LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the Company’s loan portfolio at September 30, 2014 and December 31, 2013 was as follows:



	September 30, 2014			December 31, 2013
Residential real estate loans	$	577,515		$	570,391
Commercial real estate loans	613,510			541,099
Commercial loans	245,612			179,203
Home equity loans	271,858			272,630
Consumer loans	18,149			17,651
Deferred loan fees, net of costs	(417		)	(572		)
Total loans	$	1,726,227		$	1,580,402

The Company’s lending activities are primarily conducted in Maine. The Company originates single family and multi-family residential loans, commercial real estate loans, business loans, municipal loans and a variety of consumer loans. In addition, the Company makes loans for the construction of residential homes, multi-family properties and commercial real estate properties. The ability and willingness of borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the geographic area and the general economy. The Company did not sell any loans during the three months ended September 30, 2014. For the three months ended September 30, 2013, the Company sold $7.3 million of fixed-rate residential mortgage loans on the secondary market that resulted in net gains on the sale of loans of $32,000. For the nine months ended September 30, 2014 and 2013, the Company sold $399,000 and $28.2 million, respectively, of fixed-rate residential mortgage loans on the secondary market that resulted in net gains on the sale of loans of $17,000 and $684,000, respectively.

The ALL is management’s best estimate of the inherent risk of loss in the Company’s loan portfolio as of the consolidated statement of condition date. Management makes various assumptions and judgments about the collectability of the loan portfolio and provides an allowance for potential losses based on a number of factors including historical losses. If those assumptions are incorrect, the ALL may not be sufficient to cover losses and may cause an increase in the allowance in the future. Among the factors that could affect the Company’s ability to collect loans and require an increase to the ALL in the future are: (i) financial condition of borrowers; (ii) real estate market changes; (iii) state, regional, and national economic conditions; and (iv) a requirement by federal and state regulators to increase the provision for loan losses or recognize additional charge-offs.

In the second quarter of 2014, the Company made one revision to its ALL methodology specific to the allowance allocation for overdrawn checking accounts. Historically, the allocation was determined using the previous four quarters gross charge-offs. The methodology was revised to calculate the allowance using the previous four quarters net charge-off information, which is now consistent with the Company's overall allowance methodology and approach. The change in methodology was reviewed and approved by the Company's Board of Directors prior to implementation. The change resulted in a decrease of $165,000 in the unallocated portion of the ALL.

The Company's Board of Directors monitors credit risk through the Directors' Loan Review Committee, which reviews large credit exposures, monitors the external loan review reports, reviews the lending authority for individual loan officers when required, and has approval authority and responsibility for all matters regarding the loan policy and other credit-related policies, including reviewing and monitoring asset quality trends, concentration levels, and the ALL methodology. The Corporate Risk Management Group and the Credit Risk Policy Committee oversee the Company's systems and procedures to monitor the credit quality of its loan portfolio, conduct a loan review program, maintain the integrity of the loan rating system, determine the adequacy of the ALL and support the oversight efforts of the Directors' Loan Review Committee and the Board of Directors. The Company's practice is to proactively manage the portfolio such that management can identify problem credits early, assess and implement effective work-out strategies, and take charge-offs as timely as practical. In addition, the Company continuously reassesses its underwriting standards in response to credit risk posed by changes in economic conditions. For purposes of determining the ALL, the Company disaggregates its loans into portfolio segments, which include residential real estate, commercial real estate, commercial, home equity, and consumer.

The following table presents the activity in the ALL and select loan information by portfolio segment for the three and nine months ended September 30, 2014:



	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated		Total
ALL for the three months ended:
Beginning balance	$	5,141		$	4,361		$	6,484		$	2,752		$	318		$	2,849	$	21,905
Loans charged off	(9		)	(100		)	(675		)	(166		)	(59		)	—		(1,009		)
Recoveries	2			17			117			8			11			—		155
Provision (reduction)	122			82			35			(63		)	23			335		534
Ending balance	$	5,256		$	4,360		$	5,961		$	2,531		$	293		$	3,184	$	21,585
ALL for the nine months ended:
Beginning balance	$	5,603		$	4,374		$	6,220		$	2,403		$	319		$	2,671	$	21,590
Loans charged off	(370		)	(276		)	(1,201		)	(272		)	(99		)	—		(2,218		)
Recoveries	136			67			286			19			30			—		538
Provision (reduction)	(113		)	195			656			381			43			513		1,675
Ending balance	$	5,256		$	4,360		$	5,961		$	2,531		$	293		$	3,184	$	21,585
ALL balance attributable to loans:
Individually evaluated for impairment	$	1,420		$	222		$	121		$	573		$	111		$	—	$	2,447
Collectively evaluated for impairment	3,836			4,138			5,840			1,958			182			3,184		19,138
Total ending ALL	$	5,256		$	4,360		$	5,961		$	2,531		$	293		$	3,184	$	21,585
Loans:
Individually evaluated for impairment	$	10,964		$	6,710		$	3,380		$	1,860		$	309		$	—	$	23,223
Collectively evaluated for impairment	566,134			606,800			242,232			269,998			17,840			—		1,703,004
Total ending loans balance	$	577,098		$	613,510		$	245,612		$	271,858		$	18,149		$	—	$	1,726,227

The following table presents the activity in the ALL and select loan information by portfolio segment for the three and nine months ended September 30, 2013:



	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated			Total
ALL for the three months ended:
Beginning balance	$	6,232		$	3,590		$	5,788		$	3,428		$	221		$	4,062		$	23,321
Loans charged off	(340		)	(591		)	(379		)	(86		)	(42		)	—			(1,438		)
Recoveries	—			14			77			8			12			—			111
Provision (reduction)	709			547			465			137			40			(1,231		)	667
Ending balance	$	6,601		$	3,560		$	5,951		$	3,487		$	231		$	2,831		$	22,661
ALL for the nine months ended:
Beginning balance	$	6,996		$	4,549		$	5,933		$	2,520		$	184		$	2,862		$	23,044
Loans charged off	(687		)	(762		)	(823		)	(423		)	(175		)	—			(2,870		)
Recoveries	5			106			275			10			40			—			436
Provision (reduction)	287			(333		)	566			1,380			182			(31		)	2,051
Ending balance	$	6,601		$	3,560		$	5,951		$	3,487		$	231		$	2,831		$	22,661
ALL balance attributable to loans:
Individually evaluated for impairment	$	1,655		$	686		$	177		$	449		$	81		$	—		$	3,048
Collectively evaluated for impairment	4,946			2,874			5,774			3,038			150			2,831			19,613
Total ending ALL	$	6,601		$	3,560		$	5,951		$	3,487		$	231		$	2,831		$	22,661
Loans:
Individually evaluated for impairment	$	14,059		$	11,016		$	3,369		$	1,521		$	498		$	—		$	30,463
Collectively evaluated for impairment	550,493			511,594			174,486			304,782			18,128			—			1,559,483
Total ending loans balance	$	564,552		$	522,610		$	177,855		$	306,303		$	18,626		$	—		$	1,589,946

The following table presents the activity in the ALL and select loan information by portfolio segment for the year ended December 31, 2013:



	Residential Real Estate			Commercial Real Estate			Commercial			Home Equity			Consumer			Unallocated			Total
ALL:
Beginning balance	$	6,996		$	4,549		$	5,933		$	2,520		$	184		$	2,862		$	23,044
Loans charged off	(1,059		)	(952		)	(1,426		)	(647		)	(190		)	—			(4,274		)
Recoveries	35			121			495			56			61			—			768
Provision (reduction)	(369		)	656			1,218			474			264			(191		)	2,052
Ending balance	$	5,603		$	4,374		$	6,220		$	2,403		$	319		$	2,671		$	21,590
ALL balance attributable to loans:
Individually evaluated for impairment	$	1,750		$	526		$	132		$	433		$	140		$	—		$	2,981
Collectively evaluated for impairment	3,853			3,848			6,088			1,970			179			2,671			18,609
Total ending ALL	$	5,603		$	4,374		$	6,220		$	2,403		$	319		$	2,671		$	21,590
Loans:
Individually evaluated for impairment	$	14,435		$	8,864		$	2,635		$	1,571		$	442		$	—		$	27,947
Collectively evaluated for impairment	555,384			532,235			176,568			271,059			17,209			—			1,552,455
Total ending loans balance	$	569,819		$	541,099		$	179,203		$	272,630		$	17,651		$	—		$	1,580,402

The Company focuses on maintaining a well-balanced and diversified loan portfolio. Despite such efforts, it is recognized that credit concentrations may occasionally emerge as a result of economic conditions, changes in local demand, natural loan growth and runoff. To ensure that credit concentrations can be effectively identified, all commercial and commercial real estate loans are assigned Standard Industrial Classification codes, North American Industry Classification System codes, and state and county codes. Shifts in portfolio concentrations are monitored by the Corporate Risk Management Group. As of September 30, 2014 and December 31, 2013, the two most significant industry exposures within the commercial real estate loan portfolio were non-residential building operators (operators of commercial and industrial buildings, retail establishments, theaters, banks and insurance buildings) at 26% and 28%, respectively, and lodging (inns, bed & breakfasts, ski lodges, tourist cabins, hotels and motels) at 26% and 25%.

To further identify loans with similar risk profiles, the Company categorizes each portfolio segment into classes by credit risk characteristic and applies a credit quality indicator to each portfolio segment. The indicators for commercial, commercial real estate and residential real estate loans are represented by Grades 1 through 10 as outlined below. In general, risk ratings are adjusted periodically throughout the year as updated analysis and review warrants. This process may include, but is not limited to, annual credit and loan reviews, periodic reviews of loan performance metrics, such as delinquency rates, and quarterly reviews of adversely risk rated loans. The Company uses the following definitions when assessing grades for the purpose of evaluating the risk and adequacy of the ALL:

•

Grade 1 through 6 — Grades 1 through 6 represent groups of loans that are not subject to adverse criticism as defined in regulatory guidance. Loans in these groups exhibit characteristics that represent low to moderate risks, which is measured using a variety of credit risk criteria, such as cash flow coverage, debt service coverage, balance sheet leverage, liquidity, management experience, industry position, prevailing economic conditions, support from secondary sources of repayment and other credit factors that may be relevant to a specific loan. In general, these loans are supported by properly margined collateral and guarantees of principal parties.

•

Grade 7 — Loans with potential weakness (Special Mention). Loans in this category are currently protected based on collateral and repayment capacity and do not constitute undesirable credit risk, but have potential weakness that may result in deterioration of the repayment process at some future date. This classification is used if a negative trend is evident in the obligor’s financial situation. Special mention loans do not sufficiently expose the Company such that they warrant adverse classification.


•	Grade 8 — Loans with definite weakness (Substandard). Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or by collateral pledged. This classification is used if borrowers experience difficulty in meeting debt repayment requirements. Deterioration is sufficient to cause the Company to look to the sale of collateral.

•

Grade 9 — Loans with potential loss (Doubtful). Loans classified as doubtful have all the weaknesses inherent in the substandard grade with the added characteristic that the weaknesses make collection or liquidation of the loan in full highly questionable and improbable. The possibility of some loss is extremely high, but because of specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.


•	Grade 10 — Loans with definite loss (Loss). Loans classified as loss are considered uncollectible. The loss classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the asset because recovery and collection time may be protracted.

Asset quality indicators are periodically reassessed to appropriately reflect the risk composition of the Company’s loan portfolio. Home equity and consumer loans are not individually risk rated, but rather analyzed as groups taking into account delinquency rates and other economic conditions which may affect the ability of borrowers to meet debt service requirements, including interest rates and energy costs. Performing loans include loans that are current and loans that are past due less than 90 days. Loans that are past due over 90 days and non-accrual loans, including TDRs, are considered non-performing.

The following table summarizes credit risk exposure indicators by portfolio segment as of the following dates:



	Residential Real Estate		Commercial Real Estate		Commercial		Home Equity		Consumer		Total
September 30, 2014
Pass (Grades 1-6)	$	563,276	$	579,266	$	228,019	$	—	$	—	$	1,370,561
Performing	—		—		—		269,998		17,840		287,838
Special Mention (Grade 7)	3,035		3,372		8,985		—		—		15,392
Substandard (Grade 8)	10,787		30,872		8,608		—		—		50,267
Non-performing	—		—		—		1,860		309		2,169
Total	$	577,098	$	613,510	$	245,612	$	271,858	$	18,149	$	1,726,227
December 31, 2013
Pass (Grades 1-6)	$	551,035	$	496,257	$	155,851	$	—	$	—	$	1,203,143
Performing	—		—		—		271,059		17,210		288,269
Special Mention (Grade 7)	3,196		7,749		11,315		—		—		22,260
Substandard (Grade 8)	15,588		37,093		12,037		—		—		64,718
Non-performing	—		—		—		1,571		441		2,012
Total	$	569,819	$	541,099	$	179,203	$	272,630	$	17,651	$	1,580,402

The Company closely monitors the performance of its loan portfolio. Loans past due 30 days or more are considered delinquent. In general, consumer loans will be charged off if the loan is delinquent for 90 consecutive days. Commercial and real estate loans are charged off in part or in full to the extent they appear uncollectible. A loan is placed on non-accrual status when the financial condition of the borrower is deteriorating, payment in full of both principal and interest is not expected as scheduled, or principal or interest has been in default for 90 days or more. Exceptions may be made if the asset is well-secured by collateral sufficient to satisfy both the principal and accrued interest in full and collection is assured by a specific event, such as the closing of a pending sale contract. When one loan to a borrower is placed on non-accrual status, generally all other loans to the borrower are re-evaluated to determine if they should also be placed on non-accrual status. All previously accrued and unpaid interest is reversed at this time. Interest payments received on non-accrual loans (including impaired loans) are applied as a reduction of principal. A loan remains on non-accrual status until all principal and interest amounts contractually due are brought current and future payments are reasonably assured. A loan may be returned to accrual status when collection of principal and interest is assured and the borrower has demonstrated timely payments of principal and interest for a reasonable period. Unsecured loans, however, are not normally placed on non-accrual status but instead they are charged-off once their collectability is in doubt.

The following is a loan aging analysis by portfolio segment (including loans past due over 90 days and non-accrual loans) and a summary of non-accrual loans, which include TDRs, and loans past due over 90 days and accruing as of the following dates:



	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans Outstanding		Loans > 90 Days Past Due and Accruing		Non-Accrual Loans
September 30, 2014
Residential real estate	$	700	$	355	$	5,693	$	6,748	$	570,350	$	577,098	$	—	$	7,098
Commercial real estate	1,510		324		3,729		5,563		607,947		613,510		—		5,707
Commercial	2,226		45		1,420		3,691		241,921		245,612		—		3,051
Home equity	1,805		207		1,606		3,618		268,240		271,858		—		1,860
Consumer	46		27		290		363		17,786		18,149		—		309
Total	$	6,287	$	958	$	12,738	$	19,983	$	1,706,244	$	1,726,227	$	—	$	18,025
December 31, 2013
Residential real estate	$	3,218	$	684	$	7,269	$	11,171	$	558,648	$	569,819	$	—	$	10,520
Commercial real estate	926		2,036		3,301		6,263		534,836		541,099		257		7,799
Commercial	159		237		1,980		2,376		176,827		179,203		198		2,146
Home equity	1,395		388		1,007		2,790		269,840		272,630		—		1,571
Consumer	63		21		418		502		17,149		17,651		—		441
Total	$	5,761	$	3,366	$	13,975	$	23,102	$	1,557,300	$	1,580,402	$	455	$	22,477

Interest income that would have been recognized if loans on non-accrual status had been current in accordance with their original terms was $192,000 and $256,000 for the three months ended September 30, 2014 and 2013, respectively, and $647,000 and $738,000 for the nine months ended September 30, 2014 and 2013, respectively.

The Company takes a conservative approach in credit risk management and remains focused on community lending and reinvesting. The Company works closely with borrowers experiencing credit problems to assist in loan repayment or term modifications. TDRs consist of loans where the Company, for economic or legal reasons related to the borrower’s financial difficulties, granted a concession to the borrower that it would not otherwise consider. TDRs involve term modifications or a reduction of either interest or principal. Once such an obligation has been restructured, it will remain in a restructured status, even if performing in accordance with the modified terms, until paid in full.

At September 30, 2014 and December 31, 2013, the Company had specific reserve allowance related to TDRs was $691,000 and $656,000, respectively. The specific reserve component was determined by discounting the total expected future cash flows from the borrower at the original loan interest rate, or if the loan is currently collateral-dependent, using the fair value of the underlying collateral, which was obtained through independent appraisals and internal evaluations.

At September 30, 2014, the Company had performing and non-performing TDRs of $5.2 million and $1.5 million, respectively. At December 31, 2013, the Company had performing and non-performing TDRs of $5.5 million and $1.6 million, respectively. As of September 30, 2014 and December 31, 2013, the Company did not have any commitments to lend additional funds to borrowers with loans classified as TDRs.

The following is a summary of TDRs by portfolio segment and the associated specific reserve included within the ALL as of September 30, 2014 and December 31, 2013:



	Number of Contracts		Current Balance				Specific Reserve
	September 30, 2014	December 31, 2013	September 30, 2014		December 31, 2013		September 30, 2014		December 31, 2013
Residential real estate	26	26	$	4,098	$	4,089	$	667	$	525
Commercial real estate	9	10	2,141		2,558		11		131
Commercial	9	7	437		488		13		—
Home equity and consumer	1	1	30		1		—		—
Total	45	44	$	6,706	$	7,136	$	691	$	656

The following represents loan modifications qualifying as TDRs by portfolio segment and the associated specific reserve included within the ALL for the three and nine months ended September 30, 2014:



	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Specific Reserve
Three months ended:
Residential real estate	—	$	—	$	—	$	—
Commercial real estate	1	235		235		—
Commercial	3	77		77		9
Home equity and consumer	1	40		30		—
Total	5	$	352	$	342	$	9
Nine months ended:
Residential real estate	1	$	136	$	149	$	44
Commercial real estate	1	235		235		—
Commercial	3	77		77		9
Home equity and consumer	1	40		30		—
Total	6	$	488	$	491	$	53

The following represents loan modifications qualifying as TDRs by portfolio segment and the associated specific reserve included within the ALL for the three and nine months ended September 30, 2013:



	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Specific Reserve
Three months ended
Residential real estate	2	$	359	$	379	$	—
Commercial real estate	—	—		—		—
Commercial	—	—		—		—
Home equity and consumer	—	—		—		—
Total	2	$	359	$	379	$	—
Nine months ended
Residential real estate	4	$	636	$	665	$	5
Commercial real estate	2	279		286		2
Commercial	3	236		236		1
Home equity and consumer	—	—		—		—
Total	9	$	1,151	$	1,187	$	8

For the three and nine months ended September 30, 2014 and 2013, there were no loans modified as a TDR within the previous 12 months and for which the borrower subsequently defaulted.

Impaired loans consist of non-accrual loans and TDRs. The following is a summary of impaired loan balances and associated allowance by portfolio segment as of and for the three and nine months ended September 30, 2014:



							Three Months Ended					Nine Months Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized⁽¹⁾			Average Recorded Investment		Interest Income Recognized
With an allowance recorded:
Residential real estate	$	9,441	$	9,441	$	1,420	$	9,236	$	38		$	9,928	$	102
Commercial real estate	2,987		2,987		222		3,142		1			5,588		2
Commercial	1,562		1,562		121		2,724		(2		)	2,653		8
Home equity	1,510		1,510		573		1,486		—			1,571		—
Consumer	292		292		111		333		—			392		—
Ending Balance	15,792		15,792		2,447		16,921		37			20,132		112
Without an allowance recorded:
Residential real estate	1,523		1,880		—		1,751		2			2,340		5
Commercial real estate	3,723		4,116		—		3,490		14			2,230		43
Commercial	1,818		2,318		—		870		6			609		8
Home equity	350		477		—		403		—			415		—
Consumer	17		37		—		17		—			17		—
Ending Balance	7,431		8,828		—		6,531		22			5,611		56
Total impaired loans	$	23,223	$	24,620	$	2,447	$	23,452	$	59		$	25,743	$	168

⁽¹⁾ Negative interest income represents the re-allocation of income between "with an allowance recorded" and "without an allowance recorded" (or vice versa) during the period.

The following is a summary of impaired loan balances and associated allowance by portfolio segment as of and for the three and nine months ended September 30, 2013:



							Three Months Ended				Nine Months Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With an allowance recorded:
Residential real estate	$	10,746	$	10,746	$	1,655	$	10,457	$	32	$	10,130	$	91
Commercial real estate	8,497		8,497		686		6,503		9		4,976		18
Commercial	2,347		2,347		177		2,606		3		2,721		6
Home equity	1,263		1,263		449		1,245		—		1,307		—
Consumer	480		480		81		481		—		466		—
Ending Balance	23,333		23,333		3,048		21,292		44		19,600		115
Without an allowance recorded:
Residential real estate	3,313		4,439		—		2,816		9		2,908		22
Commercial real estate	2,519		3,167		—		3,663		10		3,750		56
Commercial	1,022		1,213		—		907		2		699		8
Home equity	258		450		—		291		—		356		—
Consumer	18		38		—		7		—		3		—
Ending Balance	7,130		9,307		—		7,684		21		7,716		86
Total impaired loans	$	30,463	$	32,640	$	3,048	$	28,976	$	65	$	27,316	$	201

The following is a summary of impaired loan balances and associated allowance by portfolio segment as of and for the year ended December 31, 2013:



							Year Ended
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With an allowance recorded:
Residential real estate	$	11,902	$	11,902	$	1,750	$	10,411	$	118
Commercial real estate	6,805		6,805		526		5,517		20
Commercial	1,876		1,876		132		2,543		10
Home equity	1,228		1,228		433		1,291		—
Consumer	425		425		140		460		—
Ending Balance	22,236		22,236		2,981		20,222		148
Without an allowance recorded:
Residential real estate	2,533		3,846		—		2,925		28
Commercial real estate	2,059		2,782		—		3,362		55
Commercial	759		871		—		765		8
Home equity	343		479		—		334		—
Consumer	17		37		—		11		—
Ending Balance	5,711		8,015		—		7,397		91
Total impaired loans	$	27,947	$	30,251	$	2,981	$	27,619	$	239

The Company records its properties obtained through foreclosure or deed-in-lieu of foreclosure as OREO properties on the consolidated statements of condition at fair value of the real estate, less the estimated cost to sell (i.e. net realizable value). If a write-down of the recorded investment at the time of transfer to OREO is necessary, the write-down is charged to the ALL. If a subsequent write-down of the property is necessary due to a further decline in the fair value of the property then the write-down is recorded through a valuation allowance on the OREO property and charged to other non-interest expense in the consolidated statements of income. At September 30, 2014, the Company had 11 residential real estate properties and 6 commercial properties with a carrying value of $554,000 and $1.0 million, respectively, within OREO. At December 31, 2013, the Company had 10 residential real estate properties and 6 commercial properties with a carrying value of $1.0 million and $1.2 million, respectively, within OREO.

At September 30, 2014 and December 31, 2013, the Company had $6.0 million and $4.4 million, respectively, of consumer mortgage loans secured by residential real estate properties for which foreclosure proceedings were in process.