10-K 1 bhb201310k2013.htm UNITED STATES

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K


þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013

 

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________.


Commission File Number: 001-13349

BAR HARBOR BANKSHARES

(Exact name of registrant as specified in its charter)


Maine

(State or other jurisdiction of

incorporation or organization)

 

01-0393663

(I.R.S. Employer

Identification No.)

 

 

 

P.O. Box 400, 82 Main Street

Bar Harbor, Maine

(Address of principal executive offices)

04609-0400

(Zip Code)

(207) 288-3314

(Registrant’s telephone number,

 including area code)


Securities registered pursuant to Section 12(b) of the Act:


          Title of class                                                Name of exchange on which registered        

  Common Stock, $2.00 par value per share

     NYSE MKT, LLC


Securities registered pursuant to Section 12(g) of the Act:  None


Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: YES ¨ NO þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act: YES ¨ NO þ

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 registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: YES þ NO ¨

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, 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 þ NO ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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 þ 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 þ

The aggregate market value of the common stock held by non-affiliates of Bar Harbor Bankshares was $139,069,826 based on the closing sale price of the common stock on the NYSE MKT on June 28, 2013, the last trading day of the registrant’s most recently completed second quarter.

Number of shares of Common Stock par value $2.00 outstanding as of March 3, 2014:  3,940,790


DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 20, 2014 are incorporated by reference into Part III, Items 10-14 of this Annual Report on Form 10-K.



FORWARD-LOOKING STATEMENTS DISCLAIMER


Certain statements, as well as certain other discussions contained in this Annual Report on Form 10-K, 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 operations, financial condition, and the business of Bar Harbor Bankshares (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)

 

Adverse changes in repayment performance and fair value of underlying residential mortgage loan collateral, that differ from the Company’s current estimates, could change the Company’s expectations that it will recover the amortized cost of its private label mortgage backed securities portfolio and/or its conclusion that such securities were not other-than temporarily impaired as of the date of this report;

 

 

 

(vi)

 

The Company’s allowance for loan losses may be adversely impacted by a variety of factors, including, but not limited to, the performance of the Company’s loan portfolio, the economy, changes in interest rates, and the view of regulatory authorities toward loan classifications;

 

 

 



2





(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 this Annual Report of Form 10-K. There may be other risk factors that could cause differences from those anticipated by management.


When we say “we,” “us,” “our,” or the “Company,” we mean the Company on a consolidated basis with the Bank.


The forward-looking statements contained herein represent the Company's judgment as of the date of this Annual Report on Form 10-K, 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 Annual Report on Form 10-K, except to the extent required by federal securities laws.




3



TABLE OF CONTENTS


PART I

 

 

 

 

 

ITEM 1

BUSINESS

6

 

 

 

 

Organization

6

 

Bar Harbor Bank & Trust

6

 

Bar Harbor Trust Services

8

 

Competition

8

 

Management and Employees

9

 

Supervision and Regulation

9

 

Monetary Policy and Economic Environment

13

 

Financial Information About Industry Segments

14

 

Availability of Information – Company Website

14

 

 

 

 

 

 

ITEM 1A

RISK FACTORS

14

 

 

 

 

 

 

ITEM 1B

UNRESOLVED STAFF COMMENTS

21

 

 

 

 

 

 

ITEM 2

PROPERTIES

21

 

 

 

 

 

 

ITEM 3

LEGAL PROCEEDINGS

22

 

 

 

 

 

 

ITEM 4

MINE SAFETY DISCLOSURES

22

 

 

 

 

 

 

PART II

 

 

 

 

 

ITEM 5

MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

23

 

 

 

 

Market Information

23

 

Dividends

24

 

Recent Sale of Unregistered Securities; Use of Proceeds from Registered Securities

24

 

Purchase of Equity Securities by the Issuer and Affiliated Purchasers

24

 

Stock Based Compensation Plans

25

 

Transfer Agent Services

25

 

 

 

 

 

 

ITEM 6

SELECTED CONSOLIDATED FINANCIAL DATA

25

 

 

 

 

 

 

ITEM 7

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

27

 

 

 

 

Executive Overview

27

 

Application of Critical Accounting Policies

29

 

Financial Condition

32

 

Results of Operations

54


ITEM 7A

QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

68

 

 

 

 

 

 

ITEM 8

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

72

 

 

 

 

 

 

ITEM 9

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

120

 

 

 

 

 

 

ITEM 9A

CONTROLS AND PROCEDURES

120

 

 

 

 

 

 

ITEM 9B

OTHER INFORMATION

123

 

 

 

 

 

 

PART III

 

 

 

 

 

ITEM 10

DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE OF THE REGISTRANT

123

 

 

 

 

 

 

ITEM 11

EXECUTIVE COMPENSATION

123

 

 

 

 

 

 

ITEM 12

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

124

 

 

 

 

 

 

ITEM 13

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

124

 

 

 

 

 

 

ITEM 14

PRINCIPAL ACCOUNTING FEES AND SERVICES

124

 

 

 

 

 

 

PART IV

 

 

 

 

 

ITEM 15

EXHIBITS, FINANCIAL STATEMENTS SCHEDULES

125

 

 

 

 

SIGNATURES

126





4



PART I


ITEM 1. BUSINESS


Organization


Bar Harbor Bankshares (the “Company”) (“BHB”) was incorporated under the laws of the state of Maine on January 19, 1984. At December 31, 2013, the Company had total consolidated assets of $1.37 billion and total shareholders’ equity of $121.4 million.


The Company has one, wholly-owned first tier operating subsidiary, Bar Harbor Bank & Trust (the “Bank”), a community bank, which offers a wide range of deposit, loan, and related banking products, as well as brokerage services provided through a third-party brokerage arrangement. In addition, the Company offers trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services (“Trust Services”), a Maine chartered non-depository trust company. These products and services are offered to individuals, businesses, not-for-profit organizations and municipalities.


The Company is a bank holding company (“BHC”) registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the “FRB”). The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the state of Maine, and as such is subject to the jurisdiction of the Superintendent (the “Superintendent”) of the Maine Bureau of Financial Institutions (“BFI”).


Bar Harbor Bank & Trust


The Bank, originally founded in 1887, is a Maine financial institution, and its deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum extent permitted by law. The Bank is subject to the supervision, regulation, and examination of the FDIC and the BFI. It is not a member of the Federal Reserve Bank.


The Bank has fifteen (15) branch offices located throughout downeast, midcoast and central Maine, including its principal office located at 82 Main Street, Bar Harbor. The Bank’s branch offices are located in Hancock, Washington, Knox, Kennebec and Sagadahoc Counties, representing the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in Blue Hill, Deer Isle, Ellsworth, Northeast Harbor, Somesville, Southwest Harbor, and Winter Harbor. The Washington County offices are located in Milbridge, Machias, and Lubec. The Knox, Kennebec and Sagadahoc County offices are located in Rockland, Augusta, South China, and Topsham. The Bank delivers its operations and technology support services from its operations center located in Ellsworth, Maine.


The Bank is a retail bank serving individual and business customers, retail establishments and restaurants, seasonal lodging, biological research laboratories, and a large contingent of retirees. As a predominately coastal bank, it serves the tourism, hospitality, lobstering, fishing, boat building and marine services industries. It also serves Maine’s wild blueberry industry through its Hancock and Washington County offices. The Bank operates in a competitive market that includes other community banks, savings institutions, credit unions, and branch offices of statewide and interstate bank holding companies located in the Bank’s market area.


The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a material adverse effect on its business. 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 the summer and autumn. These seasonal swings have been fairly predictable and have historically not had a material adverse impact on the Bank or its liquidity position. Approximately 91.4% of the Bank’s deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on all of the deposit account products it offers and does not anticipate any material loss of these deposits.


The Bank emphasizes personal service to the community, with a concentration on retail banking. Customers are primarily individuals and small businesses to which the Bank offers a wide variety of products and services.


Retail Products and Services: The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and borrowing needs of its retail customers. The Bank’s retail deposit products and services include checking accounts, interest bearing NOW accounts, money market accounts, savings accounts, club accounts, short-term and long-term certificates of deposit, Health Savings Accounts, and Individual Retirement Accounts. Credit products and services include home mortgages, residential construction loans, home equity loans and lines of credit, credit cards, installment loans, and overdraft protection services. The Bank provides secured and unsecured installment loans for new or used automobiles, boats, recreational vehicles, mobile homes and other personal needs. The Bank also offers other customary products and services such as safe deposit box rentals, wire transfers, check collection services, foreign currency exchange, money orders, and U.S. Savings Bonds redemptions.


The Bank staffs a customer service center, providing customers with telephone and e-mail responses to their questions and needs. The Bank also offers free banking-by-mail services.


Retail Brokerage Services: The Bank retains Infinex Investments, Inc., (“Infinex”) as a full service third-party broker-dealer, conducting business under the assumed business name “Bar Harbor Financial Services.”  Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or its subsidiaries. These products are not deposits, are not insured by the FDIC or any other government agency, are not guaranteed by the Bank or any affiliate, and may be subject to investment risk, including possible loss of value.


Bar Harbor Financial Services principally serves the brokerage needs of individuals, from first-time purchasers, to sophisticated investors. It also offers a line of life insurance, annuity, and retirement products, as well as financial planning services. Infinex was formed by a group of member banks, and is reportedly one of the largest providers of third party investment and insurance services to banks and their customers in New England. Through Infinex, the Bank is able to take advantage of the expertise, capabilities, and experience of a well-established third-party broker-dealer in a cost effective manner.


Electronic Banking Services: The Bank continues to offer free Internet banking services, including free check images and electronic bill payment, through its dedicated website at www.bhbt.com. Additionally, the Bank offers telephone banking, an interactive voice response system through which customers can check account balances and activity, as well as initiate money transfers between their accounts. Customers can also monitor their accounts with free mobile banking access via text messaging, browser or “Apps”, and they can receive alerts, view accounts, transfer funds and pay bills. The Bank also offers Popmoney®, an innovative personal payment service that eliminates the need for checks and cash by allowing customers to send and receive money as easily as they send and receive e-mail and text messages.


Automated Teller Machines (ATMs) are located at each of the Bank’s fifteen (15) branch locations. The Bank is also a member of Maine Cash Access, providing customers with surcharge-free access to approximately 175 ATMs throughout the state of Maine. Visa debit cards are also offered, providing customers with free access to their deposit account balances at point of sale locations throughout most of the world.

Commercial Products and Services:  The Bank serves the small business market throughout downeast, midcoast and central Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate and equipment financing, working capital, real estate development, and a broad range of other business purposes. Business loans are provided primarily to organizations and sole proprietors in the tourism, hospitality, healthcare, blueberry, boatbuilding, biological research, and fishing industries, as well as to other small and mid-size businesses associated with coastal communities. Certain larger loans, which may exceed the Bank’s lending limits, are written with a participated portion sold to another financial institution, so that the Bank retains only such portions of those loans that are within its lending limits and credit risk tolerances.


The Bank offers a variety of commercial deposit accounts, most notably business checking and tiered money market accounts. These accounts are typically used as operating accounts or short-term savings vehicles. The Bank’s cash management services provide business customers with short-term investment opportunities through a cash management sweep program, whereby excess operating funds over established thresholds are swept into overnight securities sold under agreements to repurchase. The Bank also offers Business On-Line Direct (“BOLD”) an Internet banking service for businesses. This service allows business clients to view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, and transmit Automated Clearing House (ACH) files. The Bank also offers remote deposit capture, enabling its business customers to deposit checks remotely. Other commercial banking services include merchant credit card processing provided through a third party vendor, night depository, and coin and currency handling.


Bar Harbor Trust Services


Trust Services is a Maine chartered non-depository trust company and a wholly-owned subsidiary of the Bank. Trust Services provides a comprehensive array of trust and investment management services to individuals, businesses, not-for-profit organizations, and municipalities.


Trust Services serves as trustee of both living trusts and trusts under wills, including revocable and irrevocable, charitable remainder and testamentary trusts, and in this capacity holds, accounts for and manages financial assets, real estate and special assets. Trust Services offers custody, estate settlement, and fiduciary tax services. Additionally, Trust Services offers employee benefit trust services for which it acts as trustee, custodian, administrator and/or investment advisor, for employee benefit plans and for corporate, self-employed, municipal and not-for-profit employers located throughout the Company’s market areas.


The staff includes credentialed investment and trust professionals with extensive experience. At December 31, 2013, Trust Services served 751 client accounts, with assets under management and assets held in custody amounting to $387.6 million and $33.9 million, respectively.


Competition


The Company competes principally in downeast, midcoast and central Maine, which can generally be characterized as rural areas. The Company considers its primary market areas to be Hancock, Knox, Washington, Kennebec and Sagadahoc counties, each in the state of Maine. According to the 2012 Census Bureau Report estimate, the population of these five counties was 54,558, 39,668, 32,462, 121,853 and 35,191, respectively, representing a combined population of approximately 283,732. The economies in these counties are based primarily on tourism, healthcare, fishing and lobstering, agriculture, state government, and small local businesses, but are also supported by a large contingent of retirees. Major competitors in these market areas include local independent banks, local branches of large regional bank affiliates, thrift institutions, savings and loan institutions, mortgage companies, and credit

unions. Other competitors in the Company’s primary market area include financing affiliates of consumer durable goods manufacturers, insurance companies, brokerage firms, investment advisors, and other non-bank financial service providers.


Like most financial institutions in the United States, the Company competes with an ever-increasing array of financial service providers. As the national economy moves further towards a concentration of service companies, competitive pressures will mount.


The Company has generally been able to compete effectively with other financial institutions by emphasizing quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers; however, no assurance can be given that the Company will continue to be able to compete effectively with other financial institutions in the future.


No material part of the Company’s business is dependent upon one, or a few customers, or upon a particular industry segment, the loss of which would have a material adverse impact on the operations of the Company.


Management and Employees


The Company has two principal executive officers: Curtis C. Simard, President and Chief Executive Officer, and Gerald Shencavitz, Executive Vice President, Chief Financial Officer and Treasurer.

 

As of December 31, 2013, the Bank employed 170 full-time equivalent employees, Trust Services employed 12 full-time equivalent employees, and the Company employed 3 full-time employees, representing a full-time equivalent complement of 185 employees of the Company. None of the employees are represented by collective bargaining agreements.


The Company’s management believes employee relations to be good.


Supervision and Regulation


Banking is a complex, highly regulated industry. Consequently, our performance can be affected, not only by management decisions and general and local economic conditions, but also by the statutes administered by, and the extensive regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Board of Governors of the Federal Reserve System, the FDIC, the Maine Bureau of Financial Institutions, the Consumer Financial Protection Bureau, the Internal Revenue Service, and state taxing authorities. The effect of these statutes, regulations, and policies and any changes to any of them can be significant and cannot be predicted. Any change in applicable laws, regulations, or regulatory policies may have material effect on our business, operations, and prospects. We are unable to predict the nature or extent of the effects that fiscal or monetary policies, economic controls, or new federal or state legislation may have on our business and earnings in the future.


The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, the U.S. Congress and the State of Maine have created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies, and the banking industry. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the Bank’s depositors and the public, rather than the stockholders and creditors.



The following is an overview of some of the materially relevant laws, rules, and regulations governing banks and bank holding companies and significant developments since the beginning of our 2013 fiscal year, but does not purport to be a complete summary of all applicable laws, rules, and regulations governing banks and bank holding companies or developments within them. The descriptions are qualified in their entirety by reference to the specific statutes, regulations, and policies discussed.


Overview

·

Banking organizations are generally restricted to engaging only in deposit-taking and lending and other activities considered closely related to banking. As a registered bank holding company, the Company is subject to the regulation and supervision of the FRB under the BHC Act. Bank holding companies are required to file periodic reports with and are subject to periodic examination by the FRB. Under the Dodd-Frank Act, a bank holding company is expected to serve as a source of financial and managerial strength to its subsidiary banks. Pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary bank during periods of financial stress or adversity.

·

The Bank is supervised and regularly examined by state and/or federal bank regulatory agencies.  As a Maine chartered financial institution, the Bank is subject to federal regulation and supervision by the FDIC and to state regulation and supervision by the Maine Bureau of Financial Institutions (“BFI”). The Bank’s deposit accounts are insured by the Deposit Insurance Fund (“DIF”), which is administered by the FDIC. The Bank is not a member of the Federal Reserve System.

·

Many banks remain subject to formal or informal enforcement orders primarily resulting from the nonperformance of loans made before the recent recession. Neither the Company nor Bank was subject to any such orders during 2013.  

·

Banks, including our Bank, pay FDIC insurance assessments which are intended to cover the costs of the failure of other insured banks.

·

Banks, including our Bank, are subject to many risks, including credit, liquidity, interest rate, and reputation risk. See Item 1A in this Report below for further information regarding Risk Factors applicable to the financial services industry and us.

·

Bank expansion and acquisitions generally require regulatory approval or nonobjection.  

·

Banks, including our Bank, are subject to consumer compliance, customer privacy protection, and anti-money laundering legislation and regulations.

·

Banks are subject to capital and allowance for loan loss requirements, loan limits, restrictions on dividends and affiliate transactions, operations and deposit regulations, and reserve requirements.

·

As a public company whose common stock is listed on the NYSE MKT, we are subject to corporate governance requirements SEC and NYSE MKT, as well as federal and state law. Under the Sarbanes-Oxley Act, we are required to meet certain requirements regarding business dealings with members of our Board of Directors, the structure of our Audit Committee and ethical standards for our senior financial officers. Under SEC and NYSE MKT rules, we are required to comply with other standards of corporate governance, including having a majority of independent directors serve on our Board of Directors, and the establishment of independent audit, compensation and corporate governance committees.



5



·

The Dodd-Frank Act included a number of provisions imposing governance standards, including those regarding “Say-on-Pay” votes for shareholders, incentive compensation clawbacks, compensation committee independence and disclosure concerning executive compensation, employee and director hedging and chairman and CEO positions.


·

Under Section 404 of the Sarbanes-Oxley Act, we are required to assess the effectiveness of our internal controls over financial reporting and to obtain an opinion from our independent auditors regarding the effectiveness of our internal controls over financial reporting.


Recent Capital Adequacy Developments


The Company and the Bank are subject to various regulatory capital requirements established by bank regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material impact on our financial results. Under applicable capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components of capital, risk weightings of assets, off-balance sheet transactions, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company, as a bank holding company, and the Bank, to maintain minimum amounts and ratios of Total and Tier I capital to risk-weighted assets and Tier I capital to adjusted assets (as defined in the regulations). See Note 11 of the Notes to Consolidated Financial Statements in this Form 10-K for further information.


In July, 2013 the Federal Reserve Board, the FDIC and OCC, adopted a final rule that implements the Basel III changes to the international regulatory capital framework, referred to as the "Basel III Rules." The Basel III Rules apply to both depository institutions and (subject to certain exceptions not applicable to the Company) their holding companies. Although parts of the Basel III Rules apply only to large, complex financial institutions, substantial portions of the Basel III Rules apply to the Company and the Bank. The Basel III Rules include requirements contemplated by the Dodd-Frank Act as well as certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010.

The Basel III Rules include new risk-based and leverage capital ratio requirements and refine the definition of what constitutes "capital" for purposes of calculating those ratios. The Basel III Rules also create a new Common Equity Tier 1 ("CETI") risk­-based capital ratio. CET1 capital will consist of retained earnings and common stock instruments, subject to certain adjustments.

The Basel III Rules will also establish a "capital conservation buffer" of 2.5% above the new regulatory minimum risk-based capital requirements. The new capital conservation buffer requirement is to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers if its capital level is below the buffer amount.



6



The above BASEL III capital ratio requirements as applicable to the Bank after the full phase-in period are summarized in the table below.(1)

 

BASEL III

Minimum for Capital Adequacy Purposes

BASEL III

Additional Capital Conservation Buffer

BASEL III

“Adequate” Ratio with Capital Conservation Buffer

Total Risked Based Capital

     (total capital to risk weighted assets)

8.0%

2.5%

10.5%

Tier 1 Risked Based Capital

     (tier 1 to risk weighted assets)

6.0%

2.5%

8.5%

Tier 1 Leverage Ratio

     (tier 1 to average assets)

4.0%

---%

4.0%

Common Equity Tier 1 Risked Based

     (CETI to risk weighted assets

4.5%

2.5%

7.0%


(1)

Because the BASEL III final rules modify the methodology for calculating risk-weighted assets and the deduction and adjustment to capital, the ratios above may not be comparable to the current applicable regulatory requirements, or the Company's actual capital ratios as of December 31, 2013.


The Basel III Rules would also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including our Bank, if capital levels do not meet certain thresholds. These revisions are effective January 1, 2015. The prompt correction action rules will be modified to include a CETI capital component and to increase certain other capital requirements for the various thresholds. For example, under the revised prompt corrective action rules, insured depository institutions will be required to meet the following capital levels in order to qualify as "well capitalized"; (i) a Total risk-based capital ratio of 10% (unchanged from current rules); (ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a Tier 1 leverage ratio of 5% (unchanged from current rules); and (iv) a new common equity Tier 1 risk-based capital ratio of 6.5%.


The Basel III Rules set forth certain changes in the methods of calculating certain risk-weighted assets, which in turn will affect the calculation of risk based ratios. Under the Basel III Rules, higher or more sensitive risk weights would be assigned to various categories of assets, including, certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on non-accrual, foreign exposures and certain corporate exposures. In addition, the Basel III Rules include (i) alternative standards of credit worthiness consistent with the Dodd-Frank Act; (ii) greater recognition of collateral and guarantees; and (iii) revised capital treatment for derivatives and repo-style transactions.


In addition, the final Basel III Rules include certain exemptions to address concerns about the regulatory burden on community banks. For example, banking organizations, such as our Company,  with less than $15 billion in consolidated assets as of December 31, 2009 are permitted to include in Tier 1 capital trust preferred securities and cumulative perpetual preferred stock issued and included in Tier 1 capital prior to May 19, 2010 on a permanent basis, without any phase out. Community banks may also elect on a one time basis in their March 31, 2015 quarterly filings to opt-out out of the requirement to include most accumulated other comprehensive income ("AOCI") components in the calculation of CETI capital and, in effect, retain the AOCI treatment under the current capital rules. Under the Basel III Rules, the Company may make a one-time, permanent election to continue to exclude AOCI from capital. If the Company does not make this election, unrealized gains and losses would be included in the calculation of its regulatory capital. Overall, we believe the rule provides some significant concessions for smaller, less complex financial institutions, such as our Company,

The Basel III Rules generally become effective January 1, 2015. The conservation buffer will be phased- in beginning in 2016 and will take full effect on January 1, 2019. Although the Company must generally begin complying with the final rules on January 1, 2015, management believes the Company would satisfy the higher capital ratios imposed by Basel III, in addition to the new "well capitalized" requirements under the revised prompt corrective action rules discussed above, as of December 31, 2013.


Recent Mortgage Lending Rules


In January, 2014, The Consumer Financial Protection Bureau’s (“CFPB”) “Ability-to-Repay” rules became effective.  The Ability-to-Repay rules require most mortgage lenders, including the Bank, to make a good-faith effort to determine that their borrowers are likely to be able to pay back a mortgage loan. The CFPB is responsible for enforcing this law and new regulations.  In practice this means lenders must generally find out, consider, and document a borrower’s income, assets, employment, credit history and monthly expenses. According to the CFPB, certain types of mortgages are more likely to become a debt "trap" for the borrower.  The new rule attempts to eliminate or control such loans.  It also lays out basic guidelines that lenders can follow to originate what are called “Qualified Mortgages.”  These are intended to provide lenders greater certainty that they are meeting the Ability-to-Repay requirement. If lenders choose not the follow these guidelines, they can still make a loan based on their reasonable, good-faith determination that the borrower has the ability to repay it.  To be a Qualified Mortgage, the loan:

Cannot have excessive upfront points and fees;

Cannot be longer than 30 years;

Cannot have certain risky features, such as paying only interest and not principal, or paying less than the full amount of interest so that the total debt grows each month; and

Must be in one of three categories: (1) the monthly loan payment, plus the borrower’s other debt payments, does not exceed 43% of the borrower’s monthly income; or (2) the loan qualifies for purchase or guarantee by a government sponsored enterprise (Fannie Mae or Freddie Mac), or is insured or guaranteed by a federal housing agency; or (3) the loan is made by a small lender that keeps the loan in its portfolio.


Although we have adopted processes and procedures to comply, we continue to evaluate the ongoing impact of the Ability-to-Repay Rules on our business.  We anticipate additional complexity, cost, and expense associated with our retail mortgage lending line of business in the future resulting from training, compliance and documentation requirements under the new rules.  


Monetary Policy and Economic Environment  


The earnings of the Company are significantly affected by the monetary and fiscal policies of governmental authorities, including the FRB. Among the instruments of monetary policy used by the FRB to implement these objectives are open-market operations in U.S. Government securities and federal funds, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments, and deposits, and the interest rates charged on loans and paid for deposits. The FRB frequently used these instruments of monetary policy, especially its open-market operations and the discount rate, in influence the level of interest rates and to affect the strength of the economy, the level of inflation, or the price of the dollar in foreign exchange markets. The monetary policies of the FRB have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect which they may have on the Company’s business and earnings.

Financial Information about Industry Segments


The information required under this item is included in the Company’s financial statements, which appear in Part II, Item 8, Note 1,  of this Annual Report on Form 10-K, and is incorporated herein by cross reference thereto.


Availability of Information – Company Website


The Company maintains an Internet website at www.bhbt.com. At this website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and proxy statement on Schedule 14A and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after such forms are electronically filed with, or furnished to, the SEC. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room, located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website at www.sec.gov that contains reports, proxy, and information statements, and other information regarding issuers that file electronically with the SEC. In addition, the Company makes available, free of charge, its press releases and Code of Ethics through the Company’s Investor Relations page. Information on our website is not incorporated by reference into this document and should not be considered part of this Report.


ITEM 1A. RISK FACTORS


An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes affect us are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors.


If any of the following risks actually occurs, our financial condition, results of operations, or cash flow could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.


Our business may be adversely affected by conditions in the financial markets and economic conditions generally.


Negative developments in the financial services industry since 2008 resulted in uncertainty in the financial markets in general and a related general economic recession. In addition, as a consequence of the recent U.S. recession, businesses across a wide range of industries faced serious difficulties due to the decrease in consumer spending, reduced consumer confidence brought on by deflated home prices, among other things, and reduced liquidity in the credit markets. Unemployment also increased significantly during this period. Many of these circumstances continued into 2013 and continue to be an issue today.


As a result of these financial and economic crises, many lending institutions, including the Bank, experienced in recent years declines in the performance of their loans, including construction, commercial real estate loans, and other commercial and consumer loans. Moreover, competition among depository institutions for core deposits and quality loans increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages declined. Bank and bank holding company stock prices were negatively affected, and the ability of banks and bank holding companies to raise capital or borrow in the debt markets has been more difficult compared to previous periods. As a result, bank regulatory agencies have been and are expected to continue to be very aggressive in responding to concerns and trends identified in examinations, including the issuance of formal or informal enforcement actions or orders. The impact of new legislation in response to these developments may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance or our stock price.


In addition, further negative market developments, including another recession, may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial services industry.


Risks Related to Our Regulatory Environment.


We are subject to extensive regulation and supervision under federal and state laws and regulations. Some of the significant federal and state banking regulations that affect us are described in this report at Part I, Item 1, “Supervision and Regulation.”  These regulations, along with the existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time.


Changes in regulations resulting from the Dodd-Frank Act or any new regulations may affect our businesses. The market and economic conditions over the past several years have led to legislation and numerous and continuing proposals for changes in the regulation of the banking and financial services industry, including significant additional legislation and regulation in the U.S. and abroad. The Dodd-Frank Act enacted sweeping changes in the supervision and regulation of the financial industry designed to provide for greater oversight of financial industry participants, reduce risk in banking practices and in securities and derivatives trading, enhance public company corporate governance practices and executive compensation disclosures, and provide for greater protections to individual consumers and investors.


Certain elements of the Dodd-Frank Act became effective immediately, while the details of some provisions remain subject to implementing regulations that are yet to be adopted by various applicable regulatory agencies. The ultimate impact that the Dodd-Frank Act will have on us, the financial services industry and the economy cannot be known until all such implementing regulations called for under the Dodd-Frank Act have been finalized and implemented.


The Dodd-Frank Act may impact the manner in which we market our products and services, manage our business and operations and interact with regulators, all of which, while not currently anticipated to, could materially impact our results of operations, financial condition and liquidity. Certain provisions of the Dodd-Frank Act that have or may impact our business include, but are not limited to: regulatory oversight of incentive compensation, the imposition of capital requirements on holding companies and, to a lesser extent, greater oversight over derivatives trading and restrictions on proprietary trading. There is also increased regulatory scrutiny (and related compliance costs). These include but are not limited to the Bank's oversight by the CFPB.


Additionally, we are closely monitoring regulatory developments related to the “Volcker Rule” and their impact on community banks. In January 2014, the FRB, the OCC, the FDIC, the SEC and the Commodity Futures Trading Commission approved an interim final rule that exempts trust-preferred securities (TruPS) that back collateralized debt obligations (CDOs) held by qualifying community banks from the application of some portions of the Volcker Rule. The final Volcker Rule, approved by regulators in December 2013, generally prohibited banking entities from engaging in the short-term proprietary trading of securities and derivatives for their own account and barred them from having certain relationships with hedge funds or private equity funds. Included within the range of funds covered by the regulations were TruPS CDOs. Application of the Volcker Rule to TruPS CDOs would have forced many banks, including many community banks, to treat the TruPS CDO holdings as impaired and write down the value or sell the holdings entirely. The American Bankers Association filed a lawsuit in 2013 to block the provision from going into effect. In addition, some lawmakers also called on the regulators to revise the rule to minimize the effect on community banks. On January 14, 2014, the regulators announced the first revision to the Volcker Rule in the form of an interim final rule. The revision will allow some smaller banks to retain their interests in TruPS CDOs, though there are conditions to the exemption. The interim final rule exemption only applies when all of the following requirements are met:

?

The TruPS CDOs have been issued by banks with less than $15 billion in assets;

?

The TruPS CDOs have been established before May 19, 2010; and

?

The bank must have acquired the TruPS CDOs prior to December 10, 2013.


The Company did not own any TruPS CDOs as of December 31, 2013.

To the extent the Dodd-Frank Act and the related extensive rules and regulations impacts the operations, financial condition, liquidity and capital requirements of unaffiliated financial institutions with whom we transact business, those institutions may seek to pass on increased costs, reduce their capacity to transact, or otherwise present inefficiencies in their interactions with us.


We are subject to credit risk.


There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where we operate as well as those across the United States and abroad. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans.


We are also subject to various laws and regulations that affect our lending activities. Failure to comply with applicable laws and regulations could subject us to regulatory enforcement action that could result in the assessment of significant civil money penalties against us. The CPFB's new Ability-to-Repay under Regulation Z may expose lenders, such as the Bank, to heightened litigation risk unless their loans meet the definition of “Qualified Mortgage” or “QM.” Under the new rule a creditor must properly determine whether borrowers have the ability to repay their loans. Where a creditor does not act properly, the CPFB retains the ability to issue cease and desist orders, or impose civil monetary penalties. The rule also provides a private right of action to borrowers. They may seek actual damages, statutory damages, costs, and attorneys' fees, and special damages equal to the finance charges and fees incurred. In short, where the creditor does not properly assess borrowers' ability to repay loans, the Bank could be subject to legal damages from affected borrowers.  Borrowers may also seek damages in class action litigation and individual cases. While current law provides for a one-year statute of limitation on damage actions, borrowers have three years to bring their Ability-to-Repay damage claims. Borrowers may also assert the Ability-to-Repay defense in response to a foreclosure action and seek recoupment or set-off. The three-year statute of limitation does not apply to use of defense.  Use of this defense; however, borrowers are limited to three years of finance charges and fees as special damages. Assignees are liable for the errors of the original creditor.



We have adopted underwriting and credit monitoring policies and procedures, including the establishment and ongoing review of the allowance for loan losses and review of borrower financial statements and collateral appraisals, which management believes are appropriate to mitigate the risk of loss by assessing the likelihood of borrower non-performance and the value of available collateral. We also manage credit risk by diversifying our loan portfolio. An ongoing independent review, subsequent to management’s review, of individual credits is performed by an independent loan review function, which reports to the Audit Committee of the Board of Directors.


The Bank’s loans are principally concentrated in certain areas of Maine and adverse economic conditions in those markets could adversely affect our operations.


Our success is dependent to a significant extent upon general economic conditions in the United States and, in particular, the local economies of downeast, midcoast and central Maine, the primary markets served by us. We are particularly exposed to real estate and economic factors in the downeast, midcoast and central areas of Maine, as most of our loan portfolio is concentrated among borrowers in these markets. Furthermore, because a substantial portion of our loan portfolio is secured by real estate in these areas, the value of the associated collateral is also subject to regional real estate market conditions.


A number of our hospitality and other customers rely upon a high number of visits from tourists and vacationers to Acadia National Park as significant part of their businesses. In 2013, Acadia National Park experienced partial shutdowns in its operations due to the federal budget impasse. Future shut downs or changes in visitor rates to Acadia National Park for whatever reason(s) may have a significant impact on the businesses of many of our customers which may in turn have a negative impact on our business and results of operations.


Interest rate volatility could significantly reduce our profitability.


Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-bearing assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions, demand for loans, securities and deposits, and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our loans and securities that are collateralized by mortgages. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. If interest rates decline, our higher-rate loans and investments may be subject to prepayment risk, which could negatively impact our net interest margin. Conversely, if interest rates increase, our loans and investment may be subject to extension risk, which could negatively impact our net interest margin as well.


Declines in value may adversely impact our investment securities portfolio.


We may be required to record other-than-temporary impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including collateral deterioration underlying certain private-label mortgage-backed securities, municipal bond defaults, lack of liquidity for re-sales of certain investment securities, or adverse actions by regulators, could have a negative effect on our securities portfolio in future periods.

We may elect or be compelled to seek additional capital in the future, but capital may not be available when it is needed.


We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect to raise additional capital.


Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions, and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise additional capital if needed or on terms acceptable to us.  If we cannot raise additional capital when needed, or on reasonable terms, it may have a material adverse effect on our financial condition and results of operations.


We may not be able to meet our cash flow needs on a timely basis at a reasonable cost, and our cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates, and competitive pressures.


Liquidity is the ability to meet cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to make loans and to repay deposit and borrowing liabilities as they become due, or are demanded by customers and creditors. Many factors affect the Bank’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 standing in the marketplace, and general economic conditions.


The Bank’s primary source of funding is retail deposits, gathered throughout its network of fifteen banking offices. Wholesale funding sources principally consist of secured borrowing lines from the FHLB of Boston of which it is a member, secured borrowing lines from the FRB of Boston, and certificates of deposit obtained from the national market. The Bank’s securities and loan portfolios provide a source of contingent liquidity that could be accessed in a reasonable time period through sales.


Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered funds and borrowings in the future, which are typically more expensive than deposits.


Changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on our liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows.


We are subject to a variety of operational risks, including reputational risk, legal risk, and compliance risk, and the risk of fraud or theft by employees or outsiders, which may adversely affect our business and results of operations.


We are exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, and unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.


If personal, non-public, confidential, or proprietary information of customers in our possession were to be mishandled or misused, we could suffer significant regulatory consequences, reputational damage, and financial loss.


Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. Our necessary dependence upon automated systems to record and process transactions and our large transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. We also may be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control (i.e., computer viruses or electrical or telecommunications outages, natural disaster, disease pandemics, or other damage to property or physical assets), which may give rise to disruption of service to customers and to financial loss or liability. We are further exposed to the risk that our external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as we are) and to the risk that our (or our vendors’) business continuity and data security systems prove to be inadequate. The occurrence of any of these risks could result in a diminished ability to operate our business (i.e., by requiring us to expend significant resources to correct the defect), as well as potential liability to clients, reputational damage, and regulatory intervention.


We continually encounter technological change.


The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.


We are subject to possible claims and litigation pertaining to fiduciary responsibilities.


From time to time, customers make claims and take legal action pertaining to our performance of our fiduciary responsibilities. Whether customer claims and legal action related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for our products and services.


Strong competition within our markets may significantly impact our profitability.


We compete with an ever-increasing array of financial service providers. See the section entitled “Competition” of Item 1 of this Form 10-K for additional information about our competitors. Competition from nationwide banks, as well as local institutions, continues to mount in our markets.


Regional, national and international competitors have far greater assets and capitalization than we do and have greater access to capital markets and can offer a broader array of financial services than we can. For example, consumers can maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. Further, many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.


To compete, we focus on quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers. Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability.


Tax law changes may adversely affect our net income, effective tax rate, and our overall results of operations and financial condition.


Our financial performance is impacted by federal and state tax laws. Given the current economic and political environment, and ongoing state budgetary pressures, the enactment of new federal or state tax legislation may occur. The enactment of such legislation, or changes in the interpretation of existing law, including provisions impacting tax rates, apportionment, consolidation or combination, income, expenses, and credits, may have a material adverse effect on our financial condition and results of operations.


Our controls and procedures may fail or be circumvented.


We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met.


The preparation of our financial statements requires the use of estimates that could significantly vary from actual results.


The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make significant estimates that affect the financial statements. The most critical estimate is the allowance for loan losses. Due to the inherent nature of estimates, we cannot provide absolute assurance that we will not significantly increase the allowance for loan losses and/or sustain credit losses that are significantly higher than provided for in the allowance.


Our access to funds from subsidiaries may be restricted.


Bar Harbor Bankshares is a separate and distinct legal entity from our Bank and nonbanking subsidiaries. Bar Harbor Bankshares depends on dividends, distributions and other payments from its banking and nonbanking subsidiaries to fund dividend payments on its common stock and to fund all payments on its other obligations. Our subsidiaries are subject to laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to Bar Harbor Bankshares, which could impede access to funds it needs to make payments on its obligations or dividend payments.


We may be unable to attract and retain key personnel.


Our success depends, in large part, on our ability to attract and retain key personnel. Competition for qualified personnel in the financial services industry can be intense and the Company and its subsidiaries may not be able to hire or retain the key personnel that it depends upon for success. In addition, the Bank’s rural geographic marketplace, combined with relatively expensive real estate purchase prices within the area of the Bank’s principal office location in Bar Harbor, Maine, create additional risks for the Company and the Bank’s ability to attract and retain key personnel. The unexpected loss of services of one or more of the our key personnel could have a material adverse impact on our business because of their skills, knowledge of the markets in which the we operate, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

To the extent that we acquire other companies, our business may be negatively impacted by certain risks inherent with such acquisitions.


To the extent that we may acquire other financial services companies or assets in the future, our business may be negatively impacted by certain risks inherent with such acquisitions. These risks include, but are not limited to, the following:

·

the risk that the acquired business or assets will not perform in accordance with our expectations;

·

the risk that difficulties will arise in connection with the integration of the operations of the acquired business with the operations of our businesses;

·

the risk that we will divert our attention from other aspects of our existing business;

·

the risk that we may lose key employees of the combined business; and

·

the risks associated with entering into geographic and product markets in which we have limited or no direct prior experience.


We are exposed to risk of environmental liabilities with respect to properties to which we take title.


In the course of our business, we may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The cost associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property.


Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business and the business of our customers.


Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. In particular, such events may have a particularly negative impact upon the business of our customers who are engaged in the hospitality and natural resource dependent industries in our market area, which could have a direct negative impact on our business and results of operations.


ITEM 1B. UNRESOLVED STAFF COMMENTS


None


ITEM 2. PROPERTIES


The Company’s headquarters are located at 82 Main Street, Bar Harbor, Maine, which also serves as the main office for the Bank.





As of December 31, 2013, the Bank operated fifteen (15) full-service banking offices throughout downeast, midcoast and central Maine, namely: Bar Harbor, Northeast Harbor, Southwest Harbor, Somesville, Deer Isle, Blue Hill, Ellsworth, Rockland, Topsham, South China, Augusta, Winter Harbor, Milbridge, Machias, and Lubec. The Bank owns twelve of these banking offices and leases three at prevailing market rates.


The Bank’s Ellsworth office consists of a new building constructed in 2012 and two additional parcels contiguous to this branch. The Bank also owns an office building at this location, which is occupied by the Bank and Trust Services. The City of Ellsworth is considered the hub of downeast Maine and the Bank’s Ellsworth office is by far its busiest location. During the third quarter of 2012, the Bank replaced its existing Ellsworth branch office and completed a substantial reconfiguration of its surrounding campus to better meet the Company’s business needs at that location.


During 2013, the Bank completed a substantial renovation and expansion of its Rockland office to better meet its business needs at that location.


An Operations Center is located in Ellsworth, Maine, that houses the Company’s operations and data processing centers. During 2012 the Company completed a major renovation of its Operations Center to better meet its business needs at that location. The Bank also leases space at One Cumberland Place in Bangor, Maine, which houses regional business lending and Trust Services staff.


In the opinion of management, the physical properties of the Company and the Bank are considered adequate to meet the needs of customers in the communities served. Additional information relating to the Company’s properties is provided in Item 8, Note 5 of the Consolidated Financial Statements contained in this Annual Report on Form 10-K and incorporated herein by reference.


ITEM 3. 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 4. MINE SAFETY DISCLOSURES – Not applicable




7



PART II


ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES


Market Information


The common stock of the Company is traded on the NYSE MKT, LLC (“NYSE MKT”), under the trading symbol BHB.


The following table sets forth the high and low market prices per share of BHB Common Stock as reported by NYSE MKT by calendar quarter for each of the last two years:


 

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

 

High

Low

High

Low

High

Low

High

Low

2013

$37.30

$33.89

$36.99

$34.06

$41.47

$34.11

$40.50

$35.11

2012

$33.25

$29.36

$38.00

$32.59

$36.98

$33.33

$36.50

$31.78


As of March 3, 2014, there were 3,940,790 shares of Company common stock, par value $2.00 per share, outstanding and approximately 893 Registered Shareholders of record, as obtained through the Company’s transfer agent.


Performance Graph


The following graph illustrates the estimated yearly change in value of the Company's cumulative total stockholder return on its common stock for each of the last five years. Total stockholder return is computed by taking the difference between the ending price of the common stock at the end of the previous year and the current year, plus any dividends paid divided by the ending price of the common stock at the end of the previous year. For purposes of comparison, the graph also matches Bar Harbor Bankshares' cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the NYSE MKT Composite index, the S&P 500 index, and the ABA Nasdaq Community Bank index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2008 to December 31, 2013.


[bhb201310k2013002.gif]



 

12/08

12/09

12/10

12/11

12/12

12/13

     

 

 

 

 

 

 

Bar Harbor Bankshares

   100.00

   110.59

   121.48

   130.26

151.39

186.19

NYSE MKT Composite

   100.00

   135.53

   175.07

   179.96

190.69

200.56

S&P 500

   100.00

   126.46

   145.51

   148.59

172.37

228.19

ABA Nasdaq Community Bank Index

   100.00

     81.72

     92.81

     87.87

102.89

146.37



Dividends


Common stock dividends paid by the Company in 2013 and 2012 are summarized below:


 

1st

Quarter

2nd

Quarter

3rd

Quarter

4th

Quarter

Total

   

 

 

 

 

 

2013

$0.305

$0.310

$0.315

$0.320

$1.250

2012

$0.285

$0.290

$0.295

$0.300

$1.170



During 2013, the Company declared and distributed regular cash dividends on its common stock in the aggregate amount of $4,915 compared with $4,565 in 2012. The Company’s 2013 dividend payout ratio amounted to 37.3% compared with 36.6% in 2012. The total regular cash dividends paid in 2013 amounted to $1.25 per share of common stock, compared with $1.17 in 2012, representing an increase of $0.08 per share, or 6.8%.


In the first quarter of 2014, the Company’s Board of Directors declared a regular cash dividend of $0.325 per share of common stock, representing an increase of $0.02 or 6.6% compared with the first quarter of 2013.


The Company has a history of paying quarterly dividends on its common stock. However, the Company’s ability to pay such dividends depends on a number of factors, including the Company’s financial condition, earnings, its need for funds and restrictions on the Company’s ability to pay dividends under federal laws and regulations. Therefore, there can be no assurance that dividends on the Company’s common stock will be paid in the future.


For further information, refer to Item 6, Selected Consolidated Financial Data for dividend related ratios and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, (specifically the “Capital Resources” section).


Sale of Unregistered Securities; Use of Proceeds from Registered Securities


No unregistered securities were sold by the Company during the years ended December 31, 2013 and 2012.


Purchases of Equity Securities by the Issuer and Affiliated Purchasers


There were no purchases of shares of the Company’s common stock made by or on behalf of the Company or any “affiliated purchaser” for the quarter ended December 31, 2013.


Information relating to the Company’s stock repurchase program is provided in Part II, Item 7, Stock Repurchase Plan, contained in this Annual Report on Form 10-K and incorporated herein by reference.





Stock Based Compensation Plans


Information regarding stock-based compensation awards both outstanding and available for future grants as of December 31, 2013, represents stock-based compensation plans approved by shareholders and is presented in the table below. There are no compensation plans under which equity securities of the Company may be issued that have not been approved by shareholders. Additional information is presented in Note 12, Stock-Based Compensation Plans, in the Notes to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, within this Annual Report on Form 10-K.


Plan Category

Number of securities to be issued upon exercise of outstanding options, warrants and rights, net of forfeits and exercised shares    

 (a)

Weighted average exercise price of outstanding options, warrants and rights              (b)

Number of securities remaining available for issuance under equity compensation (excluding

securities referenced

in column (a))

 (c)

     

 

 

 

Equity compensation plans

     approved by security holders

           156,669

        $31.72

              55,997

Equity compensation plans

     not approved by security holders

                    ---

            N/A

                    ---

Total

           156,669

        $31.72

              55,997


Transfer Agent Services


American Stock Transfer & Trust Company provides transfer agent services for the Company. Inquiries may be directed to: American Stock Transfer & Trust Company, 6201 15th Avenue, 3rd Floor, Brooklyn, NY, 11219, telephone: 1-800-937-5449, Internet address: www.amstock.com.


ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA


The supplementary financial data presented in the following table contains information highlighting certain significant trends in the Company’s financial condition and results of operations over an extended period of time.


The following information should be analyzed in conjunction with Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, and with the audited consolidated financial statements included in this Annual Report on Form 10-K. Unless otherwise noted, all dollars are expressed in thousands except share and per share data.














FIVE-YEAR SUMMARY OF FINANCIAL DATA

As of and For the Years Ended December 31,


 

2013

2012

2011

2010

2009

Balance Sheet Data

 

 

 

 

 

   

 

 

 

 

 

Total assets

 $ 1,373,893

 $1,302,935

 $1,167,466

 $1,117,933

 $1,072,381

Total securities

       450,170

      418,040

      381,880

      357,882

      347,026

Total loans

       852,857

      815,004

      729,003

      700,670

      669,492

Allowance for loan losses

          (8,475)

         (8,097)

         (8,221)

         (8,500)

         (7,814)

Total deposits

       835,651

      795,012

      722,890

      708,328

      641,173

Total borrowings

       409,445

      371,567

      320,283

      300,014

      311,629

Total shareholders' equity

       121,379

      128,046

      118,250

      103,608

      113,514

Average assets

    1,345,353

   1,252,390

   1,151,163

   1,087,327

   1,052,496

Average shareholders' equity

       125,340

      125,600

      111,135

      105,911

        88,846

     

 

 

 

 

 

Results Of Operations

 

 

 

 

 

   

 

 

 

 

 

Interest and dividend income

 $      50,749

 $     50,838

 $     50,907

 $     51,141

 $     54,367

Interest expense

         11,663

        13,867

        16,518

        19,432

        21,086

Net interest income

         39,086

        36,971

        34,389

        31,709

        33,281

Provision for loan losses

           1,418

          1,652

          2,395

          2,327

          3,207

Net interest income after provision for loan losses

         37,668

        35,319

        31,994

        29,382

        30,074

   

 

 

 

 

 

Non-interest income

           7,566

          7,709

          6,792

          7,458

          6,022

Non-interest expense

         26,860

        25,618

        23,281

        22,046

        21,754

   

 

 

 

 

 

Income before income taxes

         18,374

        17,410

        15,505

        14,794

        14,342

Income taxes

           5,191

          4,944

          4,462

          4,132

          3,992

   

 

 

 

 

 

Net income

 $      13,183

 $     12,466

 $     11,043

 $     10,662

 $     10,350

Preferred stock dividends and accretion of discount

               ---   

               ---

               ---

             653

          1,034

Net income available to common shareholders

 $      13,183

 $     12,466

 $     11,043

 $     10,009

 $       9,316

   

 

 

 

 

 

Per Common Share Data:

 

 

 

 

 

Basic earnings per share

 $         3.35

 $         3.20

 $         2.86

 $         2.65

 $         3.19

Diluted earnings per share

 $         3.34

 $         3.18

 $         2.85

 $         2.61

 $         3.12

Cash dividends per share

 $         1.25

 $         1.17

 $         1.10

 $         1.05

 $         1.04

 

 

 

 

 

 

Dividend payout ratio

37.28%

36.62%

38.29%

39.43%

32.60%

   

 

 

 

 

 

Selected Financial Ratios:

 

 

 

 

 

Return on total average assets

0.98%

1.00%

0.96%

0.98%

0.98%

Return on total average equity

10.52%

9.93%

9.94%

10.07%

11.65%

Tax-equivalent net interest margin

3.15%

3.23%

3.23%

3.18%

3.40%

   

 

 

 

 

 

Capital Ratios:

 

 

 

 

 

Tier 1  leverage capital ratio

9.01%

8.87%

9.32%

9.01%

10.35%

Tier 1  risk-based capital ratio

14.97%

14.15%

14.29%

13.57%

15.34%

Total risk-based capital ratio

16.62%

15.78%

16.06%

15.41%

17.14%

   

 

 

 

 

 

Asset Quality Ratios:

 

 

 

 

 

Net charge-offs to average loans

0.12%

0.23%

0.37%

0.24%

0.13%

Allowance for loan losses to total loans

0.99%

0.99%

1.13%

1.21%

1.17%

Allowance for loan losses to non-performing loans

95.9%

82.1%

63.7%

62.1%

85.2%

Non-performing loans to total loans

1.04%

1.21%

1.77%

1.95%

1.37%



8



ITEM 7. 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 years ended December 31, 2013, 2012, and 2011, and financial condition at December 31, 2013, and 2012, 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 Annual Report on Form 10-K.


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 tax-equivalent basis. Specifically, included in 2013, 2012 and 2011 interest income was $3,589, $3,336 and $3,051, respectively, of tax-exempt interest income from certain investment securities and loans. 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 $1,762, $1,628 and $1,471 in 2013, 2012 and 2011, respectively, which increased net interest income accordingly. The analysis of net interest income tables included in this Annual Report on Form 10-K 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.


EXECUTIVE OVERVIEW


General Information


Bar Harbor Bankshares is a Maine corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2013, the Company had consolidated assets of $1.37 billion and was one of the larger independent community banking institutions in the state of Maine.


The Company’s principal asset is all of the capital stock of Bar Harbor Bank & Trust (the “Bank”), a community bank incorporated in March 1887. With fifteen (15) branch office locations, the Company is a diversified financial services provider, offering a full range of banking services and products to individuals, businesses, governments, and not-for-profit organizations throughout downeast, midcoast and central Maine.

The Bank attracts deposits from the general public in the markets it serves and uses such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage and home equity loans, and a variety of consumer loans. The Bank also invests in mortgage-backed securities issued by U.S. Government agencies and Government-sponsored enterprises, obligations of state and political subdivisions, as well as other debt securities. In addition to community banking, the Bank provides a comprehensive array of trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services (“Trust Services”), a Maine chartered non-depository trust company. The Bank retains Infinex Investments, Inc., (“Infinex”) as a full service third-party broker-dealer, conducting business under the assumed business name “Bar Harbor Financial Services.”  Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Bank or its subsidiaries.


Major Sources of Revenue


The principal source of the Company’s revenue is net interest income, representing the difference or spread between interest income from its loan and securities portfolios, and the interest expense paid on deposits and borrowed funds. In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations. The Company’s non-interest income is derived from financial services including trust, investment management and third-party brokerage services, as well as service charges on deposit accounts, merchant credit card processing referral and transaction fees, realized gains or losses on the sale of securities, and a variety of other miscellaneous product and service fees.


Business Strategy


The Company, as a diversified financial services provider, pursues a strategy of achieving long-term sustainable profitability, growth, and shareholder value, without sacrificing its soundness. The Company works toward achieving this goal by focusing on increasing its loan and deposit market share in downeast, midcoast and central Maine, either organically or by way of strategic acquisitions. The Company believes one of its more unique strengths is an understanding of the financial needs of coastal communities and the businesses vital to Maine’s coastal economy, namely: tourism, hospitality, retail establishments and restaurants, seasonal lodging and campgrounds, biological research laboratories, lobster and other fishing, boat building, and marine services.


Operating under a community banking philosophy, the Company’s key strategic focus is vigorous financial stewardship, by deploying investor capital safely yet efficiently for the best possible returns. The Company strives to provide unmatched service to its customers, while maintaining strong asset quality and a focus toward improving operating efficiencies. In managing its earning asset portfolios, the Company seeks to utilize funding and capital resources within well-defined credit, investment, interest-rate and liquidity guidelines. In managing its balance sheet, the Company seeks to preserve the sensitivity of net interest income to changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity under prevailing and expected conditions, and strives to maintain a balanced and appropriate mix of loans, securities, core deposits, brokered deposits and borrowed funds.









Material Risks and Challenges


In its normal course of business, the Company faces many risks inherent with providing banking and financial services. Among the more significant risks managed by the Company are losses arising from loans not being repaid, commonly referred to as “credit risk,” and losses of income arising from movements in interest rates, commonly referred to as “interest rate and market risk.”  The Company is also exposed to national and local economic conditions, downturns in the economy, or adverse changes in real estate markets, which could negatively impact its business, financial condition, results of operations or liquidity.


Management has numerous policies and control processes in place that provide for the monitoring and mitigation of risks based upon and driven by a variety of assumptions and actions which, if changed or altered, could impact the Company’s business, financial condition, results of operations or liquidity. The foregoing matters are more fully discussed in Part I, Item 1A, “Risk Factors,” and throughout this Annual Report on Form 10-K.


Summary Financial Results


For the year ended December 31, 2013, the Company reported net income of $13,183, compared with $12,466 for the year ended December 31, 2012, representing an increase of $717, or 5.8%. The Company’s 2013 diluted earnings per share amounted to $3.34, compared with $3.18 in 2012, representing an increase of $0.16, or 5.0%.


The Company’s 2013 return on average shareholders’ equity amounted to 10.52%, up from 9.93% in 2012.  The Company’s 2013 return on average assets amounted to 0.98%, compared with 1.00% in 2012.


As more fully enumerated in the following management discussion and analysis, the Company’s 2013 operating results were highlighted by a $2,249 or 5.8% increase in tax-equivalent net interest income, relatively stable credit quality and improved loan loss experience, continued commercial and consumer loan growth, and higher levels of fee income. The Company continued to focus on the management of its operating expenses, posting a 2013 efficiency ratio of 55.8%.


In the third quarter of 2012, the Bank acquired substantially all assets and assumed certain liabilities including all deposits of Border Trust Company (“Border Trust”), a subsidiary of Border Bancshares, Inc., headquartered in Augusta, Maine. The Bank acquired $38,520 of deposits and $33,606 in loans, as well as three branch offices (two of which were leased) located in Kennebec and Sagadahoc Counties. The Bank paid a deposit premium of 3.85%, or $1,115, and purchased the loan portfolio, excluding selected non-performing loans, at a discount of 2.16%, or $749. In connection with this transaction, the Bank recorded goodwill of $1,777 and a core deposit intangible of $783, or 2.7% of core deposits.


APPLICATION OF CRITICAL ACCOUNTING POLICIES


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, including those related to the allowance for loan losses, 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.

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual 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 believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements:


Allowance for Loan Losses: The allowance for loan losses (“allowance”) is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of probable loss in the loan portfolio. Management regularly evaluates the allowance for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income, and when a greater amount of provision for loan losses is necessary, the result is lower net income. Refer to Part II, Item 7, Allowance for Loan Losses and Provision, and Part II, Item 8, Note 4, Loans and allowance for loan losses, of the Consolidated Financial Statements, in this Annual Report on Form 10-K, for further discussion and analysis concerning the allowance.


Other-Than-Temporary Impairments on Securities: One of the significant estimates related to investment securities is the evaluation of other-than-temporary impairments. The evaluation of securities for other-than-temporary 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 investments 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.


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, 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.


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 an economic recession, 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.


Refer to Part II, Item 7, Impaired Securities, and Part II, Item 8, Note 1 of the Consolidated Financial Statements in this Annual Report on Form 10-K, for further discussion and analysis concerning other-than-temporary impairments.


Income Taxes: The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary differences resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from historical taxes paid and future taxable income and, to the extent that the recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2013 and 2012, there was no valuation allowance for deferred tax assets, which 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. 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.  


Goodwill represents the excess of the purchase price over the fair value of net assets acquired in accordance with the purchase method of accounting for business combinations. Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis or more frequently if an event occurs or circumstances change that reduce the fair value of a reporting unit below its carrying amount. The Company completes its annual goodwill impairment test as of December 31 of each year. The impairment testing process is conducted by assigning assets and goodwill to each reporting unit. Currently, the Company’s goodwill is evaluated at the entity level as there is only one reporting unit. The Company first assesses certain qualitative factors to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying value. If it is more likely than not that the fair value of the reporting unit is less than the carrying value, then the fair value of each reporting unit is compared to the recorded book value “step one.” If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and “step two” is not considered necessary. If the carrying value of a reporting unit exceeds its fair value, the impairment test continues (“step two”) by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets and liabilities of the reporting unit to current fair value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the goodwill. An impairment charge is recognized if the carrying fair value of goodwill exceeds the implied fair value of goodwill. At December 31, 2013, there was no indication of impairment that led the Company to believe it needed to perform a two-step test.


Identifiable intangible assets, included in other assets on the consolidated balance sheet, consist of core deposit intangibles amortized over their estimated useful lives on a straight-line method, which approximates the economic benefits to the Company. These assets are reviewed for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets.


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


Refer to Notes 1 and 6 of the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further details of the Company’s accounting policies and estimates covering goodwill.


FINANCIAL CONDITION


Asset/Liability Management


In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate, and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Average earning assets represented 96.3% and 95.6% of total average assets during 2013 and 2012, respectively.


The Company, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through retail deposit products offered within the markets served, as well as through the prudent use of borrowed and brokered funds.


The Company’s objectives in managing its 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 promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity, under prevailing and forecasted economic conditions, and to maintain an efficient and appropriate mix of core deposits, brokered deposits, and borrowed funds.


Earning Assets


For the year ended December 31, 2013, the Company’s total average earning assets amounted to $1,296,121, compared with $1,196,800 in 2012, representing an increase of $99,321, or 8.3%. The 2013 increase in average earning assets was principally attributed to a $59,210 or 7.6% increase in the Bank’s average loan portfolio and, to a lesser extent, a $39,292 or 9.8% increase in average securities.


The tax-equivalent yield on total average earning assets amounted to 4.05% in 2013 compared with 4.38% in 2012, representing a decline of 33 basis points. The weighted average yield on the Bank’s securities portfolio declined 49 basis points to 3.41% in 2013, largely reflecting the ongoing replacement of accelerated mortgage-backed securities cash flows in a historically low interest rate environment combined with incremental securities purchases at low prevailing market yields. The weighted average yield on the Bank’s loan portfolio declined 26 basis points to 4.46% in 2013, largely reflecting the ongoing origination and competitive re-pricing of certain commercial loans and the origination and refinancing of residential mortgage loans during a period of historically low interest rates.



For the year ended December 31, 2013, total tax-equivalent interest income amounted to $52,511 compared with $52,466 in 2012, representing an increase of $45, or 0.1%. Interest income from the securities portfolio declined $596 or 3.8% in 2013 compared with 2012, but this decline was essentially offset by a $658 or 1.8% increase in interest income from the loan portfolio above 2012 levels.


Total Assets


The Company’s assets principally consist of loans and securities, which at December 31, 2013 represented 62.1% and 32.8% of total assets, compared with 62.6% and 32.1% at December 31, 2012, respectively.


At December 31, 2013, the Company’s total assets stood at $1,373,893, compared with $1,302,935 at December 31, 2012, representing an increase of $70,958, or 5.4%. The increase in total assets was principally attributed to a $37,853 or 4.6% increase in total loans, followed by a $32,130 or 7.7% increase in securities.


Securities


The average securities portfolio represented 33.9% of the Company’s average earning assets in 2013 and generated 28.5% of its total tax-equivalent interest and dividend income, compared with 33.4% and 29.7% in 2012, respectively.


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 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. The securities portfolio is managed under the policy guidelines established by the Bank’s Board of Directors.


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 securities portfolio also includes tax-exempt obligations of state and political subdivisions thereof.


Total Securities: At December 31, 2013, total securities amounted to $450,170 compared with $418,040 at December 31, 2012, representing an increase of $32,130, or 7.7%. Securities purchased during 2013 consisted of mortgage-backed securities issued and guaranteed by U.S. Government agencies and sponsored enterprises and, to a lesser extent, tax exempt obligations of state and political subdivisions.


Securities Available for Sale: Securities available for sale represented 100% of total securities at December 31, 2013 and 2012.


The designation of securities available for sale is made at the time of purchase, based upon management’s intent to hold the securities for an indefinite time; however, these securities would be available for sale in response to changes in market interest rates, related changes in the securities’ prepayment risk, needs for liquidity, or changes in the availability of and yield on alternative investments. The securities available for sale portfolio is used for liquidity purposes while simultaneously producing earnings.


Securities classified as 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. Gains and losses on the sale of securities available for sale are determined using the specific-identification method and are shown separately in the consolidated statements of income.


The following table summarizes the securities available for sale portfolio as of December 31, 2013 and 2012:


December 31, 2013


Available for Sale:

Amortized

Cost

Gross

Unrealized

Gains

Gross

Unrealized

Losses

Estimated

Fair Value

     

 

 

 

 

Mortgage-backed securities:

 

 

 

 

  US Government-sponsored enterprises

 $277,838

 $  4,386

 $  8,592

 $273,632

  US Government agency

     83,153

        833

     2,457

     81,529

  Private label

       5,423

        825

          78

       6,170

Obligations of states and

     political subdivisions thereof

     95,221

     1,121

     7,503

     88,839

  Total

 $461,635

 $  7,165

 $18,630

 $450,170

   

 

 

 

 

   

 

 

 

 

December 31, 2012


Available for Sale:

Amortized

Cost

Gross

Unrealized

Gains

Gross

Unrealized

Losses

Estimated

Fair Value

    

 

 

 

 

Mortgage-backed securities:

 

 

 

 

  US Government-sponsored enterprises

 $238,974

 $  7,913

 $ 1,064

 $245,823

  US Government agency

     82,397

     2,080

       216

     84,261

  Private label

       8,063

        571

       521

       8,113

Obligations of states and

      political subdivisions thereof

     76,335

     4,040

       532

     79,843

  Total

 $405,769

 $14,604

 $ 2,333

 $418,040


Mortgage-backed Securities Issued by U.S. Government-sponsored Enterprises: This category of securities represents mortgage backed securities issued and guaranteed by U.S. Government-sponsored enterprises, specifically, FNMA and FHLMC. These Government-sponsored enterprises were placed under the conservatorship of the U.S. Government on September 7, 2008. In August of 2011, Standard and Poor’s, a major credit rating agency, downgraded all debt issued and guaranteed by the United States from “AAA” to “AA+”. Accordingly, all of these securities were credit rated “AA+” at December 31, 2013.


At December 31, 2013, the amortized cost of mortgage-backed securities issued by U.S. Government-sponsored enterprises totaled $277,838, compared with $238,974 at December 31, 2012, representing an increase of $38,864, or 16.3%. At December 31, 2013, the amortized cost of mortgage-backed securities issued by U.S. Government enterprises comprised 60.2% of the securities portfolio, compared with 58.9% at December 31, 2012.


At December 31, 2013, the Bank’s weighted average yield on mortgage-backed securities issued by U.S. Government-sponsored enterprises amounted to 3.34% compared with 3.29% at December 31, 2012. The increase in the weighted average yield was largely attributed to the increase in interest rates during the second half of 2013, causing a slowdown in MBS cash flows, lower levels of bond premium amortization and higher yields.


Mortgage-backed Securities Issued by U.S. Government Agencies: This category of securities represents mortgage-backed securities backed by the full faith and credit of the U.S. Government, such as the Government National Mortgage Association (“GNMA”). All of these securities were credit rated “AA+” at December 31, 2013 and 2012.


At December 31, 2013, the total amortized cost of the Bank’s mortgage-backed securities issued by U.S. Government agencies totaled $83,153, compared with $82,397 at December 31, 2012, representing an increase of $756, or 0.9%. At December 31, 2013, the amortized cost of mortgage-backed securities issued by U.S. Government agencies comprised 18.0% of the Bank’s securities portfolio, compared with 20.3% at December 31, 2012.


At December 31, 2013, the weighted average yield on mortgage-backed securities issued by U.S. Government agencies amounted to 2.97%, compared with 2.77% at December 31, 2012. The increase in the weighted average yield was largely attributed to the increase in interest rates during the second half of 2013, causing a slowdown in MBS cash flows, lower levels of bond premium amortization and higher yields.


Mortgage-backed Securities Issued by Private-label Issuers: This category of securities represents mortgage-backed securities issued by banks, investment banks, and thrift institutions. Typically, these securities are largely based on mortgages which exceed the conforming loan sizes required by agency securities. While private-label mortgage-backed securities are not guaranteed by any U.S. Government agency, they are credit rated by the major rating agencies (Moody’s, Standard & Poor’s and FITCH).


Most of the Bank’s mortgage-backed securities issued by private-label issuers carry various amounts of credit enhancement, and none are classified as sub-prime mortgage-backed security pools. All of these securities were purchased prior to 2008 based on the underlying loan characteristics such as loan to value ratios, borrower credit scores, property type and location, and the level of credit enhancement.


At December 31, 2013, the total amortized cost of the Bank’s private-label MBS amounted to $5,423, compared with $8,063 at December 31, 2012, representing a decline of $2,640, or 32.7%. This decline was principally attributed to principal pay downs on the underlying securities collateral throughout 2013. At December 31, 2013, the amortized cost of mortgage-backed securities issued by private-label issuers comprised 1.2% of the Bank’s securities portfolio, compared with 2.0% at December 31, 2012.


At December 31, 2013, the weighted average yield on the Bank’s private-label mortgage-backed securities portfolio amounted to 12.31%, compared with 13.66% at December 31, 2012. The unusually high yields were largely attributed to interest received on certain other-than-temporarily impaired securities where the book value was significantly lower than the contractual par value.


At December 31, 2013, $3,820 of the total amortized cost of the Bank’s private-label MBS portfolio was rated below investment grade by at least one of the major credit rating agencies, compared with $4,425 at December 31, 2012. All of these below investment grade securities had been rated “AAA” by the credit rating agencies at the date of purchase and continued to be rated “AAA” through December 31, 2007. Beginning in 2008 and continuing through 2013, unprecedented market stresses began affecting all mortgage-backed securities (Government agency and private-label) as the economy, in general, and the housing market, in particular, seriously deteriorated. As a result, the Bank revised its assessments as to the full recoverability of its private-label MBS, which necessitated OTTI write-downs under existing accounting standards each year since 2008. Refer to Part II, item 8, Notes to Consolidated Financial Statements, Notes 1 and 3 in this Annual Report on Form 10-K for further information on OTTI.


Obligations of States and Political Subdivisions Thereof: Obligations of states and political subdivisions thereof (“municipal bonds”) are issued by city, county and state governments, as well as by enterprises with a public purpose, such as certain electric utilities, universities and hospitals. One of the primary attractions of municipal bonds is that “Bank Qualified” issues are federally tax exempt. 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 with 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. The Bank’s municipal bond portfolio is generally concentrated in school districts across the U.S.A., which have historically been considered among the safer municipal bond investments.


Municipal bonds are frequently supported with insurance, which guarantees that in the event the issuer experiences financial problems, the insurer will step in and assume payment of both principal and interest. Historically, insurance support has strengthened an issuer’s underlying credit rating to AAA or AA status. Starting in 2008, many of the insurance companies providing municipal bond insurance experienced financial difficulties and, accordingly, were downgraded by at least one of the major credit rating agencies. Consequently, since 2008 a portion of the Bank’s municipal bond portfolio was downgraded by at least one of the major credit rating agencies. Notwithstanding the credit rating downgrades, at December 31, 2013 and 2012, the Bank’s municipal bond portfolio did not contain any below investment grade securities as reported by major credit rating agencies. In addition, at December 31, 2013 and 2012 all municipal bond issuers were current on contractually obligated interest and principal payments.


At December 31, 2013, the amortized cost of the Bank’s municipal bond portfolio, totaled $95,221, compared with $76,335 at December 31, 2012, representing an increase of $18,886, or 24.7%. At December 31, 2013, the amortized cost of municipal bonds comprised 20.6% of the Bank’s securities portfolio, compared with 18.8% at December 31, 2012. At December 31, 2013, the fully tax-equivalent yield on the Bank’s municipal bond portfolio amounted to 5.65%, compared with 6.31% at December 31, 2012.


Securities Maturity Distribution and Weighted Average Yields:  The following table summarizes the maturity distribution of the amortized cost of the Bank’s securities portfolio and weighted average yields of such securities on a fully tax-equivalent basis as of December 31, 2013. The maturity distribution is based upon the final maturity date of the securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay 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

MATURITY SCHEDULE AND WEIGHTED AVERAGE YIELDS

DECEMBER 31, 2013

(at fair value)


 

One Year or Less

 

Greater than

 One Year to Five Years

 

Greater than

Five to Ten Years

 

Greater than

Ten Years

 

Total

 

Estimated

Fair Value

Weighted Average Yield

 

Estimated

Fair

Value

Weighted Average

Yield

 

Estimated

Fair

Value

Weighted Average

Yield

 

Estimated

Fair

Value

Weighted Average

Yield

 

Estimated

Fair

Value

Weighted Average

Yield

   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

     securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  US Government-

      sponsored

      enterprises

   $---

0.00%

 

 $2,969

3.83%

 

   $16,306

3.91%

 

 $254,357

    3.30%

 

 $273,632

    3.34%

  US Government

      agency

     ---

0.00%

 

       741

4.09%

 

       1,268

2.33%

 

     79,520

     2.97%

 

      81,529

    2.97%

  Private label

     ---

0.00%

 

       435

5.65%

 

          594

20.67%

 

       5,141

   12.48%

 

        6,170

   12.31%

Obligations of states

     and political

     subdivisions

     thereof

     ---

0.00%

 

      305

3.52%

 

      2,457

4.80%

 

     86,077

    5.65%

 

      88,839

    5.65%

   Total

   $---

 

 

 $4,450

 

 

  $20,625

 

 

 $425,095

 

 

 $450,170

 


Securities Concentrations: At December 31, 2013 and 2012, the Bank did not hold any securities for a single issuer, other than U. S. Government agencies and sponsored enterprises, where the aggregate book value of the securities exceeded 2% of the Company’s shareholders’ equity.


Impaired Securities: The securities portfolio contains certain securities where amortized cost exceeds fair value, which at December 31, 2013, amounted to an excess of $18,630, or 4.0% of the total amortized cost of the securities portfolio. At December 31, 2012 this amount represented an excess of $2,333, or 0.6% of the total amortized cost of the securities portfolio. As of December 31, 2013, unrealized losses on securities in a continuous unrealized loss position more than twelve months amounted to $6,185, compared with $744 at December 31, 2012. The increase in net unrealized losses was attributed to a significant increase in interest rates and pricing spreads during 2013, which negatively impacted the fair value of the Bank’s fixed income portfolio.


As 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 income 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 Part II, Item 8, Notes 1 and 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K.


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 December 31, 2013, the Bank’s investment in FHLB stock totaled $18,370, compared with $18,189 at December 31, 2012, representing an increase of $181, or 1.0%.


FHLB stock is a non-marketable equity security and therefore is reported at cost, which generally equals par value. The ratio of the FHLB’s market value of equity to its par value of capital stock was 119% at December 31, 2013, compared with 108% at December 31, 2012. Shares held in excess of the minimum required amount are generally redeemable at par value.


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 December 31, 2013, and was classified as adequately capitalized by its regulator, the Federal Housing Finance Agency, based on the FHLB’s financial information at September 30, 2013. Based on the capital adequacy, liquidity position and sustained profitability of the FHLB, management believes there is no impairment related to the carrying amount of the Bank’s FHLB stock as of December 31, 2013. The Bank will continue to monitor its investment in FHLB stock.










Loans


Total Loans: At December 31, 2013, total loans amounted to $852,857, compared with $815,004 at December 31, 2012, representing an increase of $37,853, or 4.6%.


The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington, Knox, Kennebec and Sagadahoc Maine. The following table summarizes the major components of the Bank’s loan portfolio, net of deferred loan fees and costs, as of December 31 over the past five years.


SUMMARY OF LOAN PORTFOLIO AT DECEMBER 31


 

2013

2012

2011

2010

2009

   

 

 

 

 

 

Commercial real estate mortgages

 $336,542

 $324,493

 $285,484

 $283,799

 $260,713

Commercial and industrial

     73,972

     59,373

     62,450

     57,323

     59,446

Commercial construction

     and land development

     18,129

     22,120

     30,060

     32,114

     26,901

Agricultural and other loans to farmers

     26,929

     24,922

     26,580

     24,359

     22,192

  Total commercial loans

   455,572

   430,908

   404,574

   397,595

   369,252

     

 

 

 

 

 

Residential real estate mortgages

   317,115

   297,103

   239,799

   231,434

   225,750

Home equity loans

     49,565

     53,303

     51,462

     54,289

     54,889

Other consumer loans

     14,523

     19,001

     22,906

       4,417

       4,665

  Total consumer loans

   381,203

   369,407

   314,167

   290,140

   285,304

     

 

 

 

 

 

Tax exempt loans

     16,355

     15,244

       9,700

     12,126

     14,138

   

 

 

 

 

 

   Net deferred loan costs and fees

         (273)

         (555)

          562

          809

          798

Total loans

   852,857

   815,004

   729,003

   700,670

   669,492

Allowance for loan losses

      (8,475)

      (8,097)

      (8,221)

      (8,500)

      (7,814)

Total loans net of allowance

      for loan losses

 $844,382

 $806,907

 $720,782

 $692,170

 $661,678



At December 31, 2013, commercial loans comprised 53.4% of the total loan portfolio, compared with 52.9% at December 31, 2012. Consumer loans, which principally consisted of residential real estate mortgage loans, comprised 44.7% of total loans compared with 45.3% at December 31, 2012.


Factors contributing to the changes in the loan portfolio are enumerated in the following discussion and analysis.


Commercial Loans: The Bank offers a variety of commercial lending products including term loans and lines of credit. The Bank offers a broad range of short to medium term commercial loans, primarily collateralized, to businesses for working capital (including inventory and receivables), business expansion (including acquisitions of real estate and improvements) and the purchase of equipment and machinery. The purpose of a particular loan generally determines its structure. Commercial loans are provided primarily to organizations and sole proprietors in the tourism, hospitality, healthcare, blueberry, boatbuilding, biological research, and fishing industries, as well as to other small and mid-size businesses associated with the coastal communities of Maine.


Commercial loans are approved using a combination of individual loan authorities, and a Directors’ Loan Committee.  For loan relationships below $500, loans are approved using individual loan authorities.  For loan relationships over $500 but less than $1,000, loans are approved by two Senior Signers.  The Bank has four Senior Signers – the President and CEO, the EVP of Business Banking, the EVP of Retail Banking and the EVP and Chief Risk Officer.  Loans to customer relationships over $1,000 require (with some limited exceptions as permitted in the Bank’s lending policy) approval by the Bank’s Directors’ Loan Committee, a formal Committee of the Bank’s Board of Directors.  Any loans approved under any of the limited exceptions permitted by the Bank’s lending policy are ratified by the Directors’ Loan Committee, which meets regularly.


At December 31, 2013, total commercial loans amounted to $455,572, compared with $430,908 at December 31, 2012, representing an increase of $24,664, or 5.7%.


Commercial loan growth has generally been challenged by a still-recovering economy, continued economic uncertainty, diminished demand, and strong competition for quality loans. Bank management attributes the continued growth of commercial loans in 2013 to an effective business banking team, deep local market knowledge, sustained new business development efforts, and a resilient local economy that has been faring better than the nation as a whole.


Reflecting the Bank’s business region, at December 31, 2013, approximately $109,875 or 32.6% of the commercial real estate mortgage portfolio was represented by loans to the lodging industry, compared with 31.4% at December 31, 2012. The Bank underwrites lodging industry loans as operating businesses, lending primarily to seasonal establishments with stabilized cash flows.


The proportion of commercial and industrial loans to total commercial loans is reflective of the Bank’s market area demographics, which have historically limited the opportunity and growth potential in this particular category of loans. Similarly, the communities served by the Bank generally offer limited opportunities for agricultural and other loans to farmers.  This category of loans principally includes loans related to Maine’s wild blueberry industry.


Consumer Loans: At December 31, 2013, total consumer loans stood at $381,203 compared with $369,407 at December 31, 2012, representing an increase of $11,796, or 3.2%. At December 31, 2013, residential real estate mortgage loans represented 83.2% of total consumer loans, compared with 80.4% at year end 2012.


Residential real estate mortgage loans totaled at $317,115 as of December 31, 2013, compared with $297,103 at December 31, 2012, representing an increase of $20,012, or 6.7%.  This increase was largely attributed to the purchase of a New England based portfolio of residential mortgage loans during the second quarter of 2013. Loans originated and closed by the Bank during 2013 were largely offset by loan re-financings and principal pay downs from the existing residential real estate loan portfolio, as borrowers continued to take advantage of historically low interest rates. All 2013 residential real estate loan originations were held in the Bank’s loan portfolio, versus sold into the secondary market.


Home equity loans totaled $49,565 at December 31, 2013, compared with $53,303 at December 31, 2012, representing a decline of $3,738, or 7.0%. Company management believes this decline was largely due to consumer debt consolidation and the fact that the Bank did not aggressively campaign for home equity loans during 2013.


Loans to individuals for household, family and other personal expenditures (“other consumer loans”) totaled $14,523 at December 31, 2013, compared with $19,001 at December 31, 2012, representing a decline of $4,478, or 23.6%. Given strong competition from the financing affiliates of consumer durable goods manufacturers, among other considerations, the Bank does not campaign aggressively for consumer installment loans. However, in 2011 the Bank purchased a Maine-based, seasoned portfolio of prime consumer loans. The underlying collateral supporting these consumer loans consisted of recreational vehicles and vessels (i.e. pleasure boats). The 2013 decline in other consumer loans principally resulted from normal principal pay downs that were not replaced with new consumer installment loan originations.


Tax Exempt Loans: Tax-exempt loans totaled $16,355 at December 31, 2013, compared with $15,244 at December 31, 2012, representing an increase of $1,111, or 7.3%. Tax-exempt loans include loans to local government municipalities, not-for-profit organizations, and other organizations that qualify for tax-exempt treatment. Government municipality loans typically have short maturities (e.g., tax anticipation notes, etc.). 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.


Loan Concentrations: Because of the Bank’s proximity to Acadia National Park, a large part of the economic activity in the area is generated from the hospitality business associated with tourism. At December 31, 2013, approximately $114,982 or 13.5% of the Bank’s loan portfolio was represented by loans to the lodging industry, compared with $105,699 or 13.0% at December 31, 2012. Loan concentrations continued to principally reflect the Bank’s business region.


Real Estate Loans Under Foreclosure: At December 31, 2013, real estate loans under foreclosure totaled $2,900 compared with $1,567 at December 31, 2012, representing an increase of $1,333, or 85.1%.


At December 31, 2013, real estate loans under foreclosure were represented by nine residential mortgage loans totaling $1,414, one commercial construction and land development loan totaling $68, seven commercial real estate loans totaling $1,268 and one commercial and industrial loan totaling $150.


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 December 31, 2013, total OREO amounted to $1,625, compared with $2,780 as of December 31, 2012, representing a decline of $1,155 or 41.5%.  Five residential and six commercial properties comprised the December 31, 2013 balance of OREO.


During the twelve months ended December 31, 2013, five properties were added to OREO.   There were nine properties written down for an aggregate total of $331 in write downs, and there were seven sales of OREO properties, of which one was sold at a gain of $53, and six were sold at an aggregate loss of $17.  Additionally, one property with a carrying value of $13 was donated to the Habitat for Humanity.


Mortgage Loan Servicing: The Bank, from time to time, will sell residential mortgage loans to other institutions and investors such as the FHLMC. In prior years, the Bank has generally sold fixed rate, long term residential mortgage loans, as a means of managing interest rate risk. The sale of loans also allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2013, the unpaid balance of mortgage loans serviced for others totaled $15,116 compared with $17,728 at December 31, 2012, representing a decline of $2,612 or 14.7%.








Loan Portfolio Interest Rate Composition: The following table summarizes the commercial, tax-exempt and consumer components of the loan portfolio by fixed and variable interest rate composition, as of December 31, 2013 and 2012:


 

2013

2012

Commercial:

 

 

   Fixed

    $  73,391

    $  65,865

   Variable

      382,045

      364,765

     Total

    $455,436

    $430,630

   

 

 

Tax exempt:

 

 

   Fixed

    $    7,563

    $   6,239

   Variable

          8,792

         9,005

     Total

    $  16,355

    $ 15,244

   

 

 

Consumer:

 

 

   Fixed

    $290,259

    $269,623

   Variable

        90,807

        99,507

     Total

    $381,066

    $369,130

   

   

   

 

   

 

   Total loans:

 

 

   Fixed

    $371,213

    $341,727

   Variable

      481,644

      473,277

     Total

    $852,857

    $815,004


At December 31, 2013, fixed and variable rate loans comprised 43.5% and 56.5% of the loan portfolio, respectively, compared with 41.9% and 58.1% at December 31, 2012. Over the past few years variable rate loans comprised a larger portion of the commercial loan portfolio compared with historical levels. Bank management believes this was principally driven by the historically low short-term interest rates including Prime and LIBOR. Most new borrowers elected variable rate loan pricing, while some existing borrowers renegotiated their higher cost fixed rate borrowings to lower cost variable rate borrowings.


Loan Maturities and Re-pricing Distribution:  The following table summarizes fixed rate loans reported by remaining maturity, and floating rate loans by next re-pricing date, as of December 31, 2013 and 2012. Actual maturity dates may differ from contractual maturity dates due to prepayments, modifications and re-financings.


Maturities

2013

 

2012

   

 

 

 

One year or less

    $287,279

 

    $298,661

Over 1 - 5 years

      167,838

 

      150,837

Over 5 years

      397,740

 

      365,506

  Total loans

    $852,857

 

    $815,004


Credit Risk: Credit risk is managed through loan officer authorities, loan policies, and oversight from the Bank's Chief Risk Officer, the Bank’s Senior Loan Officers’ Committee, the Directors’ 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 function, which reports to the Audit Committee of the Board of Directors.



Management recognizes that early and accurate recognition of risk is the best means to reduce credit losses and maximize earnings. 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 loan losses are recognized no later than the point at which a loan is 120 days past due. Residential mortgage loan 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 correlate with regulatory definitions of “Pass,” “Other Assets Especially Mentioned,” “Substandard,” “Doubtful,” and “Loss.”


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 and loans past due 90 days or more and still accruing interest. The following table sets forth the details of non-performing loans over the past five years.


TOTAL NON-PERFORMING LOANS

AT DECEMBER 31


 

2013

2012

2011

2010

2009

   

 

 

 

 

 

Commercial real estate mortgages

   $2,046

   $1,888

 $  2,676

 $  3,572

 $3,096

Commercial and industrial loans

        793

        818

     1,078

        778

      237

Commercial construction

     and land development

     1,913

     2,359

     3,753

     5,899

      392

Agricultural and other loans to farmers

          56

        664

        595

        254

   1,848

   Total commercial loans

     4,808

     5,729

     8,102

   10,503

   5,573

   

 

 

 

 

 

Residential real estate mortgages

     3,227

     3,017

     4,266

     3,022

   2,522

Home equity loans

        745

        814

        266

        146

      304

Other consumer loans

          60

          72

        273

          ---

          5

   Total consumer loans

     4,032

     3,903

     4,805

     3,168

   2,831

   

 

 

 

 

 

       Total non-accrual loans

     8,840

     9,632

   12,907

   13,671

   8,404

Accruing loans contractually

     past due 90 days or more

          ---

        235

          ---

            6

      772

       Total non-performing loans

   $8,840

   $9,867

 $12,907

 $13,677

 $9,176

 

 

 

 

 

 

Allowance for loan losses

     to non-performing loans

95.9%

82.1%

63.7%

62.1%

85.2%

Non-performing loans to total loans

1.04%

1.21%

1.77%

1.95%

1.37%

Allowance to total loans

0.99%

0.99%

1.13%

1.21%

1.17%





At December 31, 2013, total non-performing loans amounted to $8,840, compared with $9,867 at December 31, 2012, representing a decline of $1,027, or 10.4%. At December 31, 2013, total non-performing loans represented 1.04% of total loans, down from 1.21% as of December 31, 2012. As more fully discussed below, one commercial real estate loan to a local, non-profit affordable housing authority in support of an affordable housing project accounted for $1,845, or 20.9% of total non-performing loans at December 31, 2013.


Non-performing commercial real estate mortgages totaled $2,046 at December 31, 2013, representing an increase of $158, or 8.4%, compared with December 31, 2012. At December 31, 2013, non-performing commercial real estate mortgages were represented by eleven business relationships, with outstanding balances ranging from $23 to $460.


Non-performing commercial and industrial loans totaled $793 at December 31, 2013, representing a decline of $25, or 3.1%, compared with December 31, 2012.  At December 31, 2013, non-performing commercial and industrial loans were represented by ten business relationships, with outstanding balances ranging from $6 to $224.


Non-performing commercial construction and land development loans totaled $1,913 at December 31, 2013, representing a decline of $446, or 18.9%, compared with December 31, 2012. At December 31, 2013, non-performing commercial construction and land development loans were represented by two business relationships, including a $1,845 commercial real estate loan to a local, non-profit affordable housing authority in support of an affordable housing project. This loan is principally secured by the housing units from the project. The project is fully constructed and there is no construction risk associated with the loan. The primary source of repayment is the sale of the existing housing units. This loan is impaired and was put on non-accrual status in late 2010. To date, the Bank has charged off $2,014 of the original outstanding balance of this collateral dependent impaired loan, of which $192 was recorded in 2012 and $1,822 in 2011. These charge-offs were based on current appraisals and revised prospects for future cash flows. This loan is recorded at fair value in the Company’s financial statements.


Non-performing residential real estate mortgages totaled $3,227 at December 31, 2013, representing an increase of $210, or 7.0%, compared with December 31, 2012. At December 31, 2013, non-performing residential real estate loans were represented by thirty-three, conventional, 1-4 family mortgage loans, with outstanding balances ranging from $15 to $380.


Non-performing home equity loans totaled $745 at December 31, 2013, representing a decline of $69, or 8.5%, compared with December 31, 2012. At December 31, 2013, non-performing home equity loans were represented by five relationships with outstanding balances ranging from $5 to $391.


While the level and mix of non-performing loans continued to reflect favorably on the overall quality of the Bank’s loan portfolio at December 31, 2013, Bank management is cognizant of the still-recovering real estate market, elevated unemployment rates and soft economic conditions overall. Bank management believes 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 returns to pre-recession levels and 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, monetary policy, 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. These loans amounted to $4,201 and $3,529 at December 31, 2013, and 2012, or 0.49% and 0.43% 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.


On an ongoing basis, 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 December 31, 2013, the Bank identified twenty-eight commercial relationships totaling $11,123 as potential problem loans, or 1.30% of total loans. At December 31, 2012, the Bank identified thirty-three commercial relationships totaling $10,297 as potential problem loans, or 1.26% 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 year-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 December 31, 2013, the allowance for loan losses (the “allowance”) stood at $8,475, compared with $8,097 at December 31, 2012, representing an increase of $378, or 4.7%. The increase in the allowance from December 31, 2012 largely reflected loan portfolio growth, as the Bank’s credit quality metrics were relatively stable. While non-performing loans declined $1,027 or 10.4%, other delinquent and potential problem loans increased $1,498 or 10.8%, compared with December 31, 2012.


At December 31, 2013, the allowance expressed as a percentage of total loans stood at 0.99%, unchanged compared with December 31, 2012. At December 31, 2013, the allowance expressed as a percentage of non-performing loans amounted to 95.9% compared with 82.1% at December 31, 2012.


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 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 an expedient, a collateral shortfall analysis. The amount of collateral dependent impaired loans totaled $2,699 as of December 31, 2013, compared with $3,149 as of December 31, 2012, representing a decline of $450, or 14.3%. The related allowances for loan losses on these impaired loans amounted to $120 as of December 31, 2013 and 2012.


Management reviews impaired loans to ensure such loans are transferred to interest non-accrual status, and written down when necessary. The amount of interest income not recorded on impaired loans amounted to $52, $37, and $5 for the years ended December 31, 2013, 2012 and 2011, respectively.


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 2013 compared with 2012.


Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, management believes the allowance for loan losses at December 31, 2013, is appropriate for the risks inherent in the loan portfolio.


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 for loan losses and summarizes loan loss experience by loan type over the past five years.


ALLOWANCE FOR LOAN LOSSES

SUMMARY OF LOAN LOSS EXPERIENCE


 

2013

2012

2011

2010

2009

   

 

 

 

 

 

Balance at beginning of period

  $   8,097

 $    8,221

 $    8,500

 $    7,814

 $    5,446

Charge offs:

 

 

 

 

 

Commercial real estate mortgages

          214

          474

          423

         296

           74

Commercial and industrial

          405

          102

          123

         652

         280

Commercial construction and land development

            ---

          344

       1,943

         167

           ---

Agricultural and other loans to farmers

            81

          160

            ---

         396

           68

Residential real estate mortgages

          406

          568

          254

         160

         455

Other consumer loans

          120

          294

            90

         103

           78

Home equity loans

            29

            92

            94

         100

           40

  Total charge-offs

       1,255

       2,034

       2,927

      1,874

         995

 

 

 

 

 

 

Recoveries:

 

 

 

 

 

Commercial real estate mortgages

          105

 $           9

 $           8

 $          3

 $         ---

Commercial and industrial loans

            23

            25

            82

           10

           13

Commercial construction and land development

            ---

            ---

            77

           ---

           ---

Agricultural and other loans to farmers

            37

            82

            45

             5

             8

Residential real estate mortgages

              7

          104

            ---

         106

         119

Other consumer loans

            23

            38

            41

           69

           16

Home equity loans

            20

            ---

            ---

           40

           ---

  Total recoveries

          215

          258

          253

         233

         156

   

 

 

 

 

 

Net charge-offs

       1,040

       1,776

       2,674

      1,641

         839

Provision charged to operations

       1,418

       1,652

       2,395

      2,327

      3,207

   

   

   

   

   

   

Balance at end of period

 $     8,475

 $    8,097

 $    8,221

 $    8,500

 $    7,814

   

 

 

 

 

 

Average loans outstanding during period

 $839,010

 $779,800

 $717,895

 $681,988

 $655,201

Annualized net charge-offs to average loans

  outstanding

0.12%

0.23%

0.37%

0.24%

0.13%


For the year ended December 31, 2013, total net loan charge-offs amounted to $1,040, representing a decline of $736, or 41.4%, compared with 2012. Total net charge-offs to average loans outstanding amounted to 0.12% in 2013, compared with 0.23% in 2012.


The following table presents the five-year summary of the allowance by loan type at each respective year-end.


ALLOCATION OF ALLOWANCE FOR LOAN LOSSES

(at December 31)


 

2013

2012

2011

2010

2009

 

 

 

 

 

Amount

Percent of

Loans in

Each

Category to

Total loans

 

 

 

 

Amount

Percent of

Loans in

Each

Category to

Total loans

 

 

 

 

Amount

Percent of

Loans in

Each

Category to

Total loans

 

 

 

 

Amount

Percent of

Loans in

Each

Category to

Total loans

 

 

 

 

Amount

Percent of

Loans in

Each

Category to

Total loans

   

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial,

       and agricultural

 $1,601

11.83%

 $1,329

10.35%

 $1,653

12.22%

 $1,460

11.66%

 $1,812

12.19%

Commercial and Consumer

       real estate mortgages:

   

 

   

 

   

 

   

 

   

 

   Real estate-construction

     and land development

      314

2.13%

       515

2.71%

       594

4.12%

      999

4.58%

      349

4.02%

   Real estate-mortgage

   6,255

82.42%

    5,905

82.74%

    5,602

79.19%

   5,858

81.40%

   5,377

80.98%

Installments and other

    loans to individuals

      137

1.70%

       207

2.33%

       286

3.14%

        73

0.63%

      122

0.70%

Tax exempt

      168

1.92%

       141

1.87%

         86

1.33%

      110

1.73%

      154

2.11%

TOTAL

 $8,475

100.00%

 $8,097

100.00%

 $8,221

100.00%

 $8,500

100.00%

 $7,814

100.00%


Bank Owned Life Insurance


Bank-owned life insurance (“BOLI”) represents life insurance on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received in excess of the cash value, are recorded in other non-interest income, and are not subject to income taxes. The cash surrender value of the BOLI is included on the Company’s consolidated balance sheet.


At December 31, 2013, the cash surrender value of BOLI amounted to $7,879, compared with $7,633 at December 31, 2012, representing an increase of $246, or 3.2%.


Other Assets


The Company’s other assets are principally comprised of accrued interest receivable, deferred income taxes and other real estate owned.


At December 31, 2013 total other assets amounted to $18,812, compared with $12,984 at December 31, 2012, representing an increase of $5,828, or 44.9%. The increase in other assets was principally attributed to an increase in deferred income taxes, which resulted from higher levels of unrealized losses in the Bank’s securities portfolio.



9



Funding Sources


The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Funding sources principally consist of retail deposits and, to a lesser extent, borrowings from the Federal Home Loan Bank of Boston (“FHLB”) of which it is a member, and certificates of deposit obtained from the national market.


Deposits


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 the 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, brokered certificates of deposit obtained from the national market and cash flows from its securities portfolio.


Total Deposits: At December 31, 2013, total deposits amounted to $835,651 compared with $795,765 at December 31, 2012, representing an increase of $39,886, or 5.0%.


Demand Deposits: The Bank’s demand deposits are principally business accounts, which account for approximately two-thirds of total demand deposits. At December 31, 2013, total demand deposits amounted to $72,259, compared with $71,865 at December 31, 2012, representing an increase of $394, or 0.5%. As discussed above, the Bank’s deposits are seasonal in nature and the timing and extent of seasonal swings vary from year to year. This is particularly the case with demand deposits. For the year ended December 31, 2013, total average demand deposits amounted to $70,978, compared with $67,900 in 2012, representing an increase of $3,078, or 4.5%. The increase in average demand deposits was largely attributed to a relatively strong tourist season in the local communities served by the Bank combined with new customer relationships, including those acquired in connection with the 2012 Border Trust transaction.


The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis. The Bank’s business checking account offerings include Easy Business Checking, Small Business Checking, Business Checking with Interest, Business Plus Checking, and Non-Profit Business Plus Checking, each designed to help business owners manage the varying financial aspects of their business. The Bank also offers Remote Deposit Capture, enabling its business customers to deposit checks remotely. Business demand deposits are also generated by way of the Bank’s Merchant Credit Card Processing Program.


NOW Accounts: The Bank offers interest bearing NOW accounts to individuals and not-for-profit organizations. At December 31, 2013, total NOW accounts amounted to $135,246, compared with $123,015 at December 31, 2013, representing an increase of $12,231, or 9.9%. For the year ended December 31, 2013, average NOW accounts amounted to $124,382, compared with $103,955 in 2012, representing an increase of $20,427, or 19.6%.  The increase in average NOW accounts was largely attributed to the deposits acquired in connection with the Border Trust transaction, as well as new customer relationships.


Savings and Money Market Deposits:  At December 31, 2013, total savings and money market accounts amounted to $232,558, compared with $230,325 at December 31, 2012, representing an increase of $2,233, or 1.0%. For the year ended December 31, 2013, average savings and money market accounts amounted to $241,670, compared with $209,622 in 2012, representing an increase of $32,048 or 15.3%. This increase was principally attributed to new customer relationships and, to a lesser extent, the deposits acquired in connection with the Border Trust transaction.

Time Deposits: At December 31, 2013, total time deposits amounted to $395,588, compared with $370,560 at December 31, 2012, representing an increase of $25,028, or 6.8%. 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, while maintaining its strong on-balance-sheet liquidity position via secured borrowing lines of credit with the FHLB and the Federal Reserve Bank of Boston.


The following table summarizes the changes in the average balances of deposits during the periods indicated, including the weighted average interest rates paid for each category of deposits:


AVERAGE DEPOSIT BALANCES BY CATEGORY OF DEPOSIT


 

2013

2012 

 

Average

Balance

Average

Rate

Average

Balance

Average

Rate

   

 

 

 

 

Demand deposits

 $  70,978

      ---

 $  67,900

   ---   

NOW accounts

   124,382

0.19%

   103,955

0.24%

Savings and money market deposits

   241,670

0.24%

   209,622

0.31%

Time deposits

   400,044

1.45%

   384,064

1.77%

   Total deposits

 $837,074

 

 $765,541

 


The following table summarizes the maturity distribution of time deposits of $100 or greater:


MATURITY SCHEDULE

TIME DEPOSITS $100 OR GREATER

DECEMBER 31, 2013


Three months or less

 $  30,632

Over three to six months

     40,629

Over six to twelve months

     44,349

Over twelve months

     36,711

  Total

 $152,321


Time deposits in denominations of $100 or greater totaled $152,321 at December 31, 2013, compared with $130,614 at December 31, 2012, representing an increase of $21,707, or 16.6%.


Borrowed Funds


The Bank utilizes borrowed funds in leveraging its strong capital position and supporting 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.


Borrowed funds principally consist of advances from 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, certain commercial real estate loans, and blanket liens on qualifying mortgage loans and home equity loans.  


Refer to Part II, Item 7, Contractual Obligations, and Notes 9 and 10, Short-term Borrowings and Long-term Debt, of the consolidated financial statements in this annual report on form 10-K for further information on borrowed funds.


Total Borrowings: At December 31, 2013, total borrowings amounted to $409,445, compared with $371,567 at December 31, 2012, representing an increase of $37,878, or 10.2%. The increase in borrowings was principally utilized to help fund the Bank’s earning asset growth.


Junior Subordinated Debentures: In the second quarter of 2008, the Bank issued $5,000 aggregate principal amount of subordinated debt securities. These securities qualify as Tier 2 capital for the Bank and the Company and were issued to help support future earning asset growth without jeopardizing the Bank’s historically strong capital position. The subordinated debt securities are due in 2023, but are callable by the Bank after five years without penalty. The rate of interest on these securities is three month Libor plus 345 basis points. The subordinated debt securities are classified as borrowings on the Company’s consolidated balance sheet.


Capital Resources


Consistent with its long-term goal of operating a sound and profitable organization, at December 31, 2013 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.


The Company’s Articles of Incorporation authorize the Company to issue up to 10,000,000 shares of the Company’s common stock, par value $2.00 per share and up to 1,000,000 shares of preferred stock, no par value. In October 2009, the Company filed a shelf registration statement on Form S-3 with the SEC to register an indeterminate number of shares of common stock and preferred stock, which together have an aggregate initial offering price not to exceed $35,000 (the “Shelf Registration”). The SEC declared the Company’s Shelf Registration effective on November 3, 2009.  In December of 2009 the Company announced that it had completed its offering of 800,000 shares of its common stock to the public at $27.50 per share. The principal use of the net proceeds from that offering were used to repurchase all the Company’s Series A preferred shares previously sold to the U.S. Department of the Treasury under its Capital Purchase Program.


The Company’s Shelf Registration expired on November 3, 2012. The Company has not decided whether to file a new shelf registration statement and does not have any current plans to raise additional capital; however, the Company does recognize that financial flexibility is important and that a shelf registration filed with the SEC can be a prudent capital management tool should the need or opportunity to raise capital on attractive terms arise and, therefore, the Company may consider the filing of a new shelf registration with the SEC on terms similar to the Shelf Registration or other terms during 2014 or in other future years.


Capital Ratios: As of December 31, 2013 and 2012, 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 December 31, 2013, the Company’s Total Risk-based, Tier I Risk-based, and Tier I Leverage ratios were 16.62%, 14.97% and 9.01%, respectively.







The following table sets forth the Company's regulatory capital at December 31, 2013 and 2012, under the rules applicable at that date.


 

December 31, 2013

 

December 31, 2012

   

 

 

 

 

 

 

Amount

Ratio

 

Amount

Ratio

   

 

 

 

 

 

Total Capital to Risk Weighted Assets

   $137,311

16.62%

 

   $127,857

15.78%

Regulatory Requirement

       66,106

8.00%

 

       64,812

8.00%

Excess over "adequately capitalized"

   $  71,205

8.62%

 

   $  63,045

7.78%

   

 

 

 

 

 

   

 

 

 

 

 

Tier 1 Capital to Risk Weighted Assets

   $123,730

14.97%

 

   $114,667

14.15%

Regulatory Requirement

       33,053

4.00%

 

       32,406

4.00%

Excess over "adequately capitalized"

   $  90,677

10.97%

 

   $  82,261

10.15%

    

 

 

 

 

 

   

 

 

 

 

 

Tier 1 Capital to Average Assets

   $123,730

9.01%

 

   $114,667

8.87%

Regulatory Requirement

       54,954

4.00%

 

       51,730

4.00%

Excess over "adequately capitalized"

   $  68,776

5.01%

 

   $  62,937

4.87%


As more fully disclosed in Note 11 of the Consolidated Financial Statements in this Annual Report on Form 10-K, the Bank also maintained its standing as a well-capitalized institution as defined by applicable regulatory standards. At December 31, 2013, the Bank’s Total Risk-based, Tier I Risk-based, and Tier I Leverage ratios were 16.81%, 15.16% and 9.12%, respectively.


Shareholders’ Equity: At December 31, 2013, total shareholders’ equity amounted to $121,379, compared with $128,046 at December 31, 2012, representing a decline of $6,667, or 5.2%. The decline in shareholder’s equity was attributed to a $15,637 decline in accumulated other comprehensive income. This decline was principally the result of a reduction in unrealized gains in the Bank’s securities portfolio, which declined from a tax effective unrealized gain of $8,098 at December 31, 2012 to a tax effected unrealized loss of $7,567 at December 31, 2013. The net unrealized losses at December 31, 2013 were attributed to a significant increase in interest rates and pricing spreads during 2013, which negatively impacted the fair value of the Bank’s fixed income securities portfolio.


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.


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 17, 2012. In August of 2012, the Company’s Board of Directors authorized the continuance of this program through August 17, 2014. 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 December 31, 2013, the Company had repurchased 104,952 shares of stock under this plan, at a total cost of $2,937 and an average price of $27.98 per share. During 2013, the Company repurchased 700 shares under the plan.  The Company records repurchased shares as treasury stock.


Cash Dividends:  The Company has historically paid regular quarterly cash dividends on its common stock. Each quarter, the Board of Directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook, the strength of its balance sheet, its need for funds, and other relevant factors. There can be no assurance that dividends on the Company’s common stock will be paid in the future.


The Company’s principal source of funds to pay cash dividends and support its commitments is derived from Bank operations. During 2013, the Company declared and distributed regular cash dividends on its common stock in the aggregate amount of $4,915 compared with $4,565 in 2012. The Company’s 2013 dividend payout ratio amounted to 37.3%, compared with 36.6% in 2012. The total regular cash dividends paid in 2013 amounted to $1.25 per common share of common stock, compared with $1.17 in 2012, representing an increase of $0.08 per share, or 6.8%.


In the first quarter of 2014, the Company declared a regular cash dividend of $0.325 per share of common stock, representing an increase of $0.02 or 6.6%, compared with the first quarter of 2013. Based on the December 31, 2013 price of the Company’s common stock of $39.99 per share, the dividend yield amounted to 3.25%.


Contractual Obligations


The Company is a party to certain contractual obligations under which it is obligated to make future payments. These principally include borrowings from the FHLB, consisting of short and long-term fixed rate borrowings, and collateralized by all stock in the FHLB, a blanket lien on qualified collateral consisting primarily of loans with first and second mortgages secured by one-to-four family properties, and certain pledged investment securities. The Company has an obligation to repay all borrowings from the FHLB.


The Company is also obligated to make payments on operating leases for its retail branch offices in Somesville, Topsham and Augusta, Maine, as well as office space in Ellsworth and Bangor, Maine.


The following table summarizes the Company’s contractual obligations at December 31, 2013. Borrowings are stated at their contractual maturity due dates and do not reflect call features, or principal amortization features, on certain borrowings.


CONTRACTUAL OBLIGATIONS


 

 

Payments Due By Period

Description

Total

Amount of

Obligations

< 1 Year

1-3

Years

 4-5

Years

> 5

Years

 

 

 

 

 

 

Borrowings from Federal Home Loan Bank

  $384,190

 $ 292,690

 $32,000

 $59,500

 $      ---

Securities sold under agreements

     to repurchase

      20,255

      20,255

          ---

          ---

         ---

Junior subordinated debentures

        5,000

            ---

          ---

          ---

    5,000

Operating Leases

        1,638

           412

         591

         275

       360

  Total

  $411,083

  $313,357

  $32,591

  $59,775

  $5,360


All FHLB advances are fixed-rate instruments. Advances are payable at their call dates or final maturity dates. At December 31, 2013, the Bank had $44,000 in callable advances.




In the normal course of its banking and financial services business, and in connection with providing products and services to its customers, the Company has entered into a variety of traditional third party contracts for support services. Examples of such contractual agreements would include services providing ATMs, Visa Debit Card processing, trust services accounting support, check printing, and the leasing of T-1 telecommunication lines supporting the Company’s wide area technology network.


The majority of the Company’s core operating systems and software applications are maintained “in-house” with traditional third party maintenance agreements of one year or less.


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 material to investors.


At December 31, 2013 and 2012, the Company’s off-balance sheet arrangements were limited to standby letters of credit.


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 December 31, 2013, commitments under existing standby letters of credit totaled $378, compared with $307 at December 31, 2012. The fair value of the standby letters of credit was not significant as of the foregoing dates.


Off-Balance Sheet Risk


The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and, in the past, have included certain financial derivative instruments; namely, interest rate swap agreements and interest rate floor agreements.

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, such as loans. 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 summarizes the Bank’s commitments to extend credit as of December 31:


COMMITMENTS TO EXTEND CREDIT


   

December 31,

2013

 

December 31,

2012

   

 

 

 

Commitments to originate loans

     $  10,269

 

     $  20,843

Unused lines of credit

         98,486

 

       106,773

Un-advanced portions of construction loans

         12,203

 

         22,047

   Total

     $120,958

 

     $149,663


Financial Derivative Instruments: As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank's interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that change in interest rates does not have a significant adverse effect on net interest income. Derivative instruments that management periodically uses as part of its interest rate risk management strategy include interest rate swap agreements and interest rate floor agreements.


At December 31, 2013 and 2012 and during the years then ended, the Bank did not have any outstanding, off balance sheet financial derivative instruments.


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 and stress 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 policy is to maintain a liquidity position of at least 4% of total assets. At December 31, 2013, liquidity, as measured by the basic surplus model, was 7.6% over the 30-day horizon and 6.5% over the 90-day horizon.


At December 31, 2013, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB 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 (the “FRB”). At December 31, 2013, the Bank’s available secured line of credit at the FRB stood at $166,347 or 12.2% of the Bank’s total assets. The Bank also has access to the national brokered deposit market, and has used this funding source to bolster its 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. Company management 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.


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 year ended December 31, 2013, net interest income on a tax- equivalent basis amounted to $40,848 compared with $38,599 in 2012, representing an increase of $2,249, or 5.8%. As more fully discussed below, the increase in 2013 tax-equivalent net interest income compared with 2012 was attributed to average earning asset growth of $99,321 or 8.3%, as the net interest margin declined eight basis points.


For the year ended December 31, 2012, net interest income on a tax-equivalent basis amounted to $38,599 compared with $35,860 in 2011, representing an increase of $2,739, or 7.6%. As more fully discussed below, the increase in 2012 tax-equivalent net interest income compared with 2011 was attributed to average earning asset growth of $86,957 or 7.8%, as the net interest margin remained unchanged.


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


Net Interest Income Analysis: The following tables summarize the Company’s daily average balance sheets and the components of net interest income, including a reconciliation of tax-equivalent adjustments, for the years ended December 31, 2013, 2012 and 2011:


















AVERAGE BALANCE SHEET AND

ANALYSIS OF NET INTEREST INCOME

For the year ended December 31, 2013


 

Average

Balance

 

Interest

Weighted

Average

Rate

Interest Earning Assets:

 

 

 

Loans (1,3)

 $   839,010

   $37,460

4.46%

Securities (2,3)

      438,893

     14,982

3.41%

Federal Home Loan Bank stock

        18,217

            69

0.38%

Fed funds sold, money market funds, and time

     deposits with other banks

   

                 1

            ---

 

0.00%

   

 

 

 

    Total Earning Assets

   1,296,121

     52,511

4.05%

   

 

 

 

Non-Interest Earning Assets:

 

 

 

Cash and due from banks

          3,607

 

   

Allowance for loan losses

         (8,334)

 

 

Other assets (2)

        53,959

 

   

    Total Assets

 $1,345,353

 

 

   

 

 

 

   

 

 

 

    

 

 

 

Interest Bearing Liabilities:

 

 

 

Deposits

 $   766,096

   $  6,616

0.86%

Borrowings

      376,305

       5,047

1.34%

    Total Interest Bearing Liabilities

   1,142,401

     11,663

1.02%

Rate Spread

 

 

3.03%

   

 

 

 

Non-Interest Bearing Liabilities:

 

 

 

Demand and other non-interest bearing deposits

        70,978

 

 

Other liabilities

          6,634

 

 

  Total Liabilities

   1,220,013

 

 

Shareholders' equity

      125,340

 

 

    Total Liabilities and Shareholders' Equity

 $1,345,353

 

 

Net interest income and net interest margin (3)

 

     40,848

3.15%

Less:  Tax-equivalent adjustment (3)

 

      (1,762)

 

    Net Interest Income

 

   $39,086

3.02%


(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, reported on a tax-equivalent basis calculated using a tax rate of 34%.














AVERAGE BALANCE SHEET AND

ANALYSIS OF NET INTEREST INCOME

For the year ended December 31, 2012


 

Average

Balance

 

Interest

Weighted

Average

Rate

Interest Earning Assets:

 

 

 

Loans (1,3)

 $   779,800

   $36,802

4.72%

Securities (2,3)

      399,601

     15,578

3.90%

Federal Home Loan Bank stock

        17,366

            86

0.50%

Fed funds sold, money market funds, and time

   

 

 

     deposits with other banks

               33

            ---

0.00%

   

 

 

 

    Total Earning Assets

   1,196,800

     52,466

4.38%

 

 

 

 

Non-Interest Earning Assets:

 

 

 

Cash and due from banks

          3,221

 

   

Allowance for loan losses

         (8,404)

 

 

Other assets (2)

        60,773

 

   

    Total Assets

 $1,252,390

 

 

   

 

 

 

   

 

 

 

 

 

 

 

Interest Bearing Liabilities:

 

 

 

Deposits

 $   697,641

   $  7,707

1.10%

Borrowings

      354,757

       6,160

1.74%

    Total Interest Bearing Liabilities

   1,052,398

     13,867

1.32%

Rate Spread

 

 

3.06%

   

 

 

 

Non-Interest Bearing Liabilities:

 

 

 

Demand and other non-interest bearing deposits

        67,900

 

 

Other liabilities

          6,492

 

 

  Total Liabilities

   1,126,790

 

 

Shareholders' equity

      125,600

 

 

    Total Liabilities and Shareholders' Equity

 $1,252,390

 

 

Net interest income and net interest margin (3)

 

     38,599

3.23%

Less:  Tax-equivalent adjustment (3)

 

      (1,628)

 

    Net Interest Income

 

   $36,971

3.09%


(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, reported on a tax-equivalent basis calculated using a tax rate of 34%.




















AVERAGE BALANCE SHEET AND

ANALYSIS OF NET INTEREST INCOME

For the year ended December 31, 2011


 

Average

Balance

Interest

Weighted

Average

Rate

Interest Earning Assets:

 

 

 

Loans (1,3)

    $   717,895

    $34,983

4.87%

Securities (2,3)

         375,738

      17,348

4.62%

Federal Home Loan Bank stock

           16,068

             47

0.29%

Fed funds sold, money market funds, and time

     deposits with other banks

   

                142

            ---

 

0.00%

     

 

 

 

    Total Earning Assets

      1,109,843

      52,378

4.72%

   

 

 

 

Non-Interest Earning Assets:

 

 

 

Cash and due from banks

             7,532

 

   

Allowance for loan losses

            (9,051)

 

 

Other assets (2)

           42,839

 

   

    Total Assets

    $1,151,163

 

 

     

 

 

 

 

 

 

 

    

 

 

 

Interest Bearing Liabilities:

 

 

 

Deposits

   $    677,245

    $  8,765

1.29%

Borrowings

         296,034

        7,753

2.62%

    Total Interest Bearing Liabilities

         973,279

      16,518

1.70%

Rate Spread

 

 

3.02%

     

 

 

 

Non-Interest Bearing Liabilities:

 

 

 

Demand and other non-interest bearing deposits

           61,553

 

 

Other liabilities

             5,196

 

 

  Total Liabilities

      1,040,028

 

 

Shareholders' equity

         111,135

 

 

    Total Liabilities and Shareholders' Equity

    $1,151,163

 

 

Net interest income and net interest margin (3)

 

      35,860

3.23%

Less:  Tax-equivalent adjustment (3)

 

       (1,471)

 

    Net Interest Income

 

    $34,389

3.10%


(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, reported on a tax-equivalent basis calculated using a tax rate of 34%.


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.



The Company’s tax-equivalent net interest margin amounted to 3.15% in 2013, compared with 3.23% in 2012 and 2011.


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 enumerated in the following discussion and analysis.


          NET INTEREST MARGIN ANALYSIS


WEIGHTED AVERAGE RATES

2013

 

2012

Quarter:   

4

3

2

1

 

4

3

2

1

Interest Earning Assets:

 

 

 

 

 

 

 

 

 

Loans (1,3)

4.33%

4.39%

4.55%

4.59%

 

4.71%

4.72%

4.64%

4.82%

Securities (2,3)

3.61%

3.33%

3.25%

3.45%

 

3.72%

3.72%

3.96%

4.22%

Federal Home Loan Bank stock

0.37%

0.39%

0.27%

0.49%

 

0.50%

0.49%

0.49%

0.50%

Fed Funds sold, money market funds,

     and time deposits with other banks

 

 

 

 

 

 

 

 

 

0.00%

0.00%

0.00%

0.00%

 

0.00%

0.00%

0.00%

0.00%

    Total Earning Assets

4.03%

3.97%

4.06%

4.16%

 

4.32%

4.32%

4.35%

4.56%

  

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

 

Interest Bearing Liabilities:

 

 

 

 

 

 

 

 

 

Deposits

0.82%

0.82%

0.86%

0.96%

 

1.05%

1.07%

1.13%

1.18%

Borrowings

1.15%

1.27%

1.50%

1.46%

 

1.63%

1.72%

1.69%

1.91%

    Total Interest Bearing Liabilities

0.93%

0.97%

1.06%

1.14%

 

1.24%

1.28%

1.33%

1.43%

   

 

 

 

 

 

 

 

 

 

Rate Spread

3.10%

3.00%

3.00%

3.02%

 

3.08%

3.04%

3.02%

3.13%

    

 

 

 

 

 

 

 

 

 

Net Interest Margin (3)

3.21%

3.12%

3.12%

3.15%

 

3.23%

3.20%

3.17%

3.30%

    

 

 

 

 

 

 

 

 

 

Net Interest Margin without

     Tax-equivalent Adjustments

3.07%

2.98%

2.99%

3.02%

 

3.08%

3.06%

3.04%

3.17%


 (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, reported on a tax-equivalent basis calculated using a tax rate of 34%.


Recent data suggests the U.S. economy continues to slowly emerge from a deep recession, which was driven by sharp downturns in the nationwide housing and credit markets, followed by multi-decade high unemployment rates and diminished consumer confidence and spending. In 2008, the Board of Governors of the Federal Reserve System addressed the economic decline with changes in its monetary policy by reducing the Federal Funds rate from 4.25% to a range of 0% to 0.25%, where it stayed all the way through 2013. These actions put considerable pressure on the Bank’s net interest margin. During 2011, long-term interest rates declined to historic levels with the 10-year U.S. Treasury closing as low as 1.72%. While the 2011 interest rate environment pressured a further decline in earning asset yields, the Bank was able to more than offset this decline by lowering the cost of its interest bearing deposits and borrowings, resulting in an improved net interest margin compared with 2010.


During 2012, long-term interest rates again declined to historic levels with the 10-year U.S. Treasury closing as low as 1.39%. While the 2012 interest rate environment pressured a further decline in earning asset yields, the Bank was able to offset this decline by lowering the cost of its interest bearing deposits and borrowings, resulting in a stable net interest margin compared with 2011.


In 2013, long-term interest rates increased, with the ten-year U.S. Treasury surpassing 3.00% in the second half of the year. While this increase helped strengthen the net interest margin in the third and fourth quarters of 2013, the Bank’s full year 2013 net interest margin declined eight basis points compared with 2012, as the yield on earning assets declined more than the cost of interest bearing liabilities.



The foregoing trends are discussed in more detail below.


For the year ended December 31, 2013, the weighted average yield on average earning assets amounted to 4.05%, compared with 4.38% in 2012, representing a decline of 33 basis points. The weighted average cost of interest bearing liabilities amounted to 1.02% in 2013, compared with 1.32% in 2012, representing a decline of 30 basis points. To summarize, comparing 2013 with 2012, the decline in the Bank’s weighted average yield on its earning asset portfolios exceeded the decline in its weighted average cost of interest bearing liabilities by three basis points. This resulted in an eight basis point decline in the Bank’s 2013 net interest margin and a three basis point decline in the Bank’s rate spread, principally reflecting the volume of lower yielding earning assets added to the balance sheet during the year.


For the year ended December 31, 2012, the weighted average yield on average earning assets amounted to 4.38%, compared with 4.72% in 2011, representing a decline of 34 basis points. However, the weighted average cost of interest bearing liabilities amounted to 1.32% in 2012, compared with 1.70% in 2011, representing a decline of 38 basis points. To summarize, comparing 2012 with 2011, the decline in the Bank’s weighted average cost of interest bearing liabilities exceeded the decline in the weighted average yield on its earning asset portfolios by four basis points, resulting in an improved interest rate spread. While the interest rate spread improved four basis points in 2012, the net interest margin remained unchanged, principally reflecting the volume of lower yielding earning assets added to the balance sheet during the year.


The declines in earning asset yields during 2013 and 2012 were principally attributed to the replacement of accelerated cash flows from the securities and loan portfolios, as well as the origination of new loans and the purchase of securities, during a period of historically low interest rates. The 2013 and 2012 declines in the cost of interest bearing liabilities were largely attributed to higher cost, maturing time deposits and borrowings being replaced at significantly lower interest rates. While the Bank was able to continue lowering the rates on many of its core deposit products during 2012 while remaining competitive in the markets served by the Bank, such opportunities subsided during 2013.


Interest and Dividend Income: For the year ended December 31, 2013, total interest and dividend income on a tax-equivalent basis amounted to $52,511, compared with $52,466 in 2012, representing an increase of $45, or 0.1%. The increase in interest and dividend income was attributed to average earning growth of $99,321 or 8.3%, which was almost entirely offset by a 33 basis point decline in the weighted average earning asset yield.


For the year ended December 31, 2013, tax-equivalent interest income from the securities portfolio amounted to $14,982, compared with $15,578 in 2012, representing a decline of $596 or 3.8%. This decline was principally attributed to a 49 basis point decline in the weighted average securities yield to 3.41%, partially offset by a $39,292 or 9.8% increase in total average securities. The decline in the weighted average securities yield was principally attributed to the ongoing replacement of MBS 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 driven by historically low interest rates, a variety of government stimulus programs, quantitative easing efforts by the Federal Reserve, as well as continuing credit defaults. During the second half of 2013, long-term interest rates increased significantly causing a slowing of prepayment speeds on the Bank’s MBS, which resulted in less purchase premium amortization and higher book yields compared with the first half of the year. Company management believes future prepayment speeds and premium amortization will largely be dependent on policy decisions by the Federal Reserve and the pace of the economic recovery.




For the year ended December 31, 2013, tax-equivalent interest income from the loan portfolio amounted to $37,460, compared with $36,802 in 2012, representing an increase of $658, or 1.8%. This increase was principally attributed to average loan portfolio growth of $59,210 or 7.6%, as the weighted average yield declined 26 basis points to 4.46%. The decline in yield principally reflected the origination and competitive re-pricing of certain commercial loans, as well as an elevated level of residential mortgage loan refinancing activity during a period of historically low interest rates.  


As depicted on the rate/volume analysis table below, comparing 2013 with 2012, the impact of the increased volume of total average earning assets contributed $4,332 to the increase in total tax-equivalent interest income, but this increase was almost entirely offset by a $4,287 decline attributed to the lower weighted average earning asset yield.


For the year ended December 31, 2012, total interest and dividend income on a tax-equivalent basis amounted to $52,466, compared with $52,378 in 2011, representing an increase of $88, or 0.2%. The increase in interest and dividend income was attributed to average earning growth of $86,957 or 7.8%, which was almost entirely offset by a 34 basis point decline in the weighted average earning asset yield.


For the year ended December 31, 2012, tax-equivalent interest income from the securities portfolio amounted to $15,578, compared with $17,348 in 2011, representing a decline of $1,770 or 10.2%. This decline was principally attributed to a 72 basis point decline in the weighted average securities yield to 3.90%, partially offset by a $23,863 or 6.4% increase in total average securities. The decline in the weighted average securities yield was principally attributed to the ongoing replacement of accelerated mortgage-backed securities cash flows in a historically low interest rate environment combined with incremental securities purchases at low prevailing market yields. Accelerated cash flows were principally attributed to increased securitized loan refinancing activity driven by historically low interest rates, a variety of government stimulus programs, quantitative easing efforts by the Federal Reserve, as well as continuing credit defaults.


For the year ended December 31, 2012, tax-equivalent interest income from the loan portfolio amounted to $36,802, compared with $34,983 in 2011, representing an increase of $1,819 or 5.2% compared with 2011. This increase was principally attributed to average loan portfolio growth of $61,905 or 8.6%, as the weighted average yield declined 15 basis points to 4.72%. The decline in yield principally reflected the origination and competitive re-pricing of certain commercial loans, as well as an elevated level of residential mortgage loan refinancing activity during a period of historically low interest rates.  


As depicted on the rate/volume analysis table below, comparing 2012 with 2011, the impact of the increased volume of total average earning assets contributed $4,122 to the increase in total tax-equivalent interest income, but this increase was almost entirely offset by a $4,034 decline attributed to the lower weighted average earning asset yield.


Interest Expense: For the year ended December 31, 2013, total interest expense amounted to $11,663, compared with $13,867 in 2012, representing a decline of $2,204, or 15.9%. This decline was principally attributed to a 30 basis point decline in the weighted average interest rate paid on interest bearing liabilities to 1.02%, offset in part by a $90,003 or 8.6% increase in average interest bearing liabilities.


The 2013 decline in the average cost of interest bearing liabilities 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. The weighted average cost of interest bearing deposits declined 24 basis points in 2013 to 0.86%, while the weighted average cost of borrowings declined 40 basis points to 1.34%, principally reflecting the maturity of higher cost, long-term borrowings that were replaced in a historically low interest rate environment.

As depicted on the rate/volume analysis table below, the impact of the lower weighted average rate paid on interest bearing liabilities contributed $3,336 to the 2013 decline in interest expense, offset in part by $1,132 attributed to the increased volume of interest bearing liabilities.


For the year ended December 31, 2012, total interest expense amounted to $13,867, compared with $16,518 in 2011, representing a decline of $2,651, or 16.0%. This decline was principally attributed to a 38 basis point decline in the weighted average interest rate paid on interest bearing liabilities to 1.32%, offset in part by a $79,119 or 8.1% increase in average interest bearing liabilities.


The 2012 decline in the average cost of interest bearing liabilities 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. The weighted average cost of interest bearing deposits declined 19 basis points in 2012 to 1.10%, while the weighted average cost of borrowings declined 88 basis points to 1.74%, principally reflecting the maturity of higher cost, long-term borrowings that were replaced in a historically low interest rate environment.


As depicted on the rate/volume analysis table below, the impact of the lower weighted average rate paid on interest bearing liabilities contributed $4,460 to the 2012 decline in interest expense, offset in part by $1,809 attributed to the increased volume of interest bearing liabilities.


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

FOR THE YEAR ENDED DECEMBER 31, 2013 VERSUS 2012

INCREASES (DECREASES) DUE TO:


 

Average

Volume

Average

Rate

Total

Change

    

 

 

 

Loans (1,3)

   $2,789

  $(2,131)

 $    658

Securities (2,3)

     1,539

    (2,135)

      (596)

Federal Home Loan Bank stock

            4

         (21)

        (17)

Fed funds sold, money market funds, and time

     deposits with other banks

          ---

          ---

         ---

TOTAL EARNING ASSETS

   $4,332

  $(4,287)

 $      45

   

 

 

 

Interest bearing deposits

        758

    (1,849)

   (1,091)

Borrowings

        374

    (1,487)

   (1,113)

TOTAL INTEREST BEARING LIABILITIES

   $1,132

  $(3,336)

 $(2,204)

    

 

 

 

NET CHANGE IN NET INTEREST INCOME

   $3,200

  $   (951)

 $ 2,249


(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, reported on a tax-equivalent basis calculated using a tax rate of 34%.



ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME

FOR THE YEAR ENDED DECEMBER 31, 2012 VERSUS 2011

INCREASES (DECREASES) DUE TO:


 

Average

Volume

Average

Rate

Total

Change

 

 

 

 

Loans (1,3)

   $3,015

   $(1,196)

 $ 1,819

Securities (2,3)

     1,103

     (2,873)

   (1,770)

Federal Home Loan Bank stock

            4

           35

         39

Fed funds sold, money market funds, and time

 

 

 

     deposits with other banks

          ---

            ---

         ---  

TOTAL EARNING ASSETS

   $4,122

   $(4,034)

 $      88

   

 

 

 

Interest bearing deposits

        264

     (1,322)

   (1,058)

Borrowings

     1,545

     (3,138)

   (1,593)

TOTAL INTEREST BEARING LIABILITIES

   $1,809

   $(4,460)

 $(2,651)

    

 

 

 

NET CHANGE IN NET INTEREST INCOME

   $2,313

   $    426

 $ 2,739


(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, reported on a tax-equivalent basis calculated using a tax rate of 34%.


Provision for Loan Losses


The provision for loan losses (the “provision”) reflects the amount necessary to maintain the allowance for loan losses (the “allowance”) 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 overall credit quality of the Bank’s loan portfolio remained relatively stable during 2013. While non-performing loans declined $1,027 or 10.4%, other delinquent and potential problem loans increased $1,498 or 10.8%, compared with December 31, 2012. The Bank’s loan loss experience improved in 2013 with total net loan charge-offs amounting to $1,040, or annualized net charge-offs to average loans outstanding of 0.12% compared with $1,776 or 0.23% in 2012, respectively.


For the year ended December 31, 2013, the Bank recorded a provision for loan losses (the “provision”) of $1,418, compared with $1,652 in 2012, representing a decline of $234, or 14.2%. The decline in the provision largely reflected stable credit quality metrics combined with improved loan loss experience.


For the year ended December 31, 2012, the overall credit quality of the Bank’s loan portfolio continued to improve. This improvement was highlighted by a $3,040 or 23.6% decline in non-performing loans and lower levels of delinquent and potential problem loans expressed as a percent of total loans, compared with December 31, 2011. During 2012, the Bank’s loan loss experience improved with total net loan charge-offs amounting to $1,776, or annualized net charge-offs to average loans outstanding of 0.23% compared with $2,674 or 0.37% in 2011, respectively.


For the year ended December 31, 2012, the Bank recorded a provision of $1,652, compared with $2,395 in 2011, representing a decline of $743, or 31.0%. The provision recorded in 2012 was largely driven by the Bank’s charge-off experience, growth in the loan portfolio, and still depressed real estate values. The 2012 decline in the provision largely reflected improved credit quality metrics, as discussed immediately above, which continued to stabilize during 2012.



Refer to Part II, Item 7, Non-performing Loans, Potential Problem Loans and the Allowance for Loan Losses, in this Annual Report on Form 10-K for further discussion and analysis related to the provision for loan losses.


Non-interest Income


In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations. In 2013, non-interest income represented 16.2% of total net interest income and non-interest income, compared with 17.3% in 2012.


For the year ended December 31, 2013, total non-interest income amounted to $7,566, compared with $7,709 in 2012, representing a decline of $143, or 1.9%.


For the year ended December 31, 2012, total non-interest income amounted to $7,709, compared with $6,792 in 2011, representing an increase of $917, or 13.5%.


Factors contributing to the 2013 and 2012 changes in non-interest income are enumerated in the following discussion and analysis:


Trust and Financial Services Income: Income from trust and financial services represented 48.0% of the Company’s total non-interest income in 2013, compared with 42.5% and 45.1% in 2012 and 2011, respectively. Income from trust and financial services is principally derived from fee income based on a percentage of the fair market value of client assets under management and held in custody and, to a lesser extent, revenue from brokerage services conducted through Bar Harbor Financial Services, an independent third-party broker.


For the year ended December 31, 2013, income from trust and other financial services amounted to $3,634, compared with $3,278 in 2012, representing an increase of $356, or 10.9%. This increase was attributed to higher levels of revenue from retail brokerage activities, as well as increases in the fair value of assets under management. Reflecting strength in the equity markets and additional new business, assets under management stood at $387,633 as of December 31, 2013, compared with $355,461 at December 31, 2012, representing an increase of $32,172 or 9.1%.


For the year ended December 31, 2012, income from trust and other financial services amounted to $3,278, compared with $3,061 in 2011, representing an increase of $217, or 7.1%. This increase was principally attributed to increases in the fair value of assets under management, new client relationships, as well as increased brokerage activity. Reflecting additional new business and some stability in the equity markets, assets under management stood at $355,461 as of December 31, 2012, compared with $333,868 at December 31, 2011, representing an increase of $21,593 or 6.5%.


Service Charges on Deposit Accounts: This income is principally derived from overdraft fees, monthly deposit account maintenance and activity fees, automated teller machine (“ATM”) fees and a variety of other deposit account related fees. Income from service charges on deposit accounts represented 16.5% of total 2013 non-interest income, compared with 15.5% and 18.9% in 2012 and 2011, respectively.


For the year ended December 31, 2013, income generated from service charges on deposit accounts amounted to $1,248, compared with $1,196 in 2012, representing an increase of $52, or 4.3%. This increase was principally attributed to customer overdraft increases instituted in the third quarter of 2012, as the level of customer overdraft activity was essentially unchanged compared with 2012.



For the year ended December 31, 2012, income generated from service charges on deposit accounts amounted to $1,196, compared with $1,284 in 2011, representing a decline of $88, or 6.9%. This decline was principally attributed to declines in deposit account overdraft fees, reflecting reduced overdraft activity and the impact of new regulations that limit the ability of a bank to offer overdraft protection to customers without their specific consent and to derive fees from overdraft protection programs in general.


Credit and Debit Card Service Charges and Fees: This income is principally derived from the Bank’s Visa debit card product, merchant credit card processing fees and fees associated with Visa credit cards. Income from credit and debit card service charges and fees represented 20.8% of total 2013 non-interest income, compared with 19.0% and 18.8% in 2012 and 2011, respectively.


For the year ended December 31, 2013, credit and debit card service charges and fees amounted to $1,572, compared with $1,462 and $1,277 in 2012 and 2011, representing increases of $110 and $185, or 7.5% and 14.5%, respectively. These increases were principally attributed to continued growth of the Bank’s retail deposit base, higher levels of merchant credit card processing volumes, and continued success with a program that offers rewards for certain debit card transactions.


Net Securities Gains: For the year ended December 31, 2013, total net securities gains amounted to $676, compared with $1,938 in 2012, representing a decline of $1,262, or 65.1%. The net realized securities gains recorded during 2013 were comprised of realized gains of $684, offset by realized losses of $8.


For the year ended December 31, 2012, total net securities gains amounted to $1,938, compared with $2,689 in 2011, representing a decline of $751, or 27.9%. The net realized securities gains recorded during 2012 were comprised of realized gains of $1,963, offset by realized losses of $25.


Further information regarding securities gains and losses and OTTI losses is incorporated by reference to Part II, Item 8, Notes 1 and 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K.


Net OTTI Losses Recognized in Earnings: For the years ended December 31, 2013, 2012 and 2011, net OTTI losses recognized in earnings amounted to $249, $853 and $2,219, representing declines of $604 and $1,366, or 70.8% and 61.6%, respectively. During 2013 and 2012 the Company determined that certain available-for-sale, private-label mortgage-backed securities were other-than-temporarily impaired, because the Company could no longer conclude that it was probable it would recover all of the principal and interest on these securities. The declines in 2013 and 2012 credit losses principally reflected stabilizing loss severity and constant default rates of the underlying residential mortgage loan collateral, resulting from stabilizing real estate values, foreclosure and collateral liquidation timelines, and general economic conditions.


The OTTI losses recorded in 2013 and 2012 related to fourteen, available for sale, private-label MBS, all but two of which the Company had previously determined to be other-than-temporarily impaired. These OTTI losses represented management’s best estimate of credit losses or additional credit losses on the residential mortgage loan collateral underlying these securities. The estimated 2013 and 2012 credit losses were previously recorded, net of taxes, in unrealized gains or losses on securities available for sale within accumulated other comprehensive income or loss, a component of total shareholders’ equity on the Company’s consolidated balance sheet.







Further information regarding impaired securities, other-than-temporarily impaired securities and evaluation of securities for impairment is incorporated by reference to Part II, Item 8, Notes 1 and 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K.


Other Operating Income: Other operating income principally includes income from bank-owned life insurance, representing increases in the cash surrender value of life insurance policies on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Other operating income also includes a variety of miscellaneous service charges and fees. Other operating income represented 9.1% of total 2013 non-interest income, compared with 8.9% and 10.3% in 2012 and 2011, respectively.


For the year ended December 31, 2013, total other operating income amounted to $685, compared with $688 and $700 in 2012 and 2011, representing declines of $3 and $12, or 0.4% and 1.7%, respectively.


Non-interest Expense


For the years ended December 31, 2013, 2012 and 2011, total non-interest expense amounted to $26,860, $25,618 and $23,281, representing increases of $1,242 and $2,337, or 4.8% and 10.0%, respectively.


Factors contributing to the changes in non-interest expense are enumerated in the following discussion and analysis.


Salaries and Employee Benefits: For the year ended December 31, 2013, total salaries and employee benefit expenses amounted to $15,227, compared with $14,027 in 2012, representing an increase of $1,200, or 8.6%. This increase was attributed to a variety of factors including normal increases in base salaries, higher levels of employee incentive compensation, as well as changes in staffing levels and mix. The increase in salaries and benefits also reflected the Bank’s acquisition of three branch offices in the third quarter of 2012. Also contributing to the increase were expenses related to certain equity awards to members of the Company’s Board of Directors.


For the year ended December 31, 2012, total salaries and employee benefit expenses amounted to $14,027, compared with $12,814 in 2011, representing an increase of $1,213, or 9.5%. This increase was largely attributed to higher levels of employee severance payments including $263 incurred in connection with the Border Trust transaction, higher levels of employee incentive compensation, as well as normal increases in base salaries and changes in staffing levels and mix. The year-over-year increase in salaries and employee benefits also reflected the recording of $130 in employee health insurance credits, based on favorable claims experience, in 2011.


Occupancy Expense: For the years ended December 31, 2013 and 2012, total occupancy expense amounted to $1,968 and $1,682, compared with $1,682 and $1,514 in 2012 and 2011, representing increases of $286 and $168, or 17.0% and 11.1%, respectively. These increases were largely attributed to the acquisition of three branch offices in the third quarter of 2012, two of which are leased properties. The increase in occupancy expense was also attributed to the Bank’s substantial reconfiguration of its Ellsworth campus, including the replacement of its retail banking office, which was put in service in the third quarter of 2012.

 

Furniture and Equipment Expense: For the years ended December 31, 2013, 2012 and 2011, total furniture and equipment expense amounted to $2,005, $1,778 and $1,660, representing increases of $227 and $118, or 12.8% and 7.1%, respectively. The 2013 and 2012 increases in furniture and equipment expense were largely attributed to a variety of technology upgrades and new technology systems and applications. These increases were also attributed to the acquisition of three branch offices from Border Trust in the third quarter of 2012, as well as the replacement of the Bank’s Ellsworth retail banking office.

Credit and Debit Card Expenses: These expenses principally relate to the Bank’s Visa debit card processing activities. For the year ended December 31, 2013, total debit card expenses amounted to $384, compared with $367 and $310 in 2012 and 2011, representing increases of $17 and $57, or 4.6% and 18.4%, respectively. These increases were principally attributed to higher transaction volumes and were more than offset with higher revenues from these activities.


FDIC Insurance Assessments: For the year ended December 31, 2013, FDIC assessments amounted to $696, compared with $853 and $1,099 in 2012 and 2011, representing declines of $157 and $246, or 18.4% and 22.4%, respectively. These declines were largely attributed to a new assessment formula, whereby deposit insurance premiums are principally based on asset size and risk profiles rather than insurable deposits.


Other Operating Expense: For the year ended December 31, 2013, total other operating expenses amounted to $6,580, compared with $6,911 in 2012, representing a decline of $331, or 4.8%. The decline in 2013 other operating expenses was principally attributed to certain non-recurring branch acquisition expenses in connection with the 2012 Border Trust transaction, as well as lower levels of loan collection and other real estate owned expenses compared with 2012.


For the year ended December 31, 2012, total other operating expenses amounted to $6,911, compared with $5,884 in 2011, representing an increase of $1,027, or 17.5%. This increase was principally attributed to $600 in non-recurring expenses associated with the Border Trust transaction, including fees for professional services and a wide variety of conversion and integration related expenses. The increase in 2012 other operating expenses was additionally attributed to a $304 thousand or 132.7% increase in loan collection and other real estate owned expenses compared with 2011, largely reflecting higher levels of loan collection and foreclosure activity, as well as losses on the sale or write-down of owned properties.


Income Taxes


For the year ended December 31, 2013, total income taxes amounted to $5,191, compared with $4,944 and $4,462, in 2012 and 2011, representing increases of $247 and $482, or 5.0% and 10.8%, respectively.


The Company’s 2013 effective income tax rate amounted to 28.3%, compared with 28.4% and 28.8% in 2012 and 2011, respectively. 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 income from 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.


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 effect 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 presents a summary of Accounting Standards Updates (“ASU’s”) that were recently adopted by the Company, as well as those that will be subject to implementation in future periods.


ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 amends Topic 210, “Balance Sheet,” to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and did not have a material impact on the Company’s consolidated financial statements.


ASU 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. Under the guidance in this ASU, an entity has the option to bypass the qualitative assessment outlined in ASU 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment, for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012.  The adoption of this ASU did not have a significant impact to the Company’s financial statements.


ASU 2013-02, Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments in this update apply to all entities that issue financial statements that are presented in conformity with U.S. GAAP and that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods presented, including interim periods. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012.  Adoption of this update did not have a material impact on our financial condition or results of operations.


ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40), In January 2014, the FASB issued ASU 2014-04, which clarifies when an in substance repossession or foreclosure has occurred and the creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. A creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan either when legal title to the residential real estate property is obtained upon completion of a foreclosure or when the borrower has conveyed all interest in the residential real property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or similar arrangement. The ASU also requires disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. We do not expect the adoption of these provisions to have a significant impact on the Company’s consolidated financial statements.


ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which amends ASC 740, Income Taxes.  The amendments provide guidance on the financial statement presentation of an unrecognized tax benefit, as either a reduction of a deferred tax asset or as a liability, when a net operating loss carryforward, similar tax loss, or a tax credit carryforward exists. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013 and may be applied on either a prospective or retrospective basis. We do not expect the adoption of these provisions to have a significant impact on the Company’s consolidated financial statements.


ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK


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.


The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee (“ALCO”), chaired by the Chief Financial Officer and composed of various members of senior management. ALCO meets regularly to review balance sheet structure, formulate strategies in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.


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 Bank’s ALCO and the Company’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.


Interest Rate Sensitivity Modeling: 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 for 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 degree of 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 horizon 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; and

·

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 interest 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 December 31, 2013, over one and two-year horizons and under different interest rate scenarios. In light of the prevailing Federal Funds rate of 0.00% to 0.25%, and the two-year U.S. Treasury note of 0.38% at December 31, 2013, 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

DECEMBER 31, 2013


 

-100 Basis Points  Parallel Yield Curve Shift

+200 Basis Points  Parallel Yield Curve Shift

Year 1

 

 

Net interest income ($)

      $(278)

     $(1,111)

Net interest income (%)

       -0.65%

        -2.60%

Year 2

 

 

Net interest income ($)

$(402)

     $  (853)

Net interest income (%)

-0.94%

        -2.00%


As more fully discussed below, the December 31, 2013 interest rate sensitivity modeling results indicate that the Bank’s balance sheet was moderately exposed to rising interest rates 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 and two-year horizons. The relatively stable trend over the one and two-year horizons principally results from funding costs rolling over at lower prevailing rates, while largely offsetting expected declines in earning asset yields.


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 slightly 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 to strong 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 decline moderately over the one and two-year horizons and then trend steadily upward beyond two years. 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 to strong 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 moderate earning asset growth will be necessary to meaningfully increase the current level of net interest income.


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. Management believes the most significant ongoing factor affecting market risk exposure and the impact on net interest income continues to be the slow and extended 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. Recent actions by the Federal Reserve have posed a further threat to net interest income, given its determination to maintain short-term interest rates at historically low levels for an extended period of time. 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, and 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; renegotiated loan terms with borrowers, the impact of interest rate 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.


The Bank engages an independent consultant to periodically review its interest rate risk position and the reasonableness of assumptions used, with periodic reports provided to the Bank’s Board of Directors. At December 31, 2013, there were no significant differences between the views of the independent consultant and management regarding the Bank’s interest rate risk exposure.



10



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The Board of Directors and Shareholders

Bar Harbor Bankshares:


We have audited the accompanying consolidated balance sheets of Bar Harbor Bankshares and subsidiaries (the Company) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.


We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.


In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bar Harbor Bankshares and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with U. S. generally accepted accounting principles.


We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 12, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.


/s/ KPMG LLP


Boston, Massachusetts

March 12, 2014





11



BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2013 AND 2012

(in thousands, except share and per share data)


 

December 31,

2013

 

December 31,

2012

Assets

   

 

   

 Cash and cash equivalents

 $       9,200

 

  $    14,992

 Securities available for sale, at fair value (amortized cost of

      $461,635 and $405,769, respectively)

      450,170

 

      418,040

 Federal Home Loan Bank stock

        18,370

 

        18,189

 Loans

      852,857

 

      815,004

 Allowance for loan losses

         (8,475)

 

         (8,097)

 Loans, net of allowance for loan losses

      844,382

 

      806,907

 Premises and equipment, net

        20,145

 

        19,255

 Goodwill

          4,935

 

          4,935

 Bank owned life insurance

          7,879

 

          7,633

 Other assets

        18,812

 

        12,984

TOTAL ASSETS

 $1,373,893

 

 $1,302,935

     

   

 

   

Liabilities

 

 

 

  Deposits:

 

 

 

    Demand and other non-interest bearing deposits

 $     72,259

 

 $      71,865

    NOW accounts

      135,246

 

       123,015

    Savings and money market deposits

      232,558

 

       230,325

    Time deposits

      395,588

 

       370,560

      Total deposits

      835,651

 

       795,765

 Short-term borrowings

      312,945

 

       224,077

 Long-term advances from Federal Home Loan Bank

        91,500

 

       142,490

 Junior subordinated debentures

          5,000

 

           5,000

 Other liabilities

          7,418

 

           7,557

TOTAL LIABILITIES

  1,252,514

 

   1,174,889

     

 

 

 

Shareholders' equity

 

 

 

  Capital stock, par value $2.00; authorized 10,000,000 shares;

    issued 4,525,635 shares at December 31, 2013 and December 31, 2012

          9,051

 

           9,051

  Surplus

        26,845

 

         26,693

  Retained earnings

      102,147

 

         93,900

  Accumulated other comprehensive (loss) income:

 

 

 

    Prior service cost and unamortized net actuarial losses on employee

 

 

 

       benefit plans, net of tax of ($192) and ($207), at December 31, 2013,

       and December 31, 2012, respectively

            (373)

 

             (401)

    Net unrealized (depreciation) appreciation on securities available for sale,

       net of tax of ($4,150) and $4,099, at December 31, 2013 and

       December 31, 2012, respectively

         (8,055)

 

           7,954

   Portion of OTTI attributable to non-credit gains, net of tax of $252

      and $74, at December 31, 2013, and December 31, 2012, respectively

             488

 

              144

    Total accumulated other comprehensive (loss) income

         (7,940)

 

           7,697

  Less: cost of 586,560 and 605,591 shares of treasury stock at

     December 31, 2013 and December 31, 2012, respectively

         (8,724)

 

         (9,295)

    

 

 

 

TOTAL SHAREHOLDERS' EQUITY

      121,379

 

      128,046

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

 $1,373,893

 

 $1,302,935


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



12



BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

(in thousands, except share and per share data)


 

2013

2012

2011

Interest and dividend income:

 

 

 

  Interest and fees on loans

 $       37,223

 $       36,579

 $       34,854

  Interest on securities

          13,457

          14,173

          16,006

  Dividends on FHLB stock

                 69

                 86

                 47

Total interest and dividend income

         50,749

          50,838

          50,907

   

   

   

   

Interest expense:

 

 

 

  Deposits

           6,616

            7,707

            8,765

  Short-term borrowings

              487

               436

               260

  Long-term debt

           4,560

            5,724

            7,493

Total interest expense

         11,663

          13,867

         16,518

   

   

   

   

Net interest income

         39,086

          36,971

         34,389

  Provision for loan losses

           1,418

            1,652

           2,395

Net interest income after provision for loan losses

         37,668

         35,319

         31,994

   

   

   

   

Non-interest income:

   

   

   

  Trust and other financial services

           3,634

           3,278

           3,061

  Service charges on deposit accounts

           1,248

           1,196

           1,284

  Credit and debit card service charges and fees

           1,572

           1,462

           1,277

  Net securities gains

              676

           1,938

           2,689

  Total other-than-temporary impairment ("OTTI") losses

             (359)

          (1,170)

          (2,796)

  Non-credit portion of OTTI losses (before taxes) (1)

              110

              317

              577

  Net OTTI losses recognized in earnings

             (249)

             (853)

          (2,219)

  Other operating income

              685

              688

              700

 Total non-interest income

           7,566

           7,709

           6,792

   

 

 

 

Non-interest expense:

   

   

   

  Salaries and employee benefits

         15,227

         14,027

         12,814

  Occupancy expense

           1,968

           1,682

           1,514

  Furniture and equipment expense

           2,005

           1,778

           1,660

  Credit and debit card expenses

              384

              367

              310

  FDIC insurance assessments

              696

              853

           1,099

  Other operating expense

           6,580

           6,911

           5,884

Total non-interest expense

         26,860

         25,618

         23,281

   

 

 

 

Income before income taxes

        18,374

         17,410

         15,505

Income taxes

           5,191

           4,944

           4,462

   

 

 

 

Net income

 $      13,183

 $      12,466

 $      11,043

   

 

 

 

Computation of Earnings Per Share:

 

 

 

Weighted average number of capital stock shares outstanding

   

   

   

    Basic

    3,932,051

    3,901,118

    3,860,474

    Effect of dilutive employee stock options

         20,242

         18,651

         18,140

    Diluted

    3,952,293

    3,919,769

    3,878,614

    

 

 

 

Per Common Share Data:

 

 

 

   Basic Earnings Per Share

 $          3.35

 $          3.20

 $          2.86

   Diluted Earnings Per Share

 $          3.34

 $          3.18

 $          2.85


(1)  Included in other comprehensive income, net of taxes


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



13



BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

(in thousands)


 

Years Ended

December 31,

 

2013

2012

2011

     

 

 

 

Net income

 $ 13,183

  $12,466

  $11,043

Other comprehensive income:

 

 

 

    Net unrealized (depreciation) appreciation on securities available for sale,

          net of tax of ($7,926), $915 and $3,612, respectively

   (15,383)

      1,773

      7,012

    Less reclassification adjustment for net gains related to securities

          available for sale included in net income,

          net of tax of ($230), ($658) and ($914), respectively

        (446)

    (1,279)

     (1,775)

    Add other-than-temporary impairment adjustment,

          net of tax of $122, $398 and $950, respectively

          237

         772

      1,845

    Less non-credit portion of other-than-temporary impairment losses,

          net of tax of ($37), ($108) , and ($196), respectively

           (73)

        (209)

        (381)

    Net amortization of prior service cost and actuarial gain

         for supplemental executive retirement plan,

         net of related tax of ($36), ($47) and $1, respectively

           (69)

          (92)

             2

    Actuarial gain (loss) on supplemental executive retirement plan,

         net of related tax of $51, ( $151) and $19, respectively

            97

        (292)

           37

           Total other comprehensive (loss) income

   (15,637)

         673

      6,740

Total comprehensive (loss) income

 $  (2,454)

 $13,139

 $17,783


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



14



BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

(in thousands, except share and per share data)


 

 

 

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

         ---

           ---

        11,043

            ---

            ---

        11,043

Total other comprehensive income

         ---

           ---

               ---

       6,740

            ---

          6,740

Dividend declared:

 

 

 

 

 

 

  Common stock ($1.095 per share)

         ---

           ---

         (4,228)

            ---

            ---

        (4,228)

Purchase of treasury stock (22,087 shares)

         ---

           ---

               ---

            ---

         (623)

           (623)

Stock options exercised (78,035 shares),

      including related tax effects

         ---

         248

            (996)

            ---

       2,359

         1,611

Recognition of stock based

      compensation expense

         ---

           99

               ---

            ---

            ---

               99

Balance December 31, 2011

 $9,051

 $26,512

 $     86,198

 $    7,024

 $(10,535)

   $118,250

   

 

 

 

 

 

 

   

 

 

 

 

 

 

Balance December 31, 2011

 $9,051

  $26,512

 $     86,198

 $    7,024

 $(10,535)

   $118,250

Net income

         ---

           ---

        12,466

            ---

           ---

       12,466

Total other comprehensive income

         ---

           ---

               ---

          673

           ---

            673

Dividend declared:

 

 

 

 

 

 

  Common stock ($1.170 per share)

         ---

           ---

        (4,565)

            ---

           ---

        (4,565)

Purchase of treasury stock (5,383 shares)

         ---

           ---

               ---

            ---

        (181)

           (181)

Stock options exercised (45,154 shares),

      including related tax effects

         ---

          35

           (228)

            ---

      1,380

         1,187

Recognition of stock based

     compensation expense

         ---

        195

               21

            ---

           ---

            216

Restricted stock grants (1,380 shares)

         ---

         (49)

                 8

            ---

           41

             ---

Balance December 31, 2012

 $9,051

 $26,693

 $     93,900

 $    7,697

 $ (9,295)

  $128,046

   

 

 

 

 

 

 

     

 

 

 

 

 

 

Balance December 31, 2012

 $9,051

  $26,693

 $    93,900

 $    7,697

 $ (9,295)

  $128,046

Net income

         ---

          ---

       13,183

            ---

          ---

      13,183

Total other comprehensive loss

         ---

          ---

              ---

   (15,637)

          ---

    (15,637)

Dividend declared:

 

 

 

 

 

 

  Common stock ($1.250 per share)

         ---

          ---

       (4,915)

            ---

          ---

      (4,915)

Purchase of treasury stock (700 shares)

         ---

          ---

              ---

            ---

         (24)

           (24)

Stock options exercised (16,361 shares),

     including related tax effects

         ---

          19

            (49)

            ---

         491

           461

Recognition of stock based

     compensation expense

         ---

        254

             11

            ---

          ---

           265

Restricted stock grants (3,370 shares)

         ---

       (121)

             17

            ---

        104

            ---

Balance December 31, 2013

 $9,051

 $26,845

  $102,147

 $  (7,940)

 $ (8,724)

 $121,379


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



15



BAR HARBOR BANKSHARES AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

(in thousands)


 

2013

2012

2011

 Cash flows from operating activities:

 

 

 

    Net income

$     13,183

 $     12,466

 $      11,043

    Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

    Depreciation and amortization of premises and equipment

         1,504

          1,292

           1,180

    Amortization of core deposit intangible

               92

               36

               ---

    Provision for loan losses

         1,418

         1,652

           2,395

    Net securities gains

           (676)

       (1,938)

         (2,689)

    Other-than-temporary impairment

            249

            853

          2,219

    Net amortization of bond premiums and discounts

         5,076

         4,133

          1,636

    Deferred tax benefit

           (111)

            (83)

            (477)

    Recognition of stock based expense

            265

            216

               99

    Gains on sale of other real estate owned

             (53)

            (37)

             (20)

    Net change in other assets

            752

            711

            147

    Net change in other liabilities

           (139)

         1,790

            606

    Net cash provided by operating activities

       21,560

       21,091

      16,139

   

 

 

 

 Cash flows from investing activities:

 

 

 

   

 

 

 

    Net cash received in acquisition

             ---

         1,197

               ---

    Purchases of securities available for sale

   (172,131)

   (167,358)

   (137,215)

    Proceeds from maturities, calls and principal pay downs of mortgage-backed securities

       94,382

      93,984

      73,737

    Proceeds from sales of securities available for sale  

       17,234

      39,304

      48,468

    Net increase in Federal Home Loan Bank stock

           (181)

       (1,351)

             ---

    Net loans made to customers

     (38,632)

     (55,083)

     (33,217)

    Proceeds from sale of other real estate owned

         1,084

            831

            167

    Capital expenditures

       (2,394)

       (3,894)

       (3,765)

    Net cash used in investing activities

   (100,638)

     (92,370)

     (51,825)

   

 

 

 

 Cash flows from financing activities:

 

 

 

    Net increase in deposits

      39,886

      33,602

      14,562

    Net increase (decrease) in securities sold under repurchase agreements and fed funds

       pu rchased

          (381)

      (3,992)

      (5,679)

    Proceeds from Federal Home Loan Bank advances

      82,900

     90,796

     84,000

    Repayments of Federal Home Loan Bank advances

     (44,641)

   (39,296)

    (58,052)

    Purchases of Treasury Stock

             (24)

         (181)

          (623)

    Proceeds from stock option exercises, including excess tax benefits

            461

       1,187

        1,611

    Payments of dividends

        (4,915)

      (4,565)

      (4,228)

    Net cash provided by financing activities

       73,286

    77,551

      31,591

   

   

   

 

 Net (decrease) increase in cash and cash equivalents

        (5,792)

      6,272

      (4,095)

 Cash and cash equivalents at beginning of period

       14,992

      8,720

     12,815

 Cash and cash equivalents at end of period

 $      9,200

 $ 14,992

 $    8,720

   

 

 

 

 Supplemental disclosures of cash flow information:

 

 

 

    Cash paid during the period for:

 

 

 

       Interest

 $    11,833

 $ 14,011

 $  16,768

       Income taxes

         4,514

      4,323

       5,087

   

 

 

 

 Schedule of noncash investing activities:

 

 

 

    Transfers from loans to other real estate owned

 $         261

 $   1,058

 $    2,210

   

 

 

 

 Acquisitions:

 

 

 

 Fair value of noncash assets acquired

 $         ---

 $ 41,576

 $         ---  

 Fair value of liabilities assumed

 $         ---

   (42,773)

            ---


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



16



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


BAR HARBOR BANKSHARES AND SUBSIDIARIES


(All dollar amounts expressed in thousands, except share and per share data)


Note 1: Summary of Significant Accounting Policies


The accounting and reporting policies of Bar Harbor Bankshares (the “Company”) and its wholly-owned operating subsidiary, Bar Harbor Bank & Trust (the “Bank”), conform to U.S. generally accepted accounting principles (“GAAP”) and to general practice within the banking industry.


The Company’s principal business activity is retail and commercial banking and, to a lesser extent, financial services including trust, financial planning, investment management and third-party brokerage services. The Company’s business is conducted through the Company’s fifteen banking offices located throughout downeast, midcoast and central Maine.


The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System. The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the state of Maine, and as such is subject to the jurisdiction of the Superintendent of the Maine Bureau of Financial Institutions. The Bank is subject to the supervision, regulation, and examination of the FDIC and the Maine Bureau of Financial Institutions.


Financial Statement Presentation: The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles.


The consolidated financial statements include the accounts of Bar Harbor Bankshares and its wholly-owned subsidiary, Bar Harbor Bank & Trust. All significant inter-company balances and transactions have been eliminated in consolidation. Whenever necessary, amounts in the prior years’ financial statements are reclassified to conform to current presentation. Assets held in a fiduciary capacity are not assets of the Company and, accordingly, are not included in the consolidated balance sheets.


In preparing financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change in the near term relate to the determination of the allowance for loan losses, other-than temporary impairment on securities, income tax estimates, reviews of goodwill for impairment, and accounting for postretirement plans.


Subsequent Events: The Company has evaluated events and transactions subsequent to December 31, 2013 through report issuance, for potential recognition or disclosure as required by GAAP.


Cash and Cash Equivalents:  For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and other short-term investments with maturities less than 90 days.


In the normal course of business, the Bank has funds on deposit at other financial institutions in amounts in excess of the $250 that is insured by the Federal Deposit Insurance Corporation.


Investment Securities: All securities held at December 31, 2013 and 2012 were classified as available-for-sale (“AFS”).  Available-for-sale securities consist of mortgage-backed securities and municipal debt securities, and are carried at estimated fair value. Changes in estimated fair value of AFS securities, net of applicable income taxes, are reported in accumulated other comprehensive income (loss) as a separate component of shareholders’ equity. The Bank does not have a securities trading portfolio or securities held-to-maturity.


Premiums and discounts on securities are amortized and accreted over the term of the securities using the interest method. Gains and losses on the sale of securities are recognized at the trade date using the specific-identification method and are shown separately in the consolidated statements of income.


Other-Than-Temporary Impairments on Investment Securities: One of the significant estimates relating to securities is the evaluation of other-than-temporary impairment (“OTTI”). If a decline in the fair value of a debt 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 they are other-than-temporarily impaired 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, 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.


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 recession, 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.


Federal Home Loan Bank Stock:  The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). The Bank uses the FHLB for most of its wholesale funding needs. 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.  FHLB stock is a non-marketable equity security and therefore is reported at cost, which generally equals par value. Shares held in excess of the minimum required amount are generally redeemable at par value.


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. Based on the capital adequacy, liquidity position and sustained profitability of the FHLB, management believes there is no impairment related to the carrying amount of the Bank’s FHLB stock as of December 31, 2013.


Loans: 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 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 collectibility of 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.


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.




Loans acquired through the completion of a transfer, including loans acquired in a business combination, that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Corporation will be unable to collect all contractually required payment receivable are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be received).


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 inherent in the current loan portfolio 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 for loan losses 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 and 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 for loan losses 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 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.


Refer to Note 4 of these consolidated financial statements, Loans and Allowance for Loan Losses, for further information on the allowance for loan losses, including the Company’s loan loss estimation methodology.


Premises and Equipment: Premises and equipment and related improvements are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the lesser of the lease term or estimated useful lives of related assets; generally 25 to 40 years for premises and three to seven years for furniture and equipment.



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. 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.  


Goodwill represents the excess of the purchase price over the fair value of net assets acquired in accordance with the purchase method of accounting for business combinations. Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis or more frequently if an event occurs or circumstances change that reduce the fair value of a reporting unit below its carrying amount. The Company completes its annual goodwill impairment test as of December 31 of each year. The impairment testing process is conducted by assigning assets and goodwill to each reporting unit. Currently, the Company’s goodwill is evaluated at the entity level as there is only one reporting unit. The Company first assesses certain qualitative factors to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying value. If it is more likely than not that the fair value of the reporting unit is less than the carrying value, then the fair value of each reporting unit is compared to the recorded book value “step one.” If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and “step two” is not considered necessary. If the carrying value of a reporting unit exceeds its fair value, the impairment test continues (“step two”) by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets and liabilities of the reporting unit to current fair value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the goodwill. An impairment charge is recognized if the carrying fair value of goodwill exceeds the implied fair value of goodwill. At December 31, 2013, there was no indication of impairment that led the Company to believe it needed to perform a two-step test.


Identifiable intangible assets, included in other assets on the consolidated balance sheet, consist of core deposit intangibles amortized over their estimated useful lives on a straight-line method, which approximates the economic benefits to the Company. These assets are reviewed for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets.


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


Bank-Owned Life Insurance: Bank-owned life insurance (“BOLI”) represents life insurance on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received in excess of the cash value, are recorded in other non-interest income, and are not subject to income taxes. The cash surrender value is included in other assets on the Company’s consolidated balance sheet. The Company reviews the financial strength of the insurance carrier prior to the purchase of BOLI and annually thereafter.


Mortgage Servicing Rights: Mortgage servicing rights are recognized as separate assets when purchased or when retained in a sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the carrying value of the rights.  


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 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 market value below the carrying value are charged to other operating expenses.


Derivative Financial Instruments: The Company recognizes all derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Company designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items.


Changes in fair value of derivative instruments that are highly effective and qualify as a cash flow hedge are recorded in other comprehensive income or loss. Any ineffective portion is recorded in earnings. For fair value hedges that are highly effective, the gain or loss on the derivative and the loss or gain on the hedged item attributable to the hedged risk are both recognized in earnings, with the differences (if any) representing hedge ineffectiveness. The Company discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk on the hedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.


Off-Balance Sheet Financial Instruments: In the ordinary course of business the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.


Stock Based Compensation: The Company has stock option plans, which are described more fully in Note 12.  The Company expenses the grant date fair value of options granted.  The expense is recognized over the vesting periods of the grants.


Accounting for 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 a supplemental executive retirement agreement with a certain current executive officer. Thise agreement provides a stream of future payments in accordance with individually defined vesting schedules upon retirement,  termination,  or in the event that the participating  executive  leaves  the

Company following a change of control event. The Company recognizes the net present value of payments associated with these agreements over the service periods of the participating executive officers. Upon retirement, interest costs will continue to be recognized on the benefit obligation.


The Company recognizes the over-funded or under-funded status of postretirement benefit plans as an asset or liability on the balance sheet and recognizes changes in that funded status through other comprehensive income. Gains and losses, prior service costs and credits, and any remaining transition amounts that have not yet been recognized through net periodic benefit costs are recognized in accumulated other comprehensive income (loss), net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, which is the date at which the benefit obligation and plan assets are measured, is the Company's fiscal year end.


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.


The Company performs an analysis of its tax positions and has not identified any uncertain tax positions for which tax benefits should not be recognized as of December 31, 2013. The Company’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense in the consolidated statements of income.


The Company’s income tax returns are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2010 through 2012.


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 reflect 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.


Segment Reporting:  An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and evaluate performance. The Company has determined that its operations are solely in the community banking industry and include traditional community banking services, including lending activities, acceptance of demand, savings and time deposits, business services, investment management, trust and third-party brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities. Accordingly, disaggregated segment information is not presented in the notes to the consolidated financial statements.



17



Note 2: Business Combinations


On August 10, 2012 , Bar Harbor Bank & Trust (the “Bank”), a wholly-owned first tier operating subsidiary of Bar Harbor Bankshares, completed its acquisition of the operations of the Border Trust Company (“Border Trust”), a state chartered bank headquartered in Augusta, Maine, by acquiring certain assets and assuming certain liabilities, including all deposits for a net purchase price of $133. This transaction represented a strategic extension of the Company’s franchise with three branch locations located in Kennebec and Sagadahoc counties.


The Company has determined that the acquisition of the net assets of Border Trust constituted a business combination as defined by the FASB ASC Topic 805, Business Combinations. Accordingly, the assets acquired and liabilities assumed were recorded at their fair values. Fair values were determined based on the requirements of FASB ASC Topic 820, Fair Value Measurements. In many cases, the determination of these fair values required management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change. These fair value estimates are subject to change for up to one year after the closing date of the transaction as additional information relative to closing date fair values becomes available. In addition, the tax treatment is complex and subject to interpretations that may result in future adjustments of deferred taxes as of the acquisition date.


The results of Border Trust’s operations are included in the Consolidated Statements of Income from the date of acquisition. In connection with this transaction, the consideration paid, the assets acquired, and the liabilities assumed were recorded at fair value on the date of acquisition, as summarized in the following table.


Fair value of total consideration paid:

 

     Cash consideration paid at closing to Border Trust

    $    133

 

 

Fair value of identifiable assets acquired:

 

      Cash and cash equivalents     

    $ 1,330

      Securities

       3,537

      Federal Home Loan Bank Common stock

          770

      Loans

     33,606

      Premises and equipment

          563

      Core deposit intangible

          783

      Other assets

          540

          Total identifiable assets acquired

     41,129

 

 

Fair value of liabilities assumed:

 

      Deposits

     38,520

      Borrowings

       3,776

      Other liabilities

          477

          Total liabilities assumed

     42,773

 

 

Fair value of net identifiable assets (liabilities) acquired

      (1,644)

 

 

Goodwill resulting from transaction

    $ 1,777


Goodwill of $1,777 was recorded after adjusting for the fair value of net identifiable assets acquired.  The goodwill from the acquisition represents the inherent long-term value anticipated from the synergies and business opportunities expected to be achieved as a result of the transaction. The core deposit intangible asset is being amortized over its estimated life, currently expected to be eight and one-half years.



Note 3: Securities Available For Sale


A summary of the amortized cost and market values of securities available for sale follows:


December 31, 2013

   

Available for Sale:

Amortized

Cost

Gross

Unrealized

Gains

Gross

Unrealized

Losses

Estimated

Fair Value

    

 

 

 

 

Mortgage-backed securities:

 

 

 

 

  US Government-sponsored enterprises

 $277,838

 $  4,386

 $  8,592

 $273,632

  US Government agency

     83,153

        833

     2,457

     81,529

  Private label

       5,423

        825

          78

       6,170

Obligations of states

     and political subdivisions thereof

     95,221

     1,121

     7,503

     88,839

  Total

 $461,635

 $  7,165

 $18,630

 $450,170

 

 

 

 

 

   

 

 

 

 

December 31, 2012

   

Available for Sale:

Amortized

Cost

Gross

Unrealized

Gains

Gross

Unrealized

Losses

Estimated

Fair Value

    

 

 

 

 

Mortgage-backed securities:

 

 

 

 

  US Government-sponsored enterprises

 $238,974

 $  7,913

 $  1,064

 $245,823

  US Government agency

     82,397

     2,080

        216

     84,261

  Private label

       8,063

        571

        521

       8,113

Obligations of states

     and political subdivisions thereof

     76,335

     4,040

        532

     79,843

  Total

 $405,769

 $14,604

 $  2,333

 $418,040


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.


For the year ended December 31, 2013, the Company recorded total OTTI losses of $359 (before taxes), related to three, available for sale, 1-4 family, private-label MBS, all of which the Company had previously determined was other-than-temporarily impaired. Of the $359 in total OTTI losses, $249 (before taxes) represented estimated credit losses on the collateral underlying the securities, while $110 (before taxes) represented unrealized losses for the same securities resulting from factors other than credit. The $249 in estimated credit losses were recorded in earnings (before taxes) with the $110 non-credit portion of the unrealized losses recorded within accumulated other comprehensive income (net of taxes). The additional credit losses principally reflected an increase in the future loss severity and constant default rate estimates resulting from still-recovering real estate markets, extended foreclosure and collateral liquidation timelines, and still-depressed economic conditions that affected the expected performance of the mortgage loans underlying these securities.


For the year ended December 31, 2012, the Company recorded total OTTI losses of $1,170 (before taxes), related to fourteen, available for sale, 1-4 family, private-label MBS, all but two of which the Company had previously determined was other-than-temporarily impaired. Of the $1,170 in total OTTI losses, $853 (before taxes) represented estimated credit losses on the collateral underlying the securities, while $317 (before taxes) represented unrealized losses for the same securities resulting from factors other than credit. The $853 in estimated credit losses were recorded in earnings (before taxes) with the $317 non-credit portion of the unrealized losses recorded within accumulated other comprehensive income (net of taxes). The additional credit losses principally reflected an increase in the future loss severity and constant default rate estimates resulting from depressed real estate markets, extended foreclosure and collateral liquidation timelines, and depressed economic conditions that affected the expected performance of the mortgage loans underlying these securities.


The OTTI losses recognized in earnings 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 loans underlying each security. In estimating those cash flows the Company considered 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, loan to collateral value ratios, recent collateral loss severities and future collateral loss severity estimates, recent prepayment rates and future prepayment rate assumptions, and other estimates of future collateral performance.


Despite elevated 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 as of December 31, 2013 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 future 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 estimated credit losses recognized in pre-tax earnings for the three years ended December 31, 2013.


 

2013

2012

2011

    

 

 

 

Estimated credit losses as of prior year-end,

      $5,131

     $4,697

     $3,373

Additions for credit losses for securities on which

     OTTI has been previously recognized

           249

          682

       1,757

Additions for credit losses for securities on which

      OTTI has not been previously recognized

             ---

          171

          462

Reductions for securities paid off during the period

           691

          419

          895

Estimated credit losses as of December 31,

      $4,689

     $5,131

     $4,697


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 December 31, 2013, the Company held fourteen private-label MBS (debt securities) with a total amortized cost (i.e. carrying value) of $2,681 where OTTI losses have been historically recognized in pre-tax earnings (dating back to the fourth quarter of 2008). For twelve of these securities, the Company previously recognized credit losses in excess of the unrealized losses in accumulated OCI, creating an unrealized gain of $519, net of tax, as included in accumulated OCI as of December 31, 2013.  For the remaining two securities, the total OTTI losses included in accumulated OCI amounted to $30 net of tax, as of December 31, 2013. As of December 31, 2013, the total net unrealized gains included in accumulated OCI for securities held where OTTI has been historically recognized in pre-tax earnings amounted to $488, net of tax, compared with net unrealized gains of $144, net of tax, at December 31, 2012.


As of December 31, 2013, based on a review 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 December 31, 2013.  As of that date, the Company did not intend to sell nor anticipated that it would more-likely-than-not that it would 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 tables summarize 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 December 31, 2013 and 2012. All securities referenced are debt securities. At December 31, 2013 and 2012, the Company did not hold any common stock or other equity securities in its securities portfolio.


 

Less than 12 months

12 months or longer

Total

December 31, 2013

   

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

 $111,169

140

 $  4,801

 $40,563

40

 $3,791

 $151,732

180

 $  8,592

  US Government agency

     36,356

47

     1,982

     9,156

12

      475

     45,512

   59

     2,457

  Private label

          826

12

          61

        449

  7

        17

       1,275

   19

          78

Obligations of states and

      political subdivisions thereof

     61,174

135

     5,601

     8,464

30

   1,902

     69,638

165

      7,503

Total

 $209,525

334

 $12,445

 $58,632

89

 $6,185

 $268,157

423

 $18,630

   

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

 

 

Less than 12 months

12 months or longer

Total

December 31, 2012

  

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

 $ 56,008

55

 $ 1,064

 $       ---

---

 $     ---

 $  56,008

   55

 $  1,064

  US Government agency

     15,281

18

       216

          56

  2

        ---

     15,337

   20

        216

  Private label

          783

6

         48

     2,196

14

      473

       2,979

   20

        521

Obligations of states and

     political subdivisions thereof

     10,476

27

       261

     2,561

12

      271

     13,037

   39

        532

Total

 $  82,548

106

 $ 1,589

 $  4,813

28

 $   744

 $  87,361

134

 $  2,333


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 December 31, 2013, the total unrealized losses on these securities amounted to $8,592, compared with $1,064 at December 31, 2012.  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 enterprises play a vital role in the nation’s financial markets. Management’s analysis indicates that the unrealized losses at December 31, 2013 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 December 31, 2013.

·

Mortgage-backed securities issued by U.S. Government agencies: As of December 31, 2013, the total unrealized losses on these securities amounted to $2,457, compared with $216 at December 31, 2012.  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 December 31, 2013 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 December 31, 2013.

·

Private-label mortgage-backed securities: As of December 31, 2013, the total unrealized losses on the Bank’s private-label mortgage-backed securities amounted to $78, compared with $521 at December 31 2012. The Company attributes the unrealized losses at December 31, 2013 to the current illiquid market for non-agency mortgage-backed securities, a still-recovering housing market, risk-related market pricing discounts for non-agency mortgage-backed securities and credit rating downgrades on certain private-label MBS owned by the Company. Based upon the foregoing considerations, and the expectation that the Company will receive all of the future contractual cash flows related to the 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 December 31, 2013.

·

Obligations of states of the U.S. and political subdivisions thereof: As of December 31, 2013, the total unrealized losses on the Bank’s municipal securities amounted to $7,503, compared with $532 at December 31, 2012. 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 additionally 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.

Municipal bonds are frequently supported with insurance, which guarantees that in the event the issuer experiences financial problems, the insurer will step in and assume payment of both principal and interest. Historically, insurance support has strengthened an issuer’s underlying credit rating to AAA or AA status. Starting in 2008 and continuing through 2013, many of the insurance companies providing municipal bond insurance experienced financial difficulties and, accordingly, were downgraded by at least one of the major credit rating agencies. Consequently, since 2008 a portion of the Bank’s municipal bond portfolio was downgraded by at least one of the major credit rating agencies. Notwithstanding the credit rating downgrades, at December 31, 2013, the Bank’s municipal bond portfolio did not contain any below investment grade securities as reported by major credit rating agencies. In addition, at December 31, 2013 all municipal bond issuers were current on contractually obligated interest and principal payments.

The Company attributes the unrealized losses at December 31, 2013 to changes in credit ratings on certain securities and resulting changes in prevailing market yields and pricing spreads since the date the underlying securities were purchased. The Company also attributes the unrealized losses to ongoing media attention and market concerns about the prolonged recovery from the national 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 December 31, 2013.





At December 31, 2013, 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.


Maturity Distribution: The following table summarizes the maturity distribution of the amortized cost and estimated fair value of securities available for sale as of December 31, 2013.


 

Amortized

Estimated

Securities Available for Sale

Cost

Fair Value

        

 

 

Due one year or less

    $         ---

    $         ---

Due after one year through five years

          4,360

          4,450

Due after five years through ten years

        20,080

        20,625

Due after ten years

      437,195

      425,095

Total

    $461,635

    $450,170


Actual maturities may differ from the final contractual maturities depicted above because of securities call or prepayment provisions with or without call or prepayment penalties. The contractual maturity of mortgage-backed securities is not a reliable indicator of their expected life because borrowers have the right to prepay their obligations at any time. Monthly pay downs on mortgage-backed securities cause the average lives of the securities to be much different than their stated lives. Mortgage-backed securities are allocated among the maturity groupings based on their final maturity dates.


Realized 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 years ended December 31, 2013, 2012 and 2011.


 

Proceeds from

Sale of Securities

Available for Sale

Realized

Gains

Realized

Losses

Other Than

Temporary

Impairment Losses

Net

   

 

 

 

 

 

2013

$17,234

$   684

($  8)

$   249

$   427

2012

$39,304

$1,963

($25)

$   853

$1,085

2011

$48,468

$2,689

$ ---

$2,219

$   470



















Note 4: Loans and Allowance for Loan Losses


The Company’s lending activities are principally conducted in downeast, midcoast and central Maine. The following table summarizes the composition of the loan portfolio as of December 31, 2013 and 2012:


LOAN PORTFOLIO SUMMARY


 

2013

2012

   

 

 

Commercial real estate mortgages

 $336,542

 $324,493

Commercial and industrial

     73,972

     59,373

Commercial construction and land development

     18,129

     22,120

Agricultural and other loans to farmers

     26,929

     24,922

  Total commercial loans

   455,572

   430,908

   

 

 

Residential real estate mortgages

   317,115

   297,103

Home equity loans

     49,565

     53,303

Other consumer loans

     14,523

     19,001

  Total consumer loans

   381,203

   369,407

  

 

 

Tax exempt loans

     16,355

     15,244

   

 

 

   Net deferred loan costs and fees

         (273)

         (555)

Total loans

   852,857

   815,004

Allowance for loan losses

      (8,475)

      (8,097)

Total loans net of allowance for loan losses

 $844,382

 $806,907


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 December 31, 2013, approximately 32.6% of the commercial real estate mortgage portfolio was 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. Commercial and industrial loans are primarily 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 primarily secured 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. 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. 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 sponsorship.  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, and are amortized over 10 to 30 years. 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 standards, including regular inspections throughout the construction period.




Home Equity Loans: The Company originates home equity lines of credit and second mortgage loans (loans which are secured by a 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 and evaluations, 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.


Troubled Debt Restructures: A Troubled Debt Restructure (“TDR”) results from a modification to a loan to a borrower who is experiencing financial difficulty in which the Bank grants a concession to the debtor that it would not otherwise consider but for the debtor’s financial difficulties.  Financial difficulty arises when a debtor is bankrupt or contractually past due, or is likely to become so, based upon its ability to pay.  A concession represents an accommodation not generally available to other customers, including a below-market interest rate, deferment of principal payments, extension of maturity dates, etc.  Such accommodations extended to customers who are not experiencing financial difficulty do not result in TDR classification.


As of December 31, 2013, the Bank had six real estate secured, six commercial and industrial loans, and one other consumer loan, to eight relationships totaling $1,454 that were classified as TDRs.  At December 31, 2013, seven TDRs totaling $416 were past due or classified as non-performing.


As of December 31, 2012, the Bank had four real estate secured and three commercial and industrial loans to four relationships totaling $934 that were classified as TDRs.  At December 31, 2012, three TDRs totaling $114 were past due or classified as non-performing.  


As of December 31, 2011, the Bank had four real estate secured loans totaling $913 that were classified as TDRs, of which one in the amount of $82 was past due and classified as non-performing.


Summary information pertaining to the TDRs granted during the years ended December 31, 2013 and 2012 follows:


 

For the Twelve Months Ended

December 31, 2013

 

For the Twelve Months Ended

December 31, 2012

 

Number of Loans

Pre-Modification Outstanding Recorded Investment

Post-Modification Outstanding Recorded Investment

 

Number of Loans

Pre-Modification Outstanding Recorded Investment

Post-Modification Outstanding Recorded Investment

   

 

 

 

 

 

 

 

Commercial and industrial loans

3

        $173

     $166

 

2

       $   60

       $   60

  Total commercial loans

3

          173

       166

 

2

            60

            60

   

 

 

 

 

 

 

 

Residential real estate mortgages

1

       $166

     $164

 

2

        $  77

       $   77

Home equity loans

1

            16

         20

 

0

            ---

            ---

Other consumer loans

1

            14

         13

 

0

            ---

            ---

  Total consumer loans

3

          196

       197

 

2

            77

            77

   

 

 

 

 

 

 

 

Total

6

        $369

     $363

 

4

        $137

       $137




18



The following table shows the Company’s post-modification balance of TDRs listed by type of modification for the twelve months ended December 31, 2013 and 2012:


 

2013

2012

   

 

 

Extended maturity and adjusted interest rate

     $  79

     $  23

Temporary payment amount adjustment

         ---

         54

Court ordered concession

       284

         60

Total

     $363

     $137


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 December 31, 2013 and December 31, 2012. Amounts shown exclude deferred loan origination fees and costs.


December 31, 2013

30-59 Days

Past Due

60-89

Days

Past Due

90

Days or Greater

Total

Past Due

Current

Total

Loans

Non-

Accrual

>90 Days Past Due and Accruing

Commercial real

     estate mortgages

   $  786

   $    361

 $   698

   $  1,845

   334,697

  $336,542

   $2,046

$ ---

Commercial and industrial

         29

           20

      456

          505

     73,467

      73,972

        793

   ---

Commercial construction

     and land development

        ---

        ---

   1,845

       1,845

     16,284

      18,129

     1,913

   ---

Agricultural and other

     loans to farmers

          22

        ---

       ---

            22

     26,907

      26,929

         56

   ---

Residential real

     estate mortgages

     2,170

     1,864

   1,649

       5,683

   311,432

    317,115

     3,227

   ---

Home equity

          67

        ---

       ---

            67

     49,498

      49,565

        745

   ---

Other consumer loans

          57

          80

        41

          178

     14,345

      14,523

          60

   ---

Tax exempt

         ---

         ---

       ---

           ---

     16,355

      16,355

        ---

   ---

Total

   $3,131

   $2,325

 $4,689

   $10,145

 $842,985

  $853,130

   $8,840

$ ---

   

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

December 31, 2012

30-59 Days Past Due

60-89 Days Past Due

90

Days or Greater

Total

Past Due

Current

Total

Loans

Non-

Accrual

>90 Days Past Due and Accruing

Commercial real

     estate mortgages

   $   228

   $    238

 $1,041

   $  1,507

   $322,986

 $ 324,493

  $1,888

       $---

Commercial and industrial

          22

           61

      990

       1,073

    58,300

      59,373

       818

216

Commercial construction

     and land development

         ---

        ---

   2,359

       2,359

    19,761

     22,120

    2,359

---

Agricultural and other

     loans to farmers

        203

           12

      490

          705

    24,217

     24,922

       664

---

Residential real

      estate mortgages

     2,452

         769

   1,951

       5,172

  291,931

   297,103

    3,017

---

Home equity

        219

          ---

      274

          493

    52,810

     53,303

       814

---

Other consumer loans

          75

           97

        77

          249

    18,752

     19,001

         72

19

Tax exempt

          ---

          ---

       ---

            ---

    15,244

     15,244

        ---

---

Total

   $3,199

   $1,177

 $7,182

   $11,558

$804,001

 $815,559

  $9,632

     $235


At December 31, 2013, total other real estate owned amounted to $1,625 compared with $2,780 and $2,699 at December 31, 2012 and 2011.


At December 31, 2013, the Company had no firm commitments to lend additional funds to borrowers with loans in non-accrual status.





Impaired Loans:  Impaired loans are all commercial 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 modified into a troubled debt restructure, 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 dependent loans, the lower of the fair value of the collateral, less estimated 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 estimated costs to sell.


Details of impaired loans as of December 31, 2013 and December 31, 2012 follows:


 

December 31, 2013

 

December 31, 2012

 

Recorded

Investment

Unpaid

Principal

Balance

Related

Allowance

 

Recorded

Investment

Unpaid

Principal

Balance

Related

Allowance

With no related allowance:

 

 

 

 

 

 

 

Commercial real estate mortgages

    $1,949

   $2,103

     $  ---

 

     $2,662

  $3,072

    $  ---

Commercial and industrial

         660

        770

         ---

 

          841

       966

        ---

Commercial construction

     and land development

           68

          68

         ---

 

         ---

        ---

        ---

Agricultural and other loans to farmers

           56

          56

         ---

 

          664

       748

        ---

Residential real estate loans

         442

        442

         ---

 

            77

         77

        ---

Home equity loans

           21

          21

         ---

 

           ---

        ---

        ---

Other consumer

           13

          13

         ---

 

           ---

        ---

        ---

Subtotal

    $3,209

   $3,473

      $ ---

 

     $4,244

 $4,863

    $  ---

   

 

 

 

 

 

 

 

With an allowance:

 

 

 

 

 

 

 

Commercial real estate mortgages

    $   854

   $   854

      $100

 

     $    ---

 $     ---

    $  ---

Commercial and industrial

         150

        150

        150

 

           ---

        ---

        ---

Commercial construction

     and land development

      1,845

     3,770

          20

 

       2,359

   4,329

      120

Agricultural and other loans to farmers

          ---

        ---

          ---

 

           ---

        ---

        ---

Residential real estate loans

          ---

        ---

          ---

 

           ---

        ---

        ---

Home equity loans

          ---

        ---

          ---

 

           ---

        ---

        ---

Other consumer

          ---

        ---

          ---

 

           ---

        ---

        ---

Subtotal

    $2,849

   $4,774

      $270

 

     $2,359

 $4,329

    $120

Total

    $6,058

   $8,247

      $270

 

     $6,603

 $9,192

    $120






















Details of impaired loans as of December 31, 2013, 2012, and 2011 follows:


 

December 31, 2013

 

December 31, 2012

 

December 31, 2011

 

For the Twelve Months Ended

 

For the Twelve Months Ended

 

For the Twelve Months Ended

   

Average

Recorded

Investment

 

Interest

Recorded

 

Average

Recorded

Investment

 

Interest

Recorded

 

Average

Recorded

Investment

 

Interest

Recorded

    

 

 

 

 

 

 

 

 

With no related allowance:

 

 

 

 

 

 

 

 

Commercial real estate mortgages

   $2,387

 $   74

 

    $3,391

    $146

 

   $  3,452

      $105

Commercial and industrial

        689

        6

 

         813

           8

 

       1,212

            4

Commercial construction

     and land development

        133

      ---

 

         147

        ---

 

       4,857

         ---

Agricultural and other loans to farmers

        270

      ---

 

         604

        ---

 

          213

          14

Residential real estate mortgages

        323

     21

 

         137

           5

 

            82

         ---

Home equity loans

          17

       2

 

           ---

        ---

 

             ---

         ---

Other consumer

          11

       1

 

           ---

        ---

 

             ---

         ---

Subtotal

   $3,830

 $104

 

   $5,092

    $159

 

   $  9,816

     $123

   

 

 

 

 

 

 

 

 

With an allowance:

 

 

 

 

 

 

 

 

Commercial real estate mortgages

   $     ---

$  ---

 

   $      ---

    $  ---

 

   $      396

    $  ---

Commercial and industrial

          ---

      ---

 

           ---

        ---

 

            70

        ---

Commercial construction

   and land development

     1,967

      ---

 

      3,172

        ---

 

          150

        ---

Agricultural and other loans to farmers

          ---

      ---

 

           ---

        ---

 

            ---

        ---

Residential real estate mortgages

          ---

      ---

 

           ---

        ---

 

            ---

        ---

Home equity loans

          ---

      ---

 

           ---

        ---

 

            ---

        ---

Other consumer

          ---

      ---

 

           ---

        ---

 

            ---

        ---

Subtotal

   $1,967

 $  ---

 

    $3,172

    $  ---

 

   $     616

    $  ---

   

 

 

 

 

 

 

 

 

Total

   $5,797

 $104

 

    $8,264

    $159

 

   $10,432

    $123


Credit Quality Indicators/Classified Loans: In monitoring the credit quality of the portfolio, management applies a credit quality indicator to all categories 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 one through five 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 six through nine.


Consistent with regulatory guidelines, the Bank provides for the classification of loans which are considered to be of lesser quality as substandard, doubtful, or loss. The Bank considers a loan substandard if it is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well defined weakness that jeopardizes liquidation of the debt. Substandard loans include those loans where there is the distinct possibility of some loss of principal, if the deficiencies are not corrected.


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 which possess some 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 December 31, 2013 and December 31, 2012, 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).


December 31, 2013

Commercial

real estate

mortgages

Commercial and industrial

Commercial construction and land development

Agricultural and other loans to farmers

Total

Pass

   $307,486

   $60,330

    $14,403

    $26,447

   $408,666

Other Assets

     Especially Mentioned

       19,768

     10,568

           437

           182

       30,955

Substandard

         9,288

       3,074

        3,289

           300

       15,951

Doubtful

              ---

            ---

             ---

            ---

              ---

Loss

              ---

            ---

             ---

            ---

              ---

Total

   $336,542

   $73,972

    $18,129

    $26,929

   $455,572

   

 

 

 

 

 

   

 

 

 

 

 

December 31, 2012

Commercial real estate mortgages

Commercial and industrial

Commercial construction and land development

Agricultural and other loans to farmers

Total

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