losses amounted to a net gain of $421, compared with a net gain of $407 in the third quarter of 2010, representing an increase of $14, or 3.4%. Third quarter net securities gains were comprised of realized gains on the sale of securities amounting to $993, offset by OTTI losses of $572 on certain available-for-sale, private label, residential mortgage-backed securities ("MBS"). For the nine months ended September 30, 2011, total securities gains net of OTTI losses amounted to a net gain of $587, compared with a net gain of $1,224 for the same period in 2010, representing a decline of $637, or 52.0%. Year-to-date net securities gains were comprised of realized gains on the sale of securities amounting to $2,313, offset by OTTI losses of $1,726 on certain available-for-sale, private label MBS. In all cases the OTTI losses represented management’s best estimate of credit losses on the mortgage loan collateral underlying certain private-label MBS. These credit losses principally reflected an increase in the loss severity and constant default rate estimates resulting from depressed and still declining real estate values, extended foreclosure timelines, and depressed economic conditions.

Further information regarding impaired securities, other-than-temporarily impaired securities, and evaluation of securities for impairment is incorporated by reference to Notes 2 and 4 of the consolidated financial statements in Part I, Item 1 of this quarterly report on Form 10-Q.

For the three months ended September 30, 2011, trust and other financial service fees amounted to $746, representing a decline of $54 compared with the third quarter of 2010. The decline in trust and other financial services fees was principally attributed to the recording of $69 in tax return preparation fee income in the third quarter of 2010, whereas in 2011 the majority of these fees are expected to be recorded in the fourth quarter. In addition, fees from brokerage activities declined $14 or 9.2% in the third quarter of 2011, compared with the same quarter in 2010. The foregoing declines were largely offset by a $43 or 13.5% increase in credit and debit card services and fees and a $7 or 1.9% increase in service charges on deposits, compared with the third quarter of 2010.

For the nine months ended September 30, 2011, income from trust and other financial services amounted to $2,261, compared with $2,136 for the same period in 2010, representing an increase of $125, or 5.9%. The increase in fee income from trust and financial services was largely attributed to new client relationships and increased brokerage activity. Quarter-end assets under management stood at $322,451, representing an increase of $21,422 or 7.1% compared with September 30, 2010.

For the nine months ended September 30, 2011, income from service charges on deposit accounts amounted to $997, compared with $1,051 for the same period in 2010, representing a decline of $54, or 5.1%. The decline in service charges on deposit accounts was principally attributed to a decline in deposit account overdraft fees, reflecting reduced overdraft activity and the impact of new regulations. On November 12, 2009, the Federal Reserve issued amendments to Regulation E implementing certain provisions of the Electronic Fund Transfer Act.  The new rules, which became effective on July 1, 2010, limit the ability of a bank to offer overdraft protection to deposit customers without their consent and to derive fees from overdraft programs.

For the nine months ended September 30, 2011, credit and debit card service charges and fees amounted to $940, compared with $844 for the same period in 2010, representing an increase of $96, or 11.4%. The increase in credit and debit card service charges and fees was principally attributed to continued growth of the Bank’s demand deposits and NOW accounts, higher levels of merchant credit card processing volumes, and continued success with a program that offers rewards for certain debit card transactions.

Non-interest Expense

For the three months ended September 30, 2011, total non-interest expense amounted to $5,684, compared with $5,518 in the third quarter of 2010, representing an increase of $166, or 3.0%. For the nine months ended September 30, 2011, total non-interest expense amounted to $16,981, compared with $16,115 for the same period in 2010, representing an increase of $866, or 5.4%.

The increases in non-interest expense during the three and nine months ended September 30, 2011 compared with the same periods in 2010 were principally attributed to increases in salaries and employee benefits. For the three and nine months ended September 30, 2011, total salaries and employee benefits expense amounted to $3,267 and $9,334, compared with $3,001 and $8,863 for the same periods in 2010, representing increases of $266 and $471, or 8.9% and 5.3%, respectively. The increases in salaries and employee benefits expense were principally attributed to normal increases in base salaries, increased employee health insurance costs, as well as changes in staffing levels and mix. The increase in third quarter salaries and employee benefits compared with the same quarter in 2010 was also attributed to $128 in health insurance credits recorded in the third quarter of 2010 based on favorable claims experience.

For the three and nine months ended September 30, 2011, the Company’s occupancy expenses were up $33 and $127, or 10.4% and 12.4%, respectively. These increases were largely attributed to higher levels of grounds keeping and utilities expenses.

For the three months ended September 30, 2011 other operating expenses declined $140, or 9.6%. This decrease was attributed to a wide variety of expense declines including tax preparation fees for trust clients, telecommunication expenses, professional services and shareholder related expenses, and staff development expenses. For the nine months ended September 30, 2011, other operating expenses increased $91, or 2.3%, compared with the same period in 2010. The Company also experienced moderate period-over-period increases in equipment depreciation, software depreciation and maintenance contracts, which were largely related to a variety of technology upgrades and new technology systems and applications.

Income Taxes

For the three months ended September 30, 2011, total income taxes amounted to $1,324, compared with $1,173 in the third quarter of 2010, representing an increase of $151, or 12.9%. For the nine months ended September 30, 2011, total income taxes amounted to $3,460, compared with $3,321 for the same period in 2010, representing an increase of $139, or 4.2%.

The Company's effective tax rates for the three and nine months ended Septemeber 30, 2011 amounted to 30.5% and 28.6%, compared with 29.0% and 27.8% for the same periods in 2010. The income tax provisions for these periods were less than the expense that would result from applying the federal statutory rate of 35% to income before income taxes, principally because of the impact of tax exempt interest income on certain investment securities, loans and bank owned life insurance.

Fluctuations in the Company’s effective tax rate are generally attributed to changes in the relationship between non-taxable income and non-deductible expense, and income before income taxes, during any given reporting period.

FINANCIAL CONDITION

Total Assets

The Company’s assets principally consist of loans and securities, which at September 30, 2011 represented 61.8% and 33.6% of total assets, compared with 62.7% and 32.0% at December 31, 2010, respectively.

At September 30, 2011, the Company’s total assets amounted to $1,156,032, compared with $1,117,933 at December 31, 2010, representing an increase of $38,099, or 3.4%.

Securities

The securities portfolio is comprised of Mortgage-backed securities ("MBS") issued by U.S. government agencies, U.S. government sponsored enterprises, and other non-agency, private label issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions, and debt obligations of other U.S. government sponsored enterprises.

Bank management considers securities as a relatively attractive means to effectively leverage the Bank’s strong capital position, as securities are typically assigned a significantly lower risk weighting compared with the Bank’s other earning assets for the purpose of calculating the Bank’s and the Company’s risk-based capital ratios. The overall objectives of the Bank’s strategy for the securities portfolio include maintaining appropriate liquidity reserves, diversifying earning assets, managing interest rate risk, leveraging the Bank’s strong capital position, and generating acceptable levels of net interest income.

Securities available for sale represented 100% of total securities at September 30, 2011, and December 31, 2010. Securities available for sale are reported at their fair value with unrealized gains or losses, net of taxes, excluded from earnings but shown separately as a component of shareholders’ equity. At September 30, 2011, total net unrealized securities gains amounted to $10,656, compared with net unrealized gains of $515 at December 31, 2010.

Total Securities: At September 30, 2011, total securities amounted to $388,415, compared with $357,882 at December 31, 2010, representing an increase of $30,533, or 8.5%. Of this increase, $10,141 was attributed to an increase in unrealized securities gains compared with December 31, 2010. Securities purchased during the first nine months of 2011 principally consisted of mortgage-backed securities issued and guaranteed by U.S. Government agencies and sponsored-enterprises.

The following tables summarize the securities available for sale portfolio as of September 30, 2011 and December 31, 2010:

September 30, 2011

Available for Sale:

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair Value

Obligations of US Government
     sponsored enterprises
     $    1,000       $       27       $    ---      $    1,027
Mortgage-backed securities:
     US Government-sponsored enterprises        232,369         10,209            220        242,358
     US Government agency          70,890          2,294              82          73,102
      Private label          15,175              589         1,532          14,232
Obligations of states and political
     subdivisions thereof
         58,325           1,963         2,592          57,696
Total      $377,759       $15,082       $4,426      $388,415

 

December 31, 2010

Available for Sale:

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair Value

Obligations of US Government
     sponsored enterprises
     $    1,000       $       34       $   ---      $   1,034
Mortgage-backed securities:
     US Government-sponsored enterprises        217,319           7,812            578        224,553
     US Government agency          56,083           1,216            356          56,943
     Private label          22,720              311         2,201          20,830
Obligations of states and political
     subdivisions thereof
         60,245              327         6,050          54,522
Total      $357,367       $  9,700       $9,185      $357,882

Impaired Securities: The securities portfolio contains certain securities where amortized cost exceeds fair value, which at September 30, 2011, amounted to an excess of $4,426, or 1.2% of the amortized cost of the total securities portfolio. At December 31, 2010 this amount represented an excess of $9,185, or 2.6% of the total securities portfolio. As of September 30, 2011, unrealized losses on securities in a continuous unrealized loss position more than twelve-months amounted to $3,970, compared with $6,618 at December 31, 2010.

As a part of the Company’s ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired. If a decline in the fair value of an available for sale security is judged to be other-than-temporary, a charge is recorded in pre-tax earnings equal to the estimated credit losses inherent in the security.

Further information regarding impaired securities, other-than-temporarily impaired securities and evaluation of securities for impairment is incorporated by reference to above Notes 2 and 4 of the interim consolidated financial statements in Part I, Item 1 of this report on Form 10-Q.

Federal Home Loan Bank Stock

The Bank is a member of the Federal Home Loan Bank of Boston (the "FHLB").  The FHLB is a cooperatively owned wholesale bank for housing and finance in the six New England states. Its mission is to support the residential mortgage and community-development lending activities of its members, which include over 450 financial institutions across New England. As a requirement of membership in the FHLB, the Bank must own a minimum required amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB.  The Bank uses the FHLB for most of its wholesale funding needs.

At September 30, 2011, the Bank’s investment in FHLB stock totaled $16,068, unchanged compared with December 31, 2010.

FHLB stock is a non-marketable equity security and therefore is reported at cost, which equals par value. Shares held in excess of the minimum required amount are generally redeemable at par value. However, in the first quarter of 2009 the FHLB announced a moratorium on such redemptions in order to preserve its capital in response to current market conditions and declining retained earnings. This moratorium continued throughout 2010 and the first nine months of 2011. The minimum required shares are redeemable, subject to certain limitations, five years following termination of FHLB membership. The Bank has no intention of terminating its FHLB membership.

In the first quarter of 2009, the FHLB advised its members that it was focusing on preserving capital in response to other-than-temporary impairment losses it had sustained, declining capital ratios and ongoing market volatility. Accordingly, dividend payments for all of 2009 were suspended and that continued to be the case throughout 2010. Following five consecutive quarters of profitability, the FHLB’s board of directors declared first, second, third and fourth quarter 2011 cash dividends equal to an annual yield of 0.30%, 0.31%, 0.27% and 0.30%, respectively, based on the average stock outstanding. The FHLB’s board of directors anticipates it will continue to declare modest cash dividends, but cautioned that adverse events such as a negative trend in credit losses on the FHLB’s private-label MBS or mortgage loan portfolio, a meaningful decline in income, or regulatory disapproval could lead to reconsideration of this plan.

The Company periodically evaluates its investment in FHLB stock for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. The FHLB recently reported that it remained in compliance with all regulatory capital ratios as of September 30, 2011, and, in the most recent information available, was classified "adequately capitalized" by its regulator, the Federal Housing Finance Agency, as of June 30, 2011. The FHLB also reported a total regulatory capital-to-asset ratio of 8.5% at September 30, 2011, exceeding the regulatory minimum requirement of 4.0%, and its permanent capital was $4.1 billion, exceeding its $850.9 million minimum regulatory risk-based capital requirement.

The FHLB has the capacity to issue additional debt if necessary to raise cash. If needed, the FHLB also has the ability to secure funding available to government-sponsored enterprises through the U.S. Treasury. Based on the capital adequacy, liquidity position and return to profitability of the FHLB, management believes there is no impairment related to the carrying amount of the Bank’s FHLB stock as of September 30, 2011. The Bank will continue to monitor its investment in FHLB stock.

Loans

Total Loans: At September 30, 2011, total loans stood at $714,218, compared with $700,670 at December 31, 2010, representing an increase of $13,548, or 1.9%.

The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington and Knox, Maine. The following table summarizes the components of the Bank's loan portfolio as of the dates indicated.

LOAN PORTFOLIO SUMMARY

September 30,
2011

December 31,
2010

Commercial real estate mortgages         $252,153         $260,357
Commercial and industrial             84,921             80,765
Commercial construction and land development             33,294             32,114
Agricultural and other loans to farmers             24,914             24,359
     Total commercial loans           395,282           397,595
Residential real estate mortgages           231,062           231,434
Home equity loans            54,501             54,289
Consumer loans             24,085               4,417
     Total consumer loans           309,648           290,140
Tax exempt loans               8,632             12,126
Deferred origination costs(fees), net                  656                  809
Total loans           714,218           700,670
Allowance for loan losses              (8,153)              (8,500)
Total loans net of allowance for loan losses         $706,065         $692,170

Commercial Loans: At September 30, 2011, total commercial loans amounted to $395,282, compared with $397,595 at December 31, 2010, representing a decline of $2,313, or 0.6%. Commercial loan growth has been challenged by declining loan demand reflecting a troubled economy, economic uncertainty, and strong competition for quality loans.

At September 30, 2011, commercial loans represented 55.3% of the Bank’s total loan portfolio, compared with 56.7% at December 31, 2010.

Consumer Loans: At September 30, 2011, total consumer loans, which principally consisted of residential real estate mortgage loans, amounted to $309,648, compared with $290,140 at December 31, 2010, representing an increase of $19,508, or 6.7%.

The increase in consumer loans was principally attributed to the purchase of a Maine-based, seasoned portfolio of prime consumer loans at the end of the first quarter of 2011. The underlying collateral supporting these consumer loans consisted of recreational vehicles and vessels (i.e. pleasure boats), and none of the loans purchased had any history of delinquency. Based on the weighted average note rate of this portfolio, the purchase premium paid, and the approximate weighted average life of 3.5 years, the Bank anticipates this portfolio will generate an earning asset yield of approximately 6.50%.

At September 30, 2011, the Bank’s residential real estate mortgage loan portfolio totaled $231,062, compared with $231,434 at December 31, 2010, representing a decline of $372, or 0.2%. Residential mortgage loan origination activity continued at a slow pace during the first nine months of 2011, largely reflecting current economic conditions, depressed real estate market values, and uncertainties with respect to further real estate declines in the communities served by the Bank. During the first nine months of 2011, loans originated and closed by the Bank were essentially offset by cash flows, principal pay-downs and loan re-financings from the existing residential real estate loan portfolio.

Tax Exempt Loans: At September 30, 2011, tax exempt loans, amounted to $8,632, compared with $12,126 at December 31, 2010, representing a decline of $3,494, or 28.8%.

Tax-exempt loans principally include loans to local government municipalities and, to a lesser extent, not-for-profit organizations. Government municipality loans typically have short maturities (e.g., tax anticipation notes). Government municipality loans are normally originated through a bid process among local financial institutions and are typically priced aggressively, thus generating relatively narrow net interest margins.

Credit Risk: Credit risk is managed through loan officer authorities, loan policies, and oversight from the Bank’s Senior Credit Officer, the Bank's Senior Loan Officers Committee, the Director's Loan Committee, and the Bank's Board of Directors. Management follows a policy of continually identifying, analyzing and grading credit risk inherent in the loan portfolio. An ongoing independent review, subsequent to management's review, of individual credits is performed by an independent loan review consulting firm, which reports to the Audit Committee of the Board of Directors.

As a result of management’s ongoing review of the loan portfolio, loans are placed on non-accrual status, either due to the delinquent status of principal and/or interest, or a judgment by management that, although payments of principal and or interest are current, such action is prudent because collection in full of all outstanding principal and interest is in doubt. Loans are generally placed on non-accrual status when principal and or interest is 90 days overdue, or sooner if judged appropriate by management. Consumer loans are generally charged-off when principal and/or interest payments are 120 days overdue, or sooner if judged appropriate by management.

Non-performing Loans: Non-performing loans include loans on non-accrual status, loans that have been treated as troubled debt restructurings and loans past due 90 days or more and still accruing interest. During the nine months ended September 30, 2011, there were no troubled debt restructurings in the loan portfolio. The following table sets forth the details of non-performing loans as of the dates indicated:

TOTAL NON-PERFORMING LOANS

September 30,
2011

December 31,
2010

Commercial real estate mortgages           $   3,568           $ 3,572
Commercial and industrial loans                1,242                 778
Commercial construction and land development                3,447              5,899
Agricultural and other loans to farmers                   118                 254
     Total commercial loans                8,375            10,503
Residential real estate mortgages               3,522              3,022
Home equity loans                  409                 146
Consumer loans                  126                  ---
     Total consumer loans               4,057              3,168
     Total non-accrual loans             12,432             13,671
Accruing loans contractually past due 90 days or more                    39                      6
     Total non-performing loans           $12,471           $13,677
Allowance for loan losses to non-performing loans

65%

62%

Non-performing loans to total loans

1.75%

1.95%

Allowance to total loans

1.14%

1.21%

At September 30, 2011, total non-performing loans amounted to $12,471, compared with $13,677 at December 31, 2010, representing a decline of $1,206, or 8.8%.

One commercial real estate loan to a local, non-profit affordable housing authority in support of an affordable housing project accounted for $3,218, or 25.8% of total non-performing loans at September 30, 2011, down from $5,194, or 38.0% at December 31, 2010. This loan is principally secured by the housing units from the project. The project is fully constructed and there is no further construction risk. The primary source of repayment is the sale of the housing units. This loan is impaired and was put on non-accrual status in 2010. During the quarter ended September 30, 2011 the Bank charged off $1,872 of the outstanding balance for this loan, of which $1,200 had already been allocated for in the Bank’s allowance for loan losses in prior reporting periods. During the third quarter the Bank obtained current appraisals for this housing project and, based on revised prospects for future cash flows and other considerations, classified this loan as collateral dependent and recorded it at fair value in the Company’s financial statements.

Non-performing commercial real estate mortgages amounted to $3,568 at September 30, 2011, down from $3,572 at December 31, 2010. At September 30, 2011, non-performing commercial real estate mortgages were represented by thirteen business relationships, with outstanding balances ranging from $22 to $879.

Non-performing commercial and industrial loans amounted to $1,242 at September 30, 2011, up from $778 at December 31, 2010. At September 30, 2011, non-performing commercial and industrial loans were represented by fourteen business relationships, with outstanding balances ranging from $3 to $373.

Non-performing commercial construction and land development loans totaled $3,447 at September 30, 2011, compared with $5,899 at December 31, 2010, representing a decline of $2,452. This category of non-performing loans included the $3,218 housing authority loan discussed immediately above. At September 30, 2011, non-performing commercial construction and land development loans were represented by two business relationships, with outstanding balances of $229 and $3,218.

Non-performing residential real estate mortgages totaled $3,522 at September 30, 2011, compared with $3,022 at December 31, 2010, representing an increase of $500, or 16.5%. At September 30, 2011, non-performing residential real estate loans were represented by thirty-nine, conventional, 1-4 family mortgage loans, with outstanding balances ranging from $5 to $446.

While the level and mix of non-performing loans continued to reflect favorably on the overall quality of the Bank’s loan portfolio at September 30, 2011, Bank management is cognizant of the weakened real estate market, elevated unemployment rates and depressed economic conditions overall. Bank management recognizes that the current credit cycle has yet to reach a definitive turning point and it may be some time before the overall level of credit quality in the Bank’s loan portfolio shows lasting improvement. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Bank’s customers, including debt service levels, declining collateral values, tourism activity, consumer confidence and other factors existing at the time. Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Company’s results of operations and financial condition.

Delinquencies and Potential Problem Loans: In addition to the non-performing loans discussed above, the Bank also has loans that are 30 to 89 days delinquent and still accruing. These loans amounted to $3,242 and $3,749 at September 30, 2011 and December 31, 2010, or 0.45% and 0.54% of total loans, respectively, net of any loans classified as non-performing that are within these delinquency categories. These loans and delinquency trends in general are considered in the evaluation of the allowance for loan losses and the related determination of the provision for loan losses.

Periodically, the Bank reviews the commercial loan portfolio for evidence of potential problem loans. Potential problem loans are loans that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the borrower causes doubt about the ability of the borrower to comply with the loan payment terms and may result in disclosure of such loans as non-performing at some time in the future.

At September 30, 2011, the Bank identified twenty-five commercial relationships totaling $4,830 as potential problem loans, or 0.68% of total loans. At December 31, 2010, the Bank identified eighteen commercial relationships totaling $4,886 as potential problem loans, or 0.70% of total loans. Factors such as payment history, value of supporting collateral, and personal or government guarantees led the Bank to conclude that the current risk exposure on these potential problem loans did not warrant accounting for the loans as non-performing. Although in a performing status as of quarter-end, these loans exhibited certain risk factors, which have the potential to cause them to become non-performing at some point in the future.

Allowance for Loan Losses: At September 30, 2011, the allowance for loan losses (the "allowance") stood at $8,153, compared with $8,500 at December 31, 2010, representing a decline of $347, or 4.1%. The decline in the allowance from December 31, 2010 was principally attributed to the charge-off of a commercial construction and land development loan in the current quarter as discussed immediately above under non-performing loans, of which $577 was allocated for in the Bank’s December 31, 2010 allowance.

At September 30, 2011, the allowance expressed as a percentage of total loans stood at 1.14%, down from 1.21% at December 31, 2010. At September 30, 2011, the allowance expressed as a percentage of non-performing loans stood at 65.4%, up from 62.1% at December 31, 2010. At September 30, 2011, total non-performing loans to total loans stood at 1.75%, down from 1.95% at December 31, 2010. The foregoing changes principally resulted from the commercial construction and land development loan charge-off discussed immediately above, combined with declines in non-performing loans, 30-90 day delinquent performing loans, and potential problem loans, compared with December 31, 2010.

The allowance is available to absorb probable losses on loans. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated quarterly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration.

The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the current loan portfolio, and adequate to provide for estimated, probable losses. Allowances are established for specific impaired loans, a pool of reserves based on historical net loan charge-offs by loan types, and supplemental reserves that adjust historical net loss experience to reflect current economic conditions, industry specific risks, and other qualitative and environmental considerations impacting the inherent risk of loss in the current loan portfolio.

Specific allowances for impaired loans are determined based upon a discounted cash flows analysis, or as appropriate, a collateral shortfall analysis. The amount of collateral dependent impaired loans totaled $2,877 as of September 30, 2011, compared with $3,044 as of December 31, 2010. The related allowances for loan losses on these loans amounted to $579 as of September 30, 2011, compared with $334 as of December 31, 2010.

Management recognizes that early and accurate recognition of risk is the best means to reduce credit losses. The Bank employs a comprehensive risk management structure to identify and manage the risk of loss. For consumer loans, the Bank identifies loan delinquency beginning at 10-day delinquency and provides appropriate follow-up by written correspondence or personal contact. Non-residential mortgage consumer loan losses are recognized no later than the point at which a loan is 120 days past due. Residential mortgage losses are recognized during the foreclosure process, or sooner, when that loss is quantifiable and reasonably assured. For commercial loans, the Bank applies a risk grading system, which stratifies the portfolio and allows management to focus appropriate efforts on the highest risk components of the portfolio. The risk grades include ratings that correlates substantially with regulatory definitions of "Pass," "Other Assets Especially Mentioned," "Substandard," "Doubtful," and "Loss."

While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.

The following table details changes in the allowance and summarizes loan loss experience by loan type for the nine-month periods ended September 30, 2011 and 2010.

ALLOWANCE FOR LOAN LOSSES
NINE MONTHS ENDED
SEPTEMBER 30, 2011 AND 2010

2011

2010

Balance at beginning of period

$   8,500

   $    7,814

Charge offs:
Commercial real estate mortgages               99             374
Commercial and industrial               48               93
Commercial construction and land development          1,993             167
Agricultural and other loans to farmers              ---              ---
Residential real estate mortgages             178             160
Consumer loans               30               90
Home equity loans               56             100
Tax exempt loans              ---              ---
     Total charge-offs          2,404             984
Recoveries:
Commercial real estate mortgages                 7                 1
Commercial and industrial loans               81                 2
Commercial construction and land development               ---              ---
Agricultural and other loans to farmers               45                 3
Residential real estate mortgages               40             105
Consumer loans               34               58
Home equity loans              ---               41
Tax exempt loans              ---              ---
     Total recoveries             207             210
Net charge-offs          2,197             774
Provision charged to operations          1,850          1,500
  
Balance at end of period    $    8,153    $    8,540
  
Average loans outstanding during period    $718,633    $677,829
  
Annualized net charge-offs to average loans outstanding

0.41%

0.15%

The Bank’s loan losses significantly exceeded historical experience for the three and nine months ended September 30, 2011. For the three months ended September 30, 2011, total net loan charge-offs amounted to $2,132, of which $1,872 or 87.8% was attributed to the non-performing affordable housing project loan discussed immediately above. For the nine months ended September 30, 2011, total net loan charge-offs amounted to $2,197, or annualized net charge-offs to average loans outstanding of 0.41%, compared with $744 or 0.15% for the same period in 2010. Of the $2,197 in year-to-date 2011 charge-offs, 85.2% was attributed to the affordable housing project loan discussed immediately above.

General allowances for loan losses account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There were no material changes in loan concentrations during the nine months ended September 30, 2011.

Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, Company management believes the allowance for loan losses at September 30, 2011, is appropriate for the amount of risk inherent in the current loan portfolio and adequate to provide for estimated probable losses.

Further information regarding loans and the allowance for loan losses, is incorporated by reference to above Notes 5, Loans and Allowance for Loan Losses, of the interim consolidated financial statements in Part I, Item 1 of this report on Form 10-Q.

Other Real Estate Owned: Real estate acquired in satisfaction of a loan is reported in other assets. Properties acquired by foreclosure or deed in lieu of foreclosure are transferred to other real estate owned ("OREO") and recorded at the lower of cost or fair market value less estimated costs to sell based on appraised value at the date actually or constructively received. Loan losses arising from the acquisition of such property are charged against the allowance for loan losses. Subsequent reductions in fair value below the carrying value are charged to other operating expenses.

At September 30, 2011, the Bank’s OREO consisted of ten properties with a carrying value of $1,500 compared with four properties with a carrying value of $656 at December 31, 2010. Eight residential and two commercial properties comprised the September 30, 2011 balance of OREO.

Deposits

During the three and nine months ended September 30, 2011, the most significant funding source for the Bank’s earning assets continued to be retail deposits, gathered through its network of twelve banking offices throughout downeast and midcoast Maine.

Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring and higher deposits in summer and autumn. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Seasonal swings in deposits have been typically absorbed by the Bank’s strong liquidity position, including borrowing capacity from the FHLB of Boston, brokered certificates of deposit obtained from the national market and cash flows from the securities portfolio.

At September 30, 2011, total deposits stood at $762,094, compared with $708,328 at December 31, 2010, representing an increase of $53,766, or 7.6%.

At September 30, 2011, the Bank’s demand deposits and now accounts combined totaled $167,434 compared with $143,006 at December 31, 2010, representing an increase of $24,428 or 17.1%, largely reflecting the seasonality of the Bank’s deposit base. At September 30, 2011 the Bank’s savings, money market and time deposits totaled $594,660, compared with $565,322 at December 31, 2010, representing an increase of $29,338, or 5.2%.

A portion of the Bank’s time deposits include certificates of deposit obtained from the national market. This source of funds is generally utilized to help support the Bank’s earning asset growth and seasonal deposit outflows, while maintaining its strong on-balance-sheet liquidity position via secured borrowing lines of credit with the FHLB of Boston and the Federal Reserve Bank of Boston.

Bank management believes it has exercised restraint with respect to overly aggressive deposit pricing strategies, and has sought to achieve an appropriate balance between retail deposit growth and wholesale funding levels, while considering the associated impacts on the Bank’s net interest margin and liquidity position. In offering time deposits, the Bank generally prices these deposits on a relationship basis. At September 30, 2011, the weighted average cost of time deposits was 1.90% compared with 2.13% at December 31, 2010. Given the current, historically low interest rate environment and the Bank’s continuing rate of time deposit maturities, Company management anticipates that the weighted average cost of time deposits will continue to show declines over the next twelve months.

Borrowed Funds

Borrowed funds principally consist of advances from the FHLB of Boston (the "FHLB") and, to a lesser extent, securities sold under agreements to repurchase, Fed funds purchased and borrowings from the Federal Reserve Bank of Boston. Advances from the FHLB are secured by stock in the FHLB, investment securities, blanket liens on qualifying mortgage loans and home equity loans, and certain commercial real estate loans. Borrowings from the Federal Reserve Bank of Boston are principally secured by municipal securities and liens on certain commercial real-estate loans.

The Bank utilizes borrowed funds to leverage its strong capital position and support its earning asset portfolios. Borrowed funds are principally utilized to support the Bank’s investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk, given the Bank’s ability to select desired amounts, terms and maturities on a daily basis.

At September 30, 2011, total borrowings amounted to $270,962, compared with $300,014 at December 31, 2010, representing a decline of $29,052, or 9.7%, compared with December 31, 2010. The decline in total borrowings was principally attributed to strong seasonal deposit inflows that were largely used to pay down borrowings. In addition, during the nine months ended September 30, 2011, the Bank shifted a portion of its borrowings from the FHLB to long-term brokered certificates of deposits at historically low interest rates, which strengthened both its on-balance-sheet interest rate risk profile and its on balance sheet liquidity position.

Capital Resources

Consistent with its long-term goal of operating a sound and profitable organization, at September 30, 2011, the Company maintained its strong capital position and continued to be a ""well-capitalized" financial institution according to applicable regulatory standards. Management believes this to be vital in promoting depositor and investor confidence and providing a solid foundation for future growth.

Capital Ratios: The Company and the Bank are subject to the risk-based capital guidelines administered by the Company’s and the Bank's principal regulators. The risk-based capital guidelines are designed to make regulatory 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. Under these guidelines, 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 risk-weighted assets and off-balance sheet items. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk-based capital to risk-weighted assets of 8%, including a minimum ratio of Tier I capital to total risk-weighted assets of 4% and a Tier I capital to average assets of 4% ("Leverage Ratio"). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the Company's financial statements.

As of September 30, 2011, the Company and the Bank were considered well-capitalized under the regulatory framework for prompt corrective action. Under the capital adequacy guidelines, a well-capitalized institution must maintain a minimum total risk-based capital to total risk-weighted assets ratio of at least 10.0%, a minimum Tier I capital to total risk-weighted assets ratio of at least 6.0%, and a minimum Tier I Leverage ratio of at least 5.0%. At September 30, 2011 the Company’s Total Risk-based, Tier I Risk-based, and Tier I Leverage ratios were 16.16%, 14.38% and 9.30%, respectively.

The following tables set forth the Company's and the Bank’s regulatory capital at September 30, 2011 and December 31, 2010, under the rules applicable at that date.

Consolidated

For Capital
Adequacy Purposes

To be well
Capitalized under
Prompt corrective
Action provisions

As of December 31, 2010

Actual
Amount

 

Ratio

Required
Amount

 

Ratio

Required
Amount

 

Ratio

Total Capital
     (To Risk-Weighted Assets)
          Consolidated $120,157 16.16% $59,472 8.0% N/A
          Bank $120,210 16.19% $59,388 8.0% $74,235 10.0%
Tier 1 Capital
      (To Risk-Weighted Assets)
          Consolidated $106,898 14.38% $29,736 4.0% N/A
          Bank $106,951 14.41% $29,694 4.0% $44,541 6.0%
Tier 1 Capital
     (To Average Assets)
          Consolidated $106,898 9.30% $45,964 4.0% N/A
          Bank $106,951 9.31% $45,927 4.0% $57,409 5.0$

 

Consolidated

For Capital
Adequacy Purposes

To be well
Capitalized under
Prompt corrective
Action provisions

As of December 31, 2010

Actual
Amount

 

Ratio

Required
Amount

 

Ratio

Required
Amount

 

Ratio

Total Capital
     (To Risk-Weighted Assets)
          Consolidated

$113,741

15.41%

$59,065

8.0%

N/A

          Bank

$114,735

15.56%

$58,999

8.0%

$73,748

10.0%

Tier 1 Capital
      (To Risk-Weighted Assets)
          Consolidated

$100,166

13.57%

$29,532

4.0%

N/A

          Bank

$101,160

13.72%

$29,499

4.0%

$44,249

6.0%

Tier 1 Capital
     (To Average Assets)
          Consolidated

$100,166

9.01%

$44,493

4.0%

N/A

          Bank

$101,160

9.10%

$44,459

4.0%

$55,574

5.0%

Series A Fixed Rate Cumulative Perpetual Preferred Stock and Warrant: As previously reported, on February 24, 2010 the Company redeemed all 18,751 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the "Preferred Stock") sold to the U.S. Department of the Treasury (the "Treasury") in the first quarter of 2009 as part of the Capital Purchase Program ("CPP") established by the Treasury under the Emergency Economic Stabilization Act of 2008. The Company paid $18,774 to the Treasury to redeem the Preferred Stock, consisting of $18,751 of principal and $23 of accrued and unpaid dividends. As a result of the repurchase, the Company accelerated the accretion of $496 in preferred stock discount, reducing first quarter 2010 net income available to common shareholders and diluted earnings per share by $496 and $0.13, respectively. Total preferred stock dividends and accretion of discount amounted to $653 for the nine months ended September 30, 2010, compared with none in 2011.

In the fourth quarter of 2009, the warrant (the "Warrant") received by the Treasury to purchase up to 104,910 shares of the Company’s common stock was reduced by one half to 52,455 shares with an exercise price of $26.81 per share. As previously announced, on July 28, 2010 the Company repurchased the Warrant in its entirety for $250,000. The repurchase of the Warrant did not have any effect on the Company’s earnings or earnings per share. As a result of the Warrant repurchase, the Company has repurchased all securities issued to Treasury under the CPP.

Common Stock Offering: In December 2009 the Company completed its previously announced offering of 800,000 shares of common stock to the public at $27.50 per share. The net proceeds from this offering, after deducting underwriting discounts and estimated expenses amounted to $20,412. As previously reported, in January 2010 the Company completed the closing of the underwriter’s exercise of its over-allotment option to purchase an additional 82,021 shares of the Company’s common stock at a purchase price to the public of $27.50 per share. The Company received total net proceeds from the offering, including the exercise of the over allotment option, after deducting underwriting discounts and expenses, amounting to approximately $22,411. All of the net proceeds from this offering are treated as Tier 1 capital for regulatory purposes. In February 2010, the Company used $18,751 of the net proceeds from this offering to repurchase all of its Preferred Stock sold to the U.S. Department of the Treasury.

Trends, Events or Uncertainties: There are no known trends, events or uncertainties, nor any recommendations by any regulatory authority, that are reasonably likely to have a material effect on the Company’s capital resources, liquidity, or financial condition.

Cash Dividends: The Company's principal source of funds to pay cash dividends and support its commitments is derived from Bank operations.

The Company paid a regular cash dividend of $0.275 per share of common stock in the third quarter of 2011, representing an increase of $0.015 or 5.8% compared with the dividend paid for the same quarter in 2010. The Company’s Board of Directors recently declared a fourth quarter 2011 regular cash dividend of $0.28 per share of common stock, representing an increase of $0.015, or 5.7% compared with the fourth quarter of 2010.

Stock Repurchase Plan: In August 2008, the Company’s Board of Directors approved a program to repurchase up to 300,000 shares of the Company’s common stock, or approximately 10.2% of the shares then currently outstanding. The new stock repurchase program became effective as of August 21, 2008 and was authorized to continue for a period of up to twenty-four consecutive months. In August of 2010, the Company’s Board of Directors authorized the continuance of this program through August 19, 2012. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time to time, without prior notice and may be made in the open market or through privately negotiated transactions.

As of September 30, 2011, the Company had repurchased 87,576 shares of stock under this plan, at a total cost of $2,412 and an average price of $27.55 per share. During the nine months ended September 30, 2011, 10,794 shares were repurchased under the plan. The Company recorded the repurchased shares as treasury stock.

Off-Balance Sheet Arrangements

The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be considered material to investors.

Standby Letters of Credit: The Bank guarantees the obligations or performance of certain customers by issuing standby letters of credit to third parties. These letters of credit are sometimes issued in support of third party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.

At September 30, 2011, commitments under existing standby letters of credit totaled $717, compared with $750 at December 31, 2010. The fair value of the standby letters of credit was not significant as of the foregoing dates.

Commitments to Extend Credit: Commitments to extend credit represent agreements by the Bank to lend to a customer provided there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.

Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis using the same credit policies as it does for its balance sheet instruments. The amount of collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is based on management's credit evaluation of the customer.

The following table details the notional or contractual amount for financial instruments with off-balance sheet risk as of September 30, 2011 and December 31, 2010:

September 30,
2011

December 31,
2010

Commitments to originate loans         $  27,673          $  24,112
Unused lines of credit             89,953              91,753
Un-advanced portions of construction loans               8,705              11,215
     Total         $126,331          $127,080

Liquidity

Liquidity is measured by the Company’s ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer-initiated needs. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.

The Bank actively manages its liquidity position through target ratios established under its asset liability management policy. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity. A portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.

The Bank uses a basic surplus model to measure its liquidity over 30 and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Bank’s general policy is to maintain a liquidity position of at least 4.0% of total assets. At September 30, 2011, liquidity, as measured by the basic surplus/deficit model, was 11.4% over both the 30-day and 90-day horizons.

At September 30, 2011, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB of Boston approximating $150 million. The Bank also had capacity to borrow funds on a secured basis utilizing the Borrower-In-Custody ("BIC") program and the Discount Window at the Federal Reserve Bank of Boston. At September 30, 2011 the Bank’s available secured line of credit at the Federal Reserve Bank of Boston stood at $177,288, or 15.3% of the Company’s total assets. The Bank also has access to the national brokered deposit market, and has been using this funding source to bolster its on-balance sheet liquidity position.

The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company. The Company believes that the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position.

Impact of Inflation and Changing Prices

The Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements presented elsewhere in this report have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.

Unlike many industrial companies, substantially all of the assets and virtually all of the liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates and the U.S. Treasury yield curve may not necessarily move in the same direction or in the same magnitude as inflation.

While the financial nature of the Company’s consolidated balance sheets and statements of income is more clearly affected by changes in interest rates than by inflation, inflation does affect the Company because as prices increase the money supply tends to increase, the size of loans requested tends to increase, total Company assets increase, and interest rates are affected by inflationary expectations. In addition, operating expenses tend to increase without a corresponding increase in productivity. There is no precise method, however, to measure the effects of inflation on the Company’s financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation.

Recent Accounting Developments

The following information addresses new or proposed accounting standards that could have an impact on the Company’s financial condition or results of operations.

Accounting Standards Update ("ASU") No. 2010-20, "Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses." ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a roll-forward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period became effective for the Company’s financial statements beginning on January 1, 2011. ASU 2011-01, "Receivables (Topic 310) - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20," temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of the then proposed ASU 2011-02, "Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring," which is further discussed below.

ASU No. 2010-28, "Intangibles - Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. ASU 2010-28 became effective for the Company on January 1, 2011 and did not have an impact on the Company’s financial statements.

ASU No. 2011-02, "Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring." ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 became effective for the Company on July 1, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. Adoption of ASU 2011-02 did not have a significant impact on the Company’s financial statements.

In August 2011, the FASB issued ASU No. 2011-08, "Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment." This ASU permits an entity to first assess qualitative factors in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for identifying whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. Previous guidance under Topic 350 required an entity to test goodwill for impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount, including goodwill (step one). If the fair value of a reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the amount of the impairment loss, if any. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. This guidance is effective for annual periods for fiscal years ending after December 15, 2011, with early adoption permitted. The Company believes the adoption of this new guidance will not have a material effect on the Company's consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05 "Comprehensive Income (Topic 220) — Presentation of Comprehensive Income." ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU2011-05 is effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company is assessing the impact of ASU 2011-05 on our comprehensive income presentation.

In May 2011, the FASB issued ASU No. 2011-04 "Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs." ASU 2011-04 changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. Consequently, the amendments in this update result in common fair value measurement and disclosure requirements in GAAP and IFRSs (International Financial Reporting Standards). ASU 2011-04 is effective prospectively during interim and annual periods beginning on or after December 15, 2011. Early application by public entities is not permitted. The Company is assessing the impact of ASU 2011-04 on its fair value disclosures.

In April 2011, the FASB issued ASU No. 2011-03 "Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreement." ASU 2011-03 removes from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. ASU 2011-03 is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company believes that the adoption of the standard will not have a significant impact on the Company’s consolidated financial statements.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Company’s business activities.

Interest Rate Risk: Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.

The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by the Asset/Liability Committee ("ALCO") and the Bank’s Board of Directors.

The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.

The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense of all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.

The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage backed securities are developed from industry median estimates of prepayment speeds, based upon similar coupon ranges and seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:

  • A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption.

  • A 200 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve-month period together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.

  • Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.

  • An extension of the foregoing simulations to each of two, three, four and five year horizons to determine the interest rate risk with the level of interest rates stabilizing in years two through five. Even though rates remain stable during this two to five year time period, re-pricing opportunities driven by maturities, cash flow, and adjustable rate products will continue to change the balance sheet profile for each of the rate conditions.

Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines.

The following table summarizes the Bank's net interest income sensitivity analysis as of September 30, 2011, over one and two-year horizons and under rising and declining interest rate scenarios. In light of the Federal Funds rate of 0% - 0.25% and the two-year U.S. Treasury note of 0.24% on the date presented, the analysis incorporates a declining interest rate scenario of 100 basis points, rather than the 200 basis points, as would traditionally be the case.

INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
SEPTEMBER 30, 2011

-100 Basis Points Parallel Yield Curve Shift

+200 Basis Points Parallel Yield Curve Shift

Year 1

Net interest income ($)

$(360)

$20

Net interest income (%)

-1.02%

0.06%

Year 2

Net interest income ($)

$(1,892)

$1,435

Net interest income (%)

-5.39%

4.09%

As more fully discussed below, the September 30, 2011 interest rate sensitivity modeling results indicate that the Bank’s balance sheet was about evenly matched over the one and two-year horizons.

Assuming interest rates remain at or near their current levels and the Bank’s balance sheet structure and size remain at current levels, the interest rate sensitivity simulation model suggests that net interest income will remain relatively stable over the one-year horizon and then begin to trend upward over the two-year horizon and beyond. The upward trend over the two-year horizon and beyond principally results from funding costs rolling over at lower prevailing rates while earning asset yields remain relatively stable.

Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will decline moderately over the one and two-year horizons as declining earning assets yields outpace reductions in funding costs. Should the yield curve steepen as rates fall, the model suggests that accelerated earning asset prepayments will slow, resulting in a more stabilized level of net interest income. Management anticipates that moderate earning asset growth will be needed to meaningfully increase the Bank’s current level of net interest income should both long-term and short-term interest rates decline in parallel.

Assuming the Bank’s balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points with the balance of the yield curve shifting in parallel with these increases, management believes net interest income will remain stable over the one-year horizon and then trend steadily upward over the two-year horizon and beyond. The interest rate sensitivity simulation model suggests that as interest rates rise, the Bank’s funding costs will initially re-price proportionately with earning asset yields. As funding costs begin to stabilize late in the first year of the simulation, the model suggests that the earning asset portfolios will continue to re-price at prevailing interest rate levels and cash flows from the Bank’s earning asset portfolios will be reinvested into higher yielding earning assets, resulting in a widening of spreads and increases in net interest income over the two year horizon and beyond. Management believes moderate earning asset growth will be necessary to meaningfully increase the current level of net interest income over the one-year horizon should short-term and long-term interest rates rise in parallel. Over the two-year horizon and beyond, management believes low to moderate earning asset growth will be necessary to meaningfully increase the current level of net interest income.

Management believes the most significant ongoing factor affecting market risk exposure and the impact on net interest income continues to be the very slow recovery from the severe nationwide recession and the U.S. Government’s extraordinary responses, including a variety of government stimulus programs and quantitative easing strategies. Interest rates plummeted during 2008 and have remained historically low ever since, as the global economy slowed at unprecedented levels, unemployment levels soared, delinquencies on all types of loans increased along with decreased consumer confidence and dramatic declines in housing prices. Net interest income exposure is also significantly affected by the shape and level of the U.S. Government securities and interest rate swap yield curve, and changes in the size and composition of the Bank’s loan, investment and deposit portfolios.

The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows, and renegotiated loan terms with borrowers. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate change caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Bank’s ALCO and board of directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Bank’s net interest income.

ITEM 4. CONTROLS AND PROCEDURES

Company management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report. Based on such evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company's disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and regulations and are operating in an effective manner.

No change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1: Legal Proceedings

The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management based upon currently available information will have no material effect on the Company's consolidated financial statements.

Item 1A: Risk Factors

There have been no material changes to the Risk Factors previously disclosed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year-ended December 31, 2010.

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

            (a)     None

            (b)     None

            (c)     The following table provides information with respect to any purchase of shares of the Company’s stock made by or on behalf of the Company or any "affiliated purchaser," for the quarter ended September 30, 2011.

(a)

(b)

(c )

(d)

Period

Total Number of Shares Purchased

Average Price Paid per Share

Total Number of Shares Purchased
as Part of Publicly Announced Plans
or Programs

Maximum Number of Shares that May
Yet Be Purchased Under the Plans or Programs (1)

July 1-31, 2011         1,220

$28.31

               1,220

217,778

August 1-31, 2011            870

$28.33

                  870

216,908

September 1-30, 2011         4,484

$28.20

               4,484

212,424

Item 3: Defaults Upon Senior Securities None

Item 4: (Removed and Reserved)

Item 5: Other Information

            (a)     None

            (b)     None

Item 6: Exhibits

The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index hereto and are incorporated herein by reference.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

BAR HARBOR BANKSHARES
(Registrant)

/s/ Joseph M. Murphy

Date: November 8, 2011

Joseph M. Murphy

President & Chief Executive Officer

   

/s/ Gerald Shencavitz

Date: November 8, 2011

Gerald Shencavitz

Executive Vice President, Chief Financial Officer
& Principal Accounting Officer

 

 

Exhibit Index

3.1

Articles of Incorporation, as amended to date (incorporated herein by reference to Form 10-K, Part IV, Item 15, Exhibit 3.1, filed with the Commission on March 16, 2009).

3.2

Bylaws, as amended to date (incorporated herein by reference to Form 8-K, Exhibit 3, filed with the Commission on December 17, 2008).

4

Instruments Defining Rights of Security Holders

4.1

Certificate of Designations, Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated herein by reference to Form 8-K, Exhibit 3.1, filed with the Commission on January 21, 2009).

4.2

Form of Specimen Stock Certificate for Series A Preferred Stock (incorporated by reference to Form 8-K, Exhibit 4.1, filed with the Commission on January 21, 2009).

4.3

Debt Securities Purchase Agreement (incorporated herein by reference to Form 10-K, Part IV, Item 15, Exhibit 4.5, filed with the commission on March 16, 2009).

4.4

Form of Subordinated Debt Security of Bar Harbor Bank & Trust (incorporated herein by reference to Form 10-K, Part IV, Item 15, Exhibit 4.6, filed with the commission on March 16, 2009).
11.1 Statement re computation of per share earnings (data required by SFAS No. 128, Earnings Per Share, is provided in Note 3 to the consolidated financial statements in this report on Form 10-Q).

31.1*

Certification of the Chief Executive Officer under

Rule 13a-14(a)/15d-14(a)

31.2*

Certification of the Chief Financial Officer under

Rule 13a-14(a)/15d-14(a)

32.1**

Certification of Chief Executive Officer under

18 U.S.C. Section 1350

32.2**

Certification of Chief Financial Officer under

18 U.S.C. Section 1350

101*** Financial statements from the quarterly report on Form 10-Q of Bar Harbor Bankshares for the quarter ended September 30, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Shareholders’ Equity and Comprehensive Income, (iv) the Consolidated Statements of Cash Flows and (v) Notes to Consolidated Financial Statements.

 

101.INS

XBRL Instance Document

101.SCH

XBRL Taxonomy Extension Schema

101.CAL

XBRL Taxonomy Extension Calculation Linkbase

101.DEF

XBRL Taxonomy Extension Definitions Linkbase

101.LAB

XBRL Taxonomy Extension Labels Linkbase

101.PRE

XBRL Taxonomy Extension Presentation Linkbase


* Filed herewith.

** Furnished herewith.

*** Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.