10-K 1 final10k2002.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the Fiscal Year ended December 31, 2002 Commission File Number 0-26589 FIRST NATIONAL LINCOLN CORPORATION (Exact name of Registrant as specified in its charter) MAINE 01-0404322 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) MAIN STREET, DAMARISCOTTA, MAINE 04543 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (207) 563-3195 Securities registered pursuant to Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934 Common Stock, $.01 par value per share 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 twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No[ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No[ ] State the aggregate market value of voting stock held by non-affiliates of the Registrant as of March 1, 2003: Common Stock, $.01 par value per share: $88,316,000 Indicate the number of shares outstanding of each of the registrant's classes of common stock as of March 1, 2003: Common Stock: 2,419,621 shares TABLE OF CONTENTS PART I ITEM 1. Discussion of Business ........................................... 1 ITEM 2. Properties ....................................................... 5 ITEM 3. Legal Proceedings ................................................ 6 ITEM 4. Submission of Matters to a Vote of Security Holders .............. 7 PART II ITEM 5. Market for Registrant's Common Equity ............................ 8 ITEM 6. Selected Financial Data .......................................... 9 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ........................................ 10 ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk ....... 29 ITEM 8. Financial Statements and Supplementary Data ...................... 32 ITEM 9. Changes in and/or Disagreements with Accountants ................. 68 PART III ITEM 10. Directors and Executive Officers of the Registrant ............... 69 ITEM 11. Executive Compensation ........................................... 73 ITEM 12. Security Ownership of Certain Beneficial Owners and Management ... 81 ITEM 13. Certain Relationships and Related Transactions ................... 83 PART IV ITEM 14. Controls and Procedures .......................................... 84 ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8.K. 85 Signatures ................................................................ 86 Certifications ............................................................ 87 ITEM 1. Discussion of Business First National Lincoln Corporation (the "Company") was incorporated under the general business laws of the State of Maine on January 15, 1985, for the purpose of becoming the parent holding company of The First National Bank of Damariscotta (the "Bank"). The common stock of the Bank is the principal asset of the Company, which has no other subsidiaries. As of December 31, 2002, the Company's securities consisted of one class of common stock, $.01 par value per share, of which there were 2,414,693 shares outstanding and held of record by approximately 700 shareholders. The Bank was chartered as a national bank under the laws of the United States on May 30, 1864. The Bank's capital stock consists of one class of common stock of which 120,000 shares, par value $2.50 per share, are authorized and outstanding. All of the Bank's common stock is owned by the Company. The Bank has seven offices in Mid-Coast Maine, including its principal office located on Main Street, Damariscotta, Lincoln County, Maine and six branch offices located at U.S. Route 1, Waldoboro, Maine; Townsend Avenue, Boothbay Harbor, Maine; Route 27, Wiscasset, Maine; U.S. Route 1, Rockport, Maine; Elm Street, Camden, Maine; and Route 1, Rockland, Maine. The Bank also maintains an Operations Center at the corner of Bristol Road and Cross Street in Damariscotta. The Bank has not consummated any mergers, consolidations or other acquisitions of assets with any other person during the past five years, other than as described elsewhere herein. The Bank emphasizes personal service to the community, concentrating on retail banking. Customers are primarily small businesses and individuals for whom the Bank offers a wide variety of services, including checking, savings and investment accounts, consumer and commercial and mortgage loans. The Bank has not made any material changes in its mode of conducting business during the past five years. The banking business in the Bank's market area historically has been seasonal with lower deposits in the winter and spring and higher deposits in the summer and fall. This swing is fairly predictable and has not had a materially adverse effect on the Bank. In addition to providing traditional banking services, the Company provides investment management and private banking services through Pemaquid Advisors, which is an operating division of the Bank. In 2000, the Bank separated its Trust and Investment Services Department into a separate division with a different brand identity. Under the name of Pemaquid Advisors, the division is focused on taking advantage of opportunities created as the larger banks have altered their personal service commitment to clients not meeting established account criteria. Pemaquid Advisors is able to offer a comprehensive array of private banking, financial planning, investment management and trust services to individuals, businesses, non-profit organizations and municipalities of varying asset size, and to provide the highest level of personal service. The staff includes investment and trust professionals with extensive experience. In June, 2001, the Bank acquired White Pine Asset Management of Portland, Maine, which then became part of Pemaquid Advisors. Pemaquid Advisors operates from its offices on Bristol Road in Damariscotta, Maine and Monument Square, Portland, Maine. As of December 31, 2002, the Company employed 134 persons, with 131 full- time equivalent employees. The financial services landscape has changed considerably over the past five years in the Bank's primary market area. Two large out-of-state banks have continued to experience local change as a result of mergers and acquisitions at the regional and national level. Credit unions have continued to expand their membership and the scope of banking services offered. Non-banking entities such as brokerage houses, mortgage companies and insurance companies are offering very competitive products. Many of these entities and institutions have Page 1 resources substantially greater than those available to the Bank and are not subject to the same regulatory restrictions as the Company and the Bank. Interstate banking also could intensify competition if out-of-state institutions increasingly take advantage of recent legislation liberalizing interstate banking and branching opportunities in Maine. In November of 1999, Congress adopted the Gramm-Leach-Bliley Financial Modernization Act ("GLBA"). This legislation breaks down the firewalls separating related business in order to create more competition and a level playing field. In this case, the Act eliminates depression-era restrictions which separate the business of banking from the business of insurance and securities underwriting, and also resulted in modifications to protect consumers and streamline regulation. While the Company views this legislation as an opportunity to offer a more comprehensive range of financial products and services, at the same time it will also provide additional competition in the marketplace. Over the past decade, due to more liberal interstate banking laws, Maine has seen an increase in acquisitions of locally-owned Maine-based banks. It is Management's view that these acquisitions often result in customer dissatisfaction as the decision-making on loans, marketing, and other aspects of the acquired banks' businesses are shifted from local bank management possessing independent decision-making power to management operating under policies and guidelines from corporate headquarters in other states. The Company believes that this shift often results in delayed decision-making by management which is not familiar with the needs of the acquired bank's customers or the communities they serve. Individuals and small businesses are particularly sensitive to these changes since they may not fit the product parameters established by the larger banks. Thus, the Company believes that there will continue to be a need for a bank in the Bank's primary market area with local management having decision- making power and emphasizing loans to small and medium-sized businesses and to individuals. The Bank has concentrated on extending business loans to such customers in the Bank's primary market area and to extending investment and trust services to clients with accounts of all sizes. The Bank's management also makes decisions based upon, among other things, the knowledge of the Bank's employees regarding the communities and customers in the Bank's primary market area. The individuals employed by the Bank, to a large extent, reside near the branch offices and thus are generally familiar with their communities and customers. This is important in local decision-making and allows the Bank to respond to customer questions and concerns on a timely basis and fosters quality customer service. The Bank has worked and will continue to work to position itself to be competitive in its market area. The Bank's ability to make decisions close to the marketplace, Management's commitment to providing quality banking products, the caliber of the professional staff, and the community involvement of the Bank's employees are all factors affecting the Bank's ability to be competitive. If the Company and the Bank are unable to compete successfully, however, the business and operations could be adversely affected. Customer Information Security. The FDIC and other bank regulatory agencies have published final guidelines establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the "Guidelines"). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect Page 2 against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. Privacy. The FDIC and other regulatory agencies have published final privacy rules pursuant to provisions of the GLBA ("Privacy Rules"). The Privacy Rules, which govern the treatment of nonpublic personal information about consumers by financial institutions, require a financial institution to provide notice to customers (and other consumers in some circumstances) about its privacy policies and practices, describe the conditions under which a financial institution may disclose nonpublic personal information to nonaffiliated third parties, and provide a method for consumers to prevent a financial institution from disclosing that information to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions. USA Patriot Act. The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain access to the United States financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act requires financial institutions to implement additional policies and procedures with respect to money laundering, suspicious activities, currency transaction reporting and due diligence on customers. Implementation of the Patriot Act's requirements will occur in stages, as rules regarding its provisions are finalized by government agencies. Sarbanes-Oxley Act On July 30, 2002, President George W. Bush signed into law the Sarbanes- Oxley Act of 2002. The Sarbanes-Oxley Act implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from the type of corporate wrongdoing that occurred in Enron, WorldCom and similar companies. The Sarbanes-Oxley Act's principal legislation includes: * the creation of an independent accounting oversight board; * auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients; * additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements and the expansion of powers of audit committees; * expanded disclosure requirements, including accelerated reporting of stock transactions by insiders; * mandatory disclosure by analysts of potential conflicts of interest; and * a range of enhanced penalties for fraud and other violations. We do not believe that the Sarbanes-Oxley Act will have a material adverse affect upon our operations in the near term. Page 3 Supervision and Regulation The Company is a financial holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Act"), and section 225.82 of Regulation Y issued by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), and is required to file with Federal Reserve Board an annual report and other information required pursuant to the Act. The Company is subject to examination by the Federal Reserve Board. The Act requires the prior approval of the Federal Reserve Board for a financial holding company to acquire or hold more than a 5% voting interest in any bank, and controls interstate banking activities. The Act restricts First National Lincoln Corporation's non-banking activities to those which are determined by the Federal Reserve Board to be closely related to banking. The Act does not place territorial restrictions on the activities of non-bank subsidiaries of financial holding companies. The majority of the Company's cash revenues are generally derived from dividends paid to the Company by the Bank. These dividends are subject to various legal and regulatory restrictions which are summarized in Note 17 to the accompanying financial statements. The Bank is subject to the provisions of the National Bank Act, and as such, must meet certain liquidity and capital requirements, which are discussed in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations. The Office of the Comptroller of the Currency -- the Bank's principal regulatory agency -- conducts periodic examinations of the Bank. Certain state banking regulations also apply to the Bank, as administered by the Maine Bureau of Financial Institutions. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) recapitalized the deposit insurance funds and gave regulators the authority to restrict the operations, management and capital distributions of a bank, depending upon its risk. On December 31, 2002, the Bank was classified in the lowest risk category. FDICIA also directs regulators to establish underwriting and operations standards, encompassing such areas as real estate lending, consumer disclosure rules, internal controls and new reporting requirements. The monetary policies of regulatory authorities, including the Federal Reserve Board, have a significant effect on the operating results of banks and bank holding companies. Through open market securities transactions and changes in its discount rate and reserve requirements, the Board of Governors exerts considerable influence over the cost and availability of funds for lending and investment. The nature of future monetary policies and the effect of such policies on the future business and earnings of the Company and the Bank cannot be predicted. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, regarding the Bank's net interest margin and the effect of interest-rate volatility on future earnings. Page 4 ITEM 2. Properties The principal office of the Bank is located in Damariscotta, Maine, and serves the people of Damariscotta, Newcastle, Edgecomb, Jefferson, Bremen, Wiscasset, Nobleboro, South Bristol and Bristol. A branch office opened in Waldoboro in 1975, which is located approximately ten miles from Damariscotta on U.S. Rt. 1, serves the population of Waldoboro and the surrounding towns of Friendship, Warren, Washington and Monhegan Island. In 1979, a branch office was opened in Boothbay Harbor, which is situated approximately 16 miles from Damariscotta. This office serves the towns of Boothbay, West Boothbay, Boothbay Harbor, Southport and neighboring areas. Expansion of the Bank's Boothbay Harbor office began in the Fall of 1995 to better serve customer needs. It included utilization of an adjacent property that was purchased in 1994. The project was completed in the summer of 1996. In 2002, the Bank purchased additional property in Boothbay Harbor for use as an auxiliary office for the branch and for Pemaquid Advisors. In 1988, a branch office was opened in Wiscasset, which is approximately eight miles from Damariscotta. This office serves the towns of Wiscasset, Edgecomb, Alna, Woolwich and Dresden. In 1997, the Bank purchased and renovated a property on Route 1 in Rockport, Maine, in which to open its first branch office outside of Lincoln County, Maine. Rockport is located in Knox County, Maine, which is contiguous to Lincoln County, Maine, and with similar demographic characteristics. This move into Knox County was made to provide additional growth opportunities for the Bank, which has limited potential for growth in its existing market area. In May of 1998, the Bank opened a sixth branch in Camden, Maine, which is geographically contiguous to Rockport, Maine. The addition of this branch in the Knox County market has allowed the Bank to better serve customers in this area by providing both in-town and out-of-town locations that meet different customer needs. In September of 2001, the Bank opened its Rockland office at the corner of Route One and Broadway in Rockland Maine. Located in Knox County between the Waldoboro and Rockport offices, the Rockland office serves the towns of Rockland, Thomaston, Owl's Head and St. George. An operations center is located in the block adjacent to the Damariscotta office, fronting on Bristol Road. It was put in service in July, 1989. The Bank also owns real estate on Water Street in Damariscotta, Maine, which was put into use for additional office space during 1995. In 2001, the Bank purchased property at 9 Bristol Road in Damariscotta, Maine and moved its Pemaquid Advisors division into the facility. The division also occupies leased office space at 2 Monument Square in Portland, Maine, from which it provides its services to the Portland community. The Bank owns all of its facilities except for the Camden and Portland locations, for which the Bank entered into long-term leases. Management believes that the Bank's current facilities are suitable and adequate in light of its current needs and its anticipated needs over the near term. Page 5 ITEM 3. Legal Proceedings There are no material pending legal proceedings to which the Company or the Bank is a party or to which any of its property is subject, other than routine litigation incidental to the business of the Bank. None of these proceedings is expected to have a material effect on the financial condition of the Company or of the Bank. Page 6 ITEM 4. Submission of Matters to a Vote of Security Holders There were no items submitted to a vote of security holders of the Company during the fourth quarter of 2002. Page 7 ITEM 5. Market for Registrant's Common Equity The common stock of First National Lincoln Corporation (ticker symbol FNLC) trades on the Nasdaq National Market System. The following table reflects the high and low prices of actual sales in each quarter of 2002 and 2001. Such quotations do not reflect retail mark-ups, mark-downs or brokers' commissions. ---------------------------------------------------- 2002 2001 ---------------------------------------------------- High Low High Low 1st Quarter 28.20 21.75 15.75 15.00 2nd Quarter 32.00 27.35 18.50 15.42 3rd Quarter 31.00 25.60 21.75 17.50 4th Quarter 34.50 27.00 22.25 19.50 ---------------------------------------------------- The last known transaction of the Company's stock during 2002 was on December 31 at $31.48 per share. There are no warrants outstanding with respect to the Company's common stock, and the Company has no securities outstanding which are convertible into common equity. The table below sets forth the cash dividends declared in the last two fiscal years: ------------------------------------------------------------------- Date Declared Amount Per Share Date Payable ------------------------------------------------------------------- March 13, 2001 $0.1900 April 27, 2001 June 14, 2001 $0.2000 July 31, 2001 September 20, 2001 $0.2100 October 31, 2001 December 20, 2001 $0.2200 January 31, 2002 March 27, 2002 $0.2300 April 30, 2002 June 20, 2002 $0.2400 July 31, 2002 September 19, 2002 $0.2500 October 31, 2002 December 19, 2002 $0.2600 January 31, 2003 ------------------------------------------------------------------- The ability of the Company to pay cash dividends depends on receipt of dividends from the Bank. Dividends may be declared by the Bank out of its net profits as the directors deem appropriate, subject to the limitation that the total of all dividends declared by the Bank in any calendar year may not exceed the total of its net profits of that year plus retained net profits of the preceding two years. The Bank is also required to maintain minimum amounts of capital-to-total-risk-weighted-assets, as defined by banking regulators. At December 31, 2002, the Bank was required to have minimum Tier 1 and Tier 2 risk-based capital ratios of 4.00% and 8.00%, respectively. The Bank's actual ratios were 11.75% and 12.88%, respectively, as of December 31, 2002. Page 8 ITEM 6. Selected Financial Data ------------------------------------------------------------------------------- Dollars in thousands, except for per share amounts Years ended December 31, 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------- Summary of Operations Operating Income $ 34,258 33,960 30,890 26,348 23,621 Operating Expense 25,072 26,239 24,390 20,025 17,903 Net Interest Income 17,103 15,031 12,770 11,949 10,844 Provision for Loan Losses 1,323 1,230 700 645 400 Net Income 6,507 5,493 4,607 4,451 4,011 Per Common Share Data Net Income Basic 2.71 2.30 1.93 1.84 1.62 Diluted 2.64 2.24 1.89 1.77 1.56 Cash Dividends (Declared) 0.98 0.82 0.66 0.50 0.39 Book Value 17.68 15.61 13.94 12.09 11.64 Market Value 31.48 22.10 15.50 16.25 22.50 Financial Ratios Return on Average Equity 16.34% 15.51% 15.15% 15.67% 14.86% Return on Average Assets 1.39 1.33 1.27 1.39 1.44 Average Equity to Average Assets 8.49 8.55 8.36 8.88 9.70 Net Interest Margin (Tax-Equivalent) 4.00 3.99 3.88 4.12 4.28 Dividend Payout Ratio (Declared) 36.16 35.65 34.20 27.17 24.06 Allowance for Loan Losses/Total Loans 1.11 1.00 0.87 0.88 0.87 Non-Performing Loans to Total Loans 0.32 0.22 0.89 0.29 0.34 Non-Performing Assets to Total Assets 0.27 0.20 0.69 0.30 0.36 Efficiency Ratio 50.49 50.60 52.06 50.93 51.75 At Year End Total Assets $494,068 434,466 393,216 341,287 286,806 Total Loans 332,074 301,304 264,929 232,526 209,224 Total Investment Securities 122,073 108,186 105,220 87,999 59,342 Total Deposits 334,224 262,689 254,566 205,458 201,803 Total Shareholders' Equity 42,695 37,334 33,160 28,662 28,776 ------------------------------------------------------------------------------- High Low Market price per common share of stock during 2002 $ 34.50 21.75 ------------------------------------------------------------------------------- Page 9 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations General First National Lincoln Corporation (the "Company") and its subsidiary, The First National Bank of Damariscotta (the "Bank"), posted record earnings in 2002, the result of continued positive growth in both assets and income seen during the past ten years. During this period, the Company focused on cost reduction and increased efficiency prior to 1997 to increase its profitability. In the subsequent years, however, the Company's strategy has changed to controlled, profitable, "organic" growth. The value of this strategy can be seen in the Company's expansion into Knox County during the past five years, where offices were opened in Rockport and Camden in 1997 and 1998, respectively, and in Rockland in 2001. These offices have far exceeded their initial goals and have provided the opportunity for substantial new market growth. The Company's expansion has not come at the expense of profitability, however. Since the Bank has traditionally operated on a lower net interest margin than its peers, it operates with lower expenses than its peers, and this is reflected in its efficiency ratio, which is consistently better than its peers, on average. It can also be seen in the Company's return on average assets and return on average equity, which were 1.39% and 16.34%, respectively, in 2002, and again significantly higher than those of its peer group, on average. The Company experienced strong asset growth in 2002, with the loan portfolio increasing by $30.8 million or 10.2%, and the investment portfolio increasing $13.9 million or 12.8%. The combined effect saw total assets increasing by 13.7% or $59.6 million from $434.5 million to $494.1 million. Asset growth was funded with deposits, which increased $71.5 million, or 27.2%. Deposit growth also funded a net paydown in borrowed funds, which decreased $18.0 million or 13.7% in 2002. The Company saw very good growth in low-cost core deposits during the year and, coupled with favorable pricing of borrowings, allowed approximately $12.4 million of high-cost certificates of deposit to mature without renewal by year-end. As a result of 2002's balance sheet growth and a slightly wider interest margin, the Company increased net interest income by $2.1 million or 13.8% to $17.1 million. Management believes the Bank has limited exposure to changes in interest rates, as discussed in "Interest Rate Risk Management" elsewhere in Management's Discussion. Critical Accounting Policies Management's discussion and analysis of the Company's financial condition is based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States. 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. On an ongoing basis, Management evaluates its estimates, including those related to the allowance for loan losses. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for 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. Page 10 Management believes the allowance for loan losses is a critical accounting policy that requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on Management's evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. Management believes the allowance for loan losses is a significant estimate and therefore regularly evaluates it for adequacy by taking into consideration factors such as prior loan loss experience, the character and size of the loan portfolio, business and economic conditions and Management's estimation of potential losses. The use of different estimates or assumptions could produce different provisions for loan losses. Financial Condition and Results of Operations Net income for the year ended December 31, 2002 was $6,507,000 - the highest annual net income ever recorded by the Company. This represents an 18.5% or $1,014,000 increase from net income of $5,493,000 that was posted in 2001 and is $1,900,000, or 41.2%, above 2000 net income of $4,607,000. Return on average assets in 2002 was 1.39%, up from 1.33% in 2001 and 1.27% in 2000. The increases are attributable to the Company's strong asset growth accompanied by wider interest margins due to recent drops in interest rates and lower funding costs. Return on average equity was 16.34% in 2002, compared to 15.51% in 2001 and 15.15% in 2000. The increase in 2002 was primarily due to the record earnings resulting from higher net interest income, caused by the factors noted above. Non-interest income increased by 27.0% from $3,898,000 in 2001 to $4,951,000 in 2002. The increase was attributable to increased income on mortgage origination and servicing due to higher volumes of loan sales in a favorable interest rate climate, increased document preparation fees on loans and a one-time gain of $219,000 resulting from the sale of the Bank's credit card portfolio, net of taxes and related expenses. Non-interest income increased 31.4% in 2001 to $3,898,000 from 2000's level of $2,967,000. The increase was attributable to increased income on mortgage origination and servicing due to higher volumes of loan sales in a favorable interest rate climate, newly instituted document preparation fees on loans and increased merchant credit card volume. Non-interest expense increased 15.7% to $11.5 million in 2002 from $10.0 million in 2001, which was attributable to increased employee expenses for staff expansion and increased equipment and software expense. These were necessary to maintain the high level of service we are committed to delivering to our customer base. The Company's efficiency ratio - a benchmark measure of the amount spent to generate a dollar of income - was 0.50 in 2002 compared to 0.59 for its peer group, on average. The efficiency ratio is calculated by dividing the Company's operating expenses (which excludes the provision for loan losses) by the total of net interest income on a tax-equivalent basis before provision for loan losses and other operating income (which excludes securities gains). The Company's efficiency ratio was 0.51 in 2001 compared to 0.62 for its peer group average. In 2001, non-interest expense increased 16.9% to $10.0 million from $8.5 million in 2000, attributable primarily to increased costs for merchant credit card services, increased equipment and software expenses and employee expenses. Page 11 Average shareholders' equity to average assets was 8.49% in 2002, compared to 8.55% in 2001, and 8.36% in 2000. The 2002 ratio declined due to strong asset growth and the Company repurchasing shares of its own stock. The 2001 increase was the result of strong earnings. Earnings per share for the year ended December 31, 2002 increased 17.8% to $2.71, compared to $2.30 in 2001, and $1.93 in 2000. Earnings per share on a fully diluted basis increased 17.9% for the year ended December 31, 2002, to $2.64, compared to $2.24 in 2001, and $1.89 in 2000. Book value per share was $17.68 on December 31, 2002, up from $15.61 on December 31, 2001 and $13.94 on December 31, 2000. The Bank's loan delinquency ratio decreased in 2002, and was 1.04% on December 31, 2002, versus 1.45% on December 31, 2001 and 2.26% on December 31, 2000. In Management's opinion, there has been no pattern or trend in loan delinquencies which is of concern. The levels seen in 2002 and 2001 are related to the Bank's ability to control loan quality and resolve delinquency issues quickly. Delinquencies in 2000 were isolated circumstances involving a small number of borrowers. Average Rates and Net Interest Yield The following table shows, for the years ended December 31, 2002, 2001 and 2000, the interest earned or paid for each major asset and liability category, the average yield for each major asset and liability category, and the net yield between assets and liabilities. Tax-exempt income has been calculated on a tax-equivalent basis using a 35% rate. Unrecognized interest on non-accrual loans is not included in the amount presented, but the average balance of non- accrual loans is included in the denominator when calculating yields. ------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 --------------- -------------- --------------- Amount Avg Amount Avg Amount Avg of Yield/ of Yield/ of Yield/ Dollars in thousands interest Rate interest Rate interest Rate ------------------------------------------------------------------------------- Interest-earning assets Interest-bearing deposits $ 62 1.34% 77 3.94% 25 7.41% Investments 7,685 6.44% 7,537 6.82% 6,660 7.12% Loans held for sale 151 7.46% 33 7.05% 0 0% Loans 22,143 6.93% 23,138 8.21% 21,841 8.71% ------ ----- ------ ----- ------ ----- Total interest-earning assets $30,041 6.74% 30,785 7.79% 28,526 8.28% ------ ----- ------ ----- ------ ----- Interest-bearing liabilities Deposits $ 7,702 2.76% 10,006 4.07% 8,626 4.23% Other borrowings 4,502 3.68% 5,025 4.59% 6,528 6.10% ------ ----- ----- ----- ----- ----- Total interest-bearing liabilities $12,204 3.04% 15,031 4.23% 15,154 4.88% ------ ----- ------ ----- ------ ----- Net interest income $17,837 15,754 13,372 ====== ====== ====== Interest rate spread 3.70% 3.56% 3.40% Net interest margin 4.00% 3.99% 3.88% ------------------------------------------------------------------------------- Page 12 Average Daily Balance Sheets The following table shows the Company's average daily balance sheets for the years ended December 31, 2002, 2001 and 2000. ------------------------------------------------------------------------------- Dollars in thousands Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Cash and due from banks $ 9,419 5,997 6,943 Interest-bearing deposits 4,640 1,954 343 ------- ------ ------- Investments U.S. Treasury securities & government agencies 60,480 53,094 57,113 Obligations of states & political subdivisions 21,774 18,514 13,282 Other securities 37,045 38,992 23,129 ------- ------- ------- Total investments 119,299 110,600 93,524 ------- ------- ------- Loans held for sale 2,025 466 - ------- ------- ------- Loans Commercial 112,483 95,401 80,167 Consumer 29,898 31,645 30,195 State and municipal 8,377 9,059 9,180 Real estate 168,872 145,783 131,231 ------- ------- ------- Total loans 319,630 281,888 250,773 Allowance for loan losses 3,401 2,583 2,126 ------- ------- ------- Net loans 316,229 279,305 248,647 ------- ------- ------- Fixed assets 7,803 6,119 5,421 Other assets 9,526 9,764 8,724 ------- ------- ------- Total assets $ 468,941 414,205 363,602 ======= ======= ======= Deposits Demand $ 24,316 20,529 20,324 NOW 45,916 40,616 38,067 Money market 50,490 12,297 12,874 Savings 53,313 42,004 40,205 Certificates of deposit 76,115 67,776 43,169 Certificates of deposit over $100,000 53,022 83,075 69,385 ------- ------- ------- Total deposits 303,172 266,297 224,024 ------- ------- ------- Borrowed funds 122,253 109,418 107,044 Other liabilities 3,698 3,072 2,126 ------- ------- ------- Total liabilities 429,123 378,787 333,194 Common stock 25 25 25 Additional paid in capital 4,687 4,687 4,687 Retained earnings 37,296 32,929 27,851 Treasury stock (2,190) (2,223) (2,155) ------- ------- ------- Total capital 39,818 35,418 30,408 ------- ------- ------- Total liabilities and capital $ 468,941 414,205 363,602 ======= ======= ======= ------------------------------------------------------------------------------- Rate Volume Analysis The following tables present changes in interest income and expense attributable to changes in interest rates, volume, and rate/volume(1) for interest-earning assets and interest-bearing liabilities. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate in 2002 and 2001. Year ended December 31, 2002 compared to 2001 ------------------------------------------------------------------------------- Rate/ Dollars in thousands Volume Rate volume(1) Total ------------------------------------------------------------------------------- Interest on earning assets Interest-bearing deposits $ 106 (51) (70) (15) Investment securities 593 (413) (32) 148 Loans held for sale 110 2 6 118 Loans 3,098 (3,610) (483) (995) ----- ----- --- ----- Total interest income 3,907 (4,072) (579) (744) ----- ----- --- ----- Interest expense Deposits 1,347 (3,218) (433) (2,304) Other borrowings(2) 589 (995) (117) (523) ----- ----- --- ----- Total interest expense 1,936 (4,213) (550) (2,827) ----- ----- --- ----- Change in net interest income $ 1,971 141 (29) 2,083 ===== ===== === ===== ------------------------------------------------------------------------------- Year ended December 31, 2001 compared to 2000 ------------------------------------------------------------------------------- Rate/ Dollars in thousands Volume Rate volume(1) Total ------------------------------------------------------------------------------- Interest on earning assets Interest-bearing deposits $ 120 (12) (56) 52 Investment securities 1,215 (286) (52) 877 Loans held for sale - - 33 33 Loans 2,710 (1,257) (156) 1,297 ----- ----- --- ----- Total interest income 4,045 (1,555) (231) 2,259 ----- ----- --- ----- Interest expense Deposits 1,781 (332) (69) 1,380 Other borrowings(2) 146 (1,613) (36) (1,503) ----- ----- ---- ----- Total interest expense 1,927 (1,945) (105) (123) ----- ----- --- ----- Change in net interest income $ 2,118 390 (126) 2,382 ===== ===== === ===== ------------------------------------------------------------------------------- (1) Represents the change attributable to a combination of change in rate and change in volume. (2)Includes federal funds purchased. Page 14 Investment Activities During 2002, the Company's investment portfolio increased 12.8% to end the year at $122,073,000, compared to $108,186,000 on December 31, 2001. Much of the Company's investment portfolio consists of callable securities. A declining interest rate environment in 2002 resulted in a large number of the Company's portfolio being called by issuers. The Company was able to replace these securities at favorable levels, resulting in the $13.9 million net growth in the portfolio in 2002. The Company's investment securities are classified into two categories: securities available for sale and securities to be held to maturity. Securities available for sale consist primarily of debt securities which Management intends to hold for indefinite periods of time. They may be used as part of the Company's funds management strategy, and may be sold in response to changes in interest rates, changes in prepayment risk, changes in liquidity needs, to increase capital ratios, or for other similar reasons. Securities to be held to maturity consist primarily of debt securities that the Company has acquired solely for long-term investment purposes, rather than for trading or future sale. For securities to be categorized as held to maturity, Management must have the intent and the Company must have the ability to hold such investments until their respective maturity dates. The Company does not hold trading account securities. All investment securities are managed in accordance with a written investment policy adopted by the Board of Directors. It is the Company's general policy that investments for either portfolio be limited to government debt obligations, time deposits, banker's acceptances, corporate bonds and commercial paper with one of the three highest ratings given by a nationally recognized rating agency. In 2002, the growth in the Company's investment portfolio was primarily in U.S. Government Agency mortgage-backed securities, tax-exempt obligations of states and political subdivisions, and corporate debt securities. These changes were made to enhance the portfolio's overall yield while not materially adding to the Company's level of interest rate risk. The following table sets forth the Company's investment securities at their carrying amounts as of December 31, 2002, 2001 and 2000. ------------------------------------------------------------------------------- Dollars in thousands 2002 2001 2000 ------------------------------------------------------------------------------- Securities available for sale U.S. Treasury and agency $ - - 13,847 Mortgage-backed securities 6,397 2,425 3,712 State and political subdivisions 14,626 13,770 10,952 Corporate securities 28,288 27,861 27,742 Federal Home Loan Bank stock 6,195 6,005 5,941 Federal Reserve Bank stock 53 53 53 Other equity securities 851 800 670 ------- ------- ------- $ 56,410 50,914 62,917 ------- ------- ------- Securities to be held to maturity U.S. Treasury and agency 30,952 35,444 27,025 Mortgage-backed securities 16,090 13,851 10,311 State and political subdivisions 12,032 6,393 4,380 Corporate securities 6,589 1,584 587 ------- ------- ------- 65,663 57,272 42,303 ------- ------- ------- Total securities $ 122,073 108,186 105,220 ======= ======= ======= ------------------------------------------------------------------------------- The following table sets forth certain information regarding the yields and expected maturities of the Company's investment securities as of December 31, 2002. Yields on tax-exempt securities have been computed on a tax- equivalent basis using a tax-rate of 35%. Mortgage-backed securities are presented according to their final contractual maturity date, while the calculated yield takes into effect the intermediate cashflows from repayment of principal which results in a much shorter average life. ------------------------------------------------------------------------------- Available for sale Held to maturity ------------------ ----------------------- Fair Yield to Amortized Yield to Dollars in thousands value maturity cost maturity ------------------------------------------------------------------------------- U.S. Treasury and Agency Due in 1 year or less $ - - $ - - Due in 1 to 5 years - - - - Due in 5 to 10 years - - 4,996 5.39% Due after 10 years - - 25,956 6.06% ------ ------ ------ ------ - - 30,952 5.95% ------ ------ ------ ------ Mortgage-backed securities Due in 1 year or less - - 27 5.58% Due in 1 to 5 years 60 3.84% - - Due in 5 to 10 years 2,408 4.91% 2,463 2.30% Due after 10 years 3,929 5.58% 13,600 5.31% ------ ------ ------ ------ 6,397 5.31% 16,090 4.85% ------ ----- ------ ------ State and political subdivisions Due in 1 year or less - - - - Due in 1 to 5 years - - - - Due in 5 to 10 years 506 6.71% 4,822 7.36% Due after 10 years 14,120 7.61% 7,210 6.10% ------ ----- ------ ------ 14,626 7.58% 12,032 6.60% ------ ----- ------ ------ Corporate debt securities Due in 1 year or less 502 6.35% - - Due in 1 to 5 years 10,217 7.45% 125 4.00% Due in 5 to 10 years 13,596 7.70% 469 8.10% Due after 10 years 3,973 6.13% 5,995 4.77% ------ ----- ------ ------ 28,288 7.36% 6,589 4.99% ------ ----- ------ ------ Equity Securities 7,099 4.23% - - ------ ----- ------ ------ $ 56,410 6.79% $ 65,663 5.70% ====== ===== ====== ====== ------------------------------------------------------------------------------- Page 16 Lending Activities The loan portfolio experienced growth in almost all areas during 2002, with the most significant increase seen in residential real estate loans and commercial loans. Total loans were $332,074,000 at December 31, 2002, a 10.2% increase from total loans of $301,304,000 at December 31, 2001. This continues the loan growth trend experienced by the Company over the past five years. The following tables summarize the Bank's loan portfolio as of December 31, 2002, 2001, 2000, 1999 and 1998.
----------------------------------------------------------------------------------------------------------------- Dollars in thousands As of December 31, 2002 2001 2000 1999 1998 ----------------------------------------------------------------------------------------------------------------- Commercial loans Real estate $ 37,082 11.2% $ 32,638 10.8% $ 30,695 11.6% $ 30,305 13.0% $ 25,585 12.2% Other 82,504 24.8% 68,378 22.7% 53,362 20.1% 41,970 18.0% 38,718 18.5% Residential real estate loans Construction 1,019 0.3% 2,522 0.9% 1,060 0.4% 1,661 0.7% 3,397 1.6% Term 174,070 52.4% 159,743 53.0% 139,300 52.6% 121,599 52.4% 105,877 50.6% Consumer loans 27,925 8.4% 30,727 0.2% 33,028 12.5% 29,227 12.6% 27,993 13.4% Municipal 9,474 2.9% 7,296 2.4% 7,484 2.8% 7,764 3.3% 7,654 3.7% -------- ------ ------- ------ -------- ------ -------- ------ -------- ------ Total $332,074 100.0% $301,304 100.0% $264,929 100.0% $232,526 100.0% $209,224 100.0% ======= ====== ======= ====== ======= ====== ======= ====== ======= ====== ----------------------------------------------------------------------------------------------------------------- Credit cards included in consumer loans $ - 2,510 2,676 2,536 2,569 -----------------------------------------------------------------------------------------------------------------
The Bank issued both VISA and MasterCard credit cards, whose balances are shown in the table above, until December 2002 when the Bank sold its credit card portfolio. Balances totaling $2,499,000 were sold. Page 17 The following table sets forth certain information regarding the contractual maturities of the Bank's loan portfolio as of December 31, 2002. ------------------------------------------------------------------------------- Dollars in thousands < 1 Year 1-5 Years 5-10 Years >10 Years Total ------------------------------------------------------------------------------- Commercial real estate $ 90 1,506 2,650 32,836 37,082 Commercial other 21,667 11,132 16,996 32,709 82,504 Residential real estate 795 508 5,904 166,863 174,070 Residential construction 1,019 - - - 1,019 Consumer 6,259 7,592 7,345 6,729 27,925 Municipal 2,777 483 1,427 4,787 9,474 ------ ------ ------ ------- ------- Totals $ 32,607 21,221 34,322 243,924 332,074 ====== ====== ====== ======= ======= ------------------------------------------------------------------------------- The following table provides a listing of loans by category, excluding loans held for sale, between variable and fixed rates as of December 31, 2002. ------------------------------------------------------------------------------- Dollars in thousands Amount % of total ------------------------------------------------------------------------------- Variable-rate loans Commercial loans $ 98,688 29.7% State and municipal loans 5,689 1.7% Consumer loans 3,260 1.0% Equity loans 30,766 9.3% Residential adjustable-rate mortgages 77,325 23.3% -------- ------ Total variable-rate loans 215,728 65.0% Fixed-rate loans 116,346 35.0% --------- ------ Total loans $ 332,074 100.0% ========= ====== ------------------------------------------------------------------------------- The Bank's loan delinquency ratio decreased in 2002, and was 1.04% on December 31, 2002, versus 1.45% on December 31, 2001. Loan Concentrations As of December 31, 2002, the Bank did not have any concentration of loans in one particular industry that exceeded 10% of its total loan portfolio. Loans Held for Sale In 2002, the Bank placed a higher volume of residential mortgages into the secondary market compared to 2001. This was the result of increased mortgage underwriting opportunities resulting from lower interest rates. Loans held for sale are carried at the lower of cost or market value, which was $2,613,000 at December 31, 2002. Loans held for sale at December 31, 2001 were $466,000. Page 18 Non-Performing Assets The aggregate dollar amount of loans more than 90 days past-due or on non- accrual status increased during 2002, but remains low relative to the Bank's peer group average. In Management's opinion, there has been no pattern or trend in non-performing assets of concern. An increase in 2000 was related to isolated circumstances involving a small number of borrowers. The levels at December 31, 2002 and 2001 are more in line with the Bank's normal delinquency rates. The following table sets forth a summary of the value of delinquent loans (more than ninety days past due) by category, total loans carried on a non- accrual basis, and income not recognized from non-accrual loans as of December 31, 2002, 2001, 2000, 1999 and 1998. ------------------------------------------------------------------------------- Dollars in thousands As of December 31, 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------- Commercial real estate & business $ 921 655 2,479 822 414 Residential real estate 463 275 267 260 222 Consumer 92 150 103 90 91 ----- ----- ----- ----- ---- Total 1,476 1,080 2,849 1,172 727 ===== ===== ===== ===== ==== Non-accrual loans included in above total $1,070 667 2,366 681 716 Income not recognized from non-accrual loans $ 108 77 185 64 51 ------------------------------------------------------------------------------- It is the policy of the Bank to place a loan on non-accrual status only after a careful review of the loan circumstances and a determination that payment in full of principal and/or interest is not expected. Income not recognized from non-accrual loans represents the interest income, as of the end of each period, that would have been recorded on loans placed on non-accrual status if they were current in accordance with their original terms. None of these amounts were included in interest income for the same periods. Other real estate owned increased during 2002. At December 31, 2002 it included three properties valued at $255,000, compared to two properties valued at $202,000 at December 31, 2001. Other real estate owned and repossessed assets are comprised of (i) properties or other assets acquired through a foreclosure proceeding, or acceptance of a deed or title in lieu of foreclosure, (ii) properties which secure loans where the Bank obtains possession of the underlying collateral from the borrower, and (iii) other assets repossessed in connection with non- real estate loans. Other real estate owned and repossessed assets are carried at the lower of cost or fair value less the estimated selling expenses of the collateral. An allowance is established for the amount by which cost exceeds fair value less estimated selling expenses on a property by property basis. Losses arising from the acquisition of such properties are charged against the allowance for loan losses. Operating expenses and any subsequent provisions to reduce the carrying value of the property are charged to operations. Gains and losses upon disposition of the property are reflected in earnings as realized. Page 19 Allowance for Loan Losses and Loan Loss Experience The allowance for loan losses represents the amount available for credit losses inherent in the Company's loan portfolio. Loans are charged off when they are deemed uncollectible, after giving consideration to factors such as the customer's financial condition, underlying collateral and guarantees, as well as general and industry economic conditions. In general, the Company determines the appropriate overall reserve for loan losses based upon periodic, systematic reviews of its portfolio to identify inherent losses based on Management's judgment about various qualitative factors. These reviews result in the identification and quantification of loss factors, which are used in determining the amount of the allowance for loan losses. The Company periodically evaluates prevailing economic and business conditions, industry concentrations, changes in the size and characteristics of the portfolio and other pertinent factors. Portions of the allowance for loan losses are quantified to cover the estimated losses inherent in each loan category based on the results of this detailed review process. Commercial loans are individually reviewed and assigned a credit risk rating from "1" (low risk of loss) to "8" (high risk of loss). For non-impaired loans with a credit risk rating of "1" to "7", estimated loss factors based on historical loss experience (ranging from two to five years) are used to calculate a loan loss reserve for each credit risk rating classification. Qualitative adjustments are also made based upon Management's assessment of prevailing economic conditions, trends in volumes and terms of loans, levels and trends in delinquencies and non-accruals, and the effect of changes in lending policies. A specific allocation is made for impaired loans (loans on non-accrual status), which are measured at the net present value of future cash flows, discounted at the loan's effective interest rate, or at fair market value of collateral if the loan is collateral dependent. The combination of these analyses is the basis for the determination of the commercial loan portion of the allowance for loan losses. Consumer loans, which include credit cards, residential mortgages, home equity loans/lines, and direct/indirect loans, are generally evaluated as a group based on product type. The determination of the consumer loan portion of the allowance for loan losses is based on a five-year average of annual historical losses, adjusted for the qualitative factors noted above. The results of all analyses are reviewed and discussed by the Directors' Loan Committee. An integral component of the Company's risk management process is to ensure the proper quantification of the reserve for loan losses based upon an analysis of risk characteristics, demonstrated losses, loan segmentations, and other factors. Reserve methodology is reviewed on a periodic basis and modified as appropriate. Based on this analysis, including the aforementioned assumptions, the Company believes that the allowance for loan losses is adequate as of December 31, 2002. The unallocated component of the allowance for loan losses represents Management's view that, given the complexities of the loan portfolio, there are estimable losses that have been incurred within the portfolio but not yet tied to specific loans. Page 20 The following table reflects the Bank's allowance for loan losses by category of loan as of December 31, 2002, 2001, 2000, 1999 and 1998. The unallocated portion of the allowance for loan losses is a general reserve that is not allocated to a specific portion of the loan portfolio. The commercial category includes commercial real estate loans. ------------------------------------------------------------------------------- Dollars in thousands As of December 31, 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------- Real estate $ 568 53% 618 54% 562 53% 488 53% 440 52% Commercial 1,835 39% 1,467 36% 907 35% 686 34% 736 35% Consumer 806 8% 604 10% 631 12% 580 13% 408 13% Unallocated 491 - 311 - 201 - 281 - 238 - ------ ---- ----- ---- ----- ---- ----- ---- ----- ---- Total $3,700 100% 3,000 100% 2,301 100% 2,035 100% 1,822 100% ====== ==== ===== ==== ===== ==== ===== ==== ===== ==== ------------------------------------------------------------------------------- Percentage is amount of loans in each category as a percent of total loans for the stated year. Net loans charged off in 2002 were $623,000, or 0.19% of average loans outstanding for the year. This compares to net loan chargeoffs of $531,000, or 0.19% in 2001 and $434,000 or 0.17% in 2000. The following table summarizes the activity with respect to loan losses for the years ended December 31, 2002, 2001, 2000, 1999 and 1998. ------------------------------------------------------------------------------- Dollars in thousands As of December 31, 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------- Balance at beginning of period $ 3,000 2,301 2,035 1,822 1,800 ===== ===== ===== ===== ===== Loans charged off: Commercial(1) 432 391 164 153 121 Real estate mortgage 24 1 5 31 46 Consumer 268 243 388 359 285 ----- ----- ----- ----- ----- Total 724 635 557 543 452 ----- ----- ----- ----- ----- Recoveries on loans previously charged off: Commercial(1) 16 34 44 12 14 Real estate mortgage - 1 6 8 - Consumer 85 69 73 91 60 ----- ----- ----- ----- ----- Total 101 104 123 111 74 ----- ----- ----- ----- ----- Net loans charged off 623 531 434 432 378 Provision for loan losses 1,323 1,230 700 645 400 ----- ----- ----- ----- ----- Balance at end of period $ 3,700 3,000 2,301 2,035 1,822 ===== ===== ===== ===== ===== Ratio of net loans charged off to average loans outstanding 0.19% 0.19% 0.17% 0.19% 0.19% ------------------------------------------------------------------------------- (1) Includes commercial real estate loans Page 21 During 2002, a provision of $1,323,000 was made to the allowance for loan losses, compared to a provision of $1,230,000 in 2001, and $700,000 in 2000. In Management's opinion, this increased level of provision is not indicative of a decline in overall credit quality within the portfolio. Instead, it is the result of the significant loan growth experienced combined with an additional provision for commercial loans as a result of the impact on the fishing and hospitality industries from the September 11, 2001, terrorist attack as well as probable unanticipated declines in the credit quality of our borrowers due to the current economic recession. At December 31, 2002, the allowance for loan losses stood at $3,700,000, or 1.11% of total loans outstanding. This compares to $3,000,000, or 1.00% of total loans outstanding at December 31, 2001, and $2,301,000, or 0.87% of total loans outstanding at December 31, 2000. Deposits The Bank realized an increase in deposits of 27.2% in 2002, compared to a 3.2% increase in 2001 and a 23.9% increase in 2000. Most of the growth in 2002 was seen in core deposits, which are typically added at favorable costs relative to borrowed funds and certificates of deposit. The Bank's deposit balances generally increase during the summer and autumn months of each year due to increased seasonal business activity. In 2002, the maximum amount of deposits at any month end was $336.8 million on September 30. Because of uncertainty about future interest rates, in recent years investors have shown a preference for shorter-term deposits which could reprice quickly should rates begin to rise. The Bank's average cost of deposits (including non-interest-bearing accounts) was 2.54% for the year ended December 31, 2002, compared to 3.76% for the year ended December 31, 2001 and 3.85% for the year ended December 31, 2000. The following table sets forth the average daily balance for the Bank's principal deposit categories for each period. ------------------------------------------------------------------------------- Dollars in thousands %growth Years ended December 31, 2002 2001 2000 2002 vs.2001 ------------------------------------------------------------------------------- Demand deposits $ 24,316 20,529 20,324 18.4% NOW accounts 45,916 40,616 38,067 13.0% Money market accounts 50,490 12,297 12,874 310.6% Savings 53,313 42,004 40,205 26.9% Certificates of deposit 129,137 150,851 112,554 -14.4% ------- ------- ------- ------ Total deposits $ 303,172 266,297 224,024 13.8% ======= ======= ======= ====== ------------------------------------------------------------------------------- The following table sets forth the average cost of each category of interest-bearing deposits for the periods indicated. ------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- NOW accounts 0.49% 1.05% 1.27% Money market accounts 2.47% 3.40% 3.70% Savings accounts 1.83% 2.57% 2.79% Certificates of deposit 4.07% 5.36% 5.82% ----- ------ ------ Total interest-bearing deposits 2.76% 4.07% 4.23% ===== ===== ===== ------------------------------------------------------------------------------- Page 22 As of December 31, 2002, the Bank held a total of $50,256,000 in certificate of deposit accounts with balances in excess of $100,000. The following table summarizes the time remaining to maturity for these certificates of deposit: ------------------------------------------------------------------------------- Dollars in thousands ------------------------------------------------------------------------------- Within 3 months $ 5,834 3 months through 6 months 13,955 6 months through 12 months 16,651 Over 12 months 13,816 ------ Total $ 50,256 ====== ------------------------------------------------------------------------------- Of all certificates of deposit, $86.0 million or 70.8% will mature by December 31, 2003. Borrowed Funds Borrowed funds consists mainly of advances from the Federal Home Loan Bank (FHLB) which are secured by stock in the FHLB, funds on deposit with FHLB, U.S. Treasury and Agency notes and mortgage-backed securities and qualifying first mortgage loans. Advances at December 31, 2002 totaled $90,500,000, with a weighted average interest rate of 4.32% and remaining maturities ranging from five months to eight years. The Bank offers securities repurchase agreements to municipal and corporate customers as an alternative to deposits. The balance of these agreements as of December 31, 2002 was $19,317,000, compared to $22,424,000 on December 31, 2001, and $16,512,000 on December 31, 2000. The Bank also had a repurchase agreement with a brokerage firm at December 31, 2001 in the amount of $9,767,000, which was repaid in 2002. The Bank participates in the Note Option Depository which is offered by the U.S. Treasury Department. Under the Treasury Tax & Loan Note program, the Bank accumulates tax deposits made by its customers and is eligible to receive additional Treasury Direct investments up to an established maximum balance of $5.0 million. The balances invested by the Treasury are increased and decreased at the discretion of the Treasury. The deposits are generally made at interest rates that are favorable in comparison to other borrowings. The balances on the Treasury Tax & Loan note at December 31, 2002, 2001 and 2000 were $3,548,000, $166,000 and $1,077,000, respectively. The maximum amount of borrowed funds outstanding at any month-end during each of the last three years was $143,553,000 at the end of May during 2002, $131,357,000 at the end of December for the year 2001, and $116,966,000 at the end of December for the year 2000. The average amount outstanding during 2002 was $122,253,000, with a weighted average interest rate of 3.68%. This compares to an average outstanding amount of $109,418,000 in 2001, with a weighted average interest rate of 4.59%. The average balance outstanding on the Bank's borrowed funds for the year ended December 31, 2000 was $107,044,000, with a weighted average interest rate of 6.10%. Page 23 Contractual Obligations The following table sets forth the contractual obligations of the Company as of December 31, 2002: ------------------------------------------------------------------------------- Less than 1-3 4-5 More than Dollars in thousands Total 1 Year Years Years 5 Years ------------------------------------------------------------------------------- Borrowed funds $ 113,365 50,865 23,000 12,000 27,500 Operating leases 313 78 136 91 8 Certificates of deposit 121,425 86,017 26,093 9,315 - ------- ------- ------ ------ ------ Total $ 235,103 136,960 49,229 21,406 27,508 ======= ======= ====== ====== ====== Commitments to extend credit and unused lines of credit $ 64,665 65,665 - - - ------------------------------------------------------------------------------- Capital Resources Capital at December 31, 2002 was sufficient to meet the requirements of regulatory authorities. Average equity to average assets was 8.49% in 2002, versus 8.55% in 2001. Leverage capital of the Company, or total shareholders' equity divided by average total assets less goodwill and any net unrealized gain or loss on securities available for sale, stood at 8.19% on December 31, 2002, versus 8.56% in 2001. At December 31, 2002, the Company had tier-one risk-based capital of 12.32% and tier-two risk-based capital of 13.45%, versus 12.88% and 13.95%, respectively, in 2001. To be rated "well-capitalized", regulatory requirements call for minimum tier-one and tier-two risk-based capital ratios of 6.00% and 10.00%, respectively. The Company's actual levels of capitalization were comfortably above the standards to be rated "well-capitalized" by regulatory authorities. During 2002, the Company declared cash dividends of $0.23 per share for the first quarter, $0.24 per share for the second quarter, $0.25 per share for the third quarter, and $0.26 per share for the fourth quarter. The Company's dividend payout ratio was 36.16% of earnings in 2002, 35.65% in 2001, and 34.20% in 2000. In determining future dividend payout levels, the Board of Directors carefully analyzes capital requirements and earnings retention, as set forth in the Company's Dividend Policy. The ability of the Company to pay cash dividends to its shareholders depends on receipt of dividends from its subsidiary, the Bank. The subsidiary may pay dividends to its parent out of so much of its net profits as the Bank's directors deem appropriate, subject to the limitation that the total of all dividends declared by the Bank in any calendar year may not exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. The amount available for dividends in 2003 will be that year's net income plus $7,043,000. A total of $2,363,000 in dividends was declared in 2002. In 2002, 43,200 shares of common stock were issued in conjunction with the exercise of stock options for consideration totaling $294,000. The Company also purchased 32,067 shares of common stock for total consideration of $945,000, of which 12,185 shares were reissued via employee stock programs during the year. Management knows of no present trends, events or uncertainties that will have, or are reasonably likely to have, a material effect on capital resources, liquidity, or results of operations. Page 24 Capital Purchases In 2002, the Company made capital purchases totaling $1,222,000. This cost will be amortized over an average of seventeen years, adding approximately $75,000 to pre-tax operating costs per year. The capital purchases included primarily real estate improvements for Branch premises and equipment related to technology. Investment Management and Fiduciary Activities As of December 31, 2002, Pemaquid Advisors, the Bank's private banking and investment management division, had assets with a market value of $118,995,000 under management. This amount consisted of 628 trust accounts, estate accounts, agency accounts, and self-directed individual retirement accounts. This compares to December 31, 2001 when 597 accounts with market value of $126,486,000 were under management. The decline in value of assets under management was in proportion to the average market value decline seen throughout the equity markets in 2002. Effect of Future Interest Rates on Post-retirement Benefit Liabilities In evaluating the Company's post-retirement benefit liabilities, Management believes that changes in assumptions, especially in discount rates, will not have a significant impact on the Company's future operating results or financial condition. Impact of Recently Issued Accounting Standards Statement of Financial Accounting Standards (SFAS) No. 147, "Acquisitions of Certain Financial Institutions," amends SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," to exclude from its scope most acquisitions of financial institutions. Such transactions should be accounted for in accordance with SFAS No. 141, "Business Combinations." This Statement had no impact on the Company's consolidated financial condition and results of operations. SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," contains enhanced disclosure requirements for stock-based compensation. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. Adoption of the Statement in 2002 had no impact on the Company's consolidated financial condition and results of operations. Statement of Position (SOP) 01-6, "Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others," was issued in December 2001. The SOP is effective for financial statements issued for the fiscal year beginning after December 15, 2001. The SOP reconciles and conforms the accounting and financial reporting provisions established by various Audit and Accounting Industry Guides. Adoption of this Statement had no impact on the Company's consolidated financial condition and results of operations. Page 25 Liquidity As of December 31, 2002, the Bank had primary sources of liquidity of $55.3 million, or 11.2% of its assets. It is Management's opinion that this is adequate. The Bank has established guidelines for liquidity management, with policies and procedures prescribed in its funds management policy. The Bank's principal sources of funds are deposits, cash and due from banks, federal funds sold, loan and interest payments, loan and investment maturities, and borrowed funds from the Federal Home Loan Bank. To compensate for the seasonal flow in its deposit structure, the Bank maintains adequate funding for its loan portfolio by monitoring maturities within its investment portfolio and utilizing advances from the Federal Home Loan Bank or entering into securities repurchase agreements. Through the Federal Home Loan Bank, the Bank has a credit line of $8.0 million for overnight borrowings, plus short-term and long-term advance capacity of $132.5 million. The Bank's liquidity position is further supplemented with securities repurchase agreements with certain brokers and a $5.0 million credit line with a correspondent bank. Deposits grew during 2002, ending the year at $334.2 million. The growth was primarily in core deposits. Because of the liquidity provided in part by the increase in core deposits, Management allowed certificates of deposit from non-local sources to mature without renewal. These funds are typically available to the Bank to meet future liquidity needs. Management has not seen any recent significant deposit trends which would have a material effect on the Bank's liquidity position. At December 31, 2002, the Company had a net unrealized gain of $2,170,000 (net of $1,118,000 in deferred income taxes) on available for sale securities. This unrealized gain is in line with Management's expectations given the drop in interest rates experienced in 2002. While the Bank maintains an available for sale portfolio of securities to enhance its overall liquidity position, its present policy is not to liquidate securities to meet short-term liquidity needs. Instead, the Bank uses Federal Home Loan Bank advances or its securities repurchase agreements for this purpose. Page 26 Quarterly Information The following tables provides unaudited financial information by quarter for each of the past two years: ------------------------------------------------------------------------------- Dollars in thousands 2002 Q1 2002 Q2 2002 Q3 2002 Q4 ------------------------------------------------------------------------------- Balance Sheets Cash $ 7,829 9,573 26,304 23,506 Investments 107,200 128,350 124,104 122,073 Net loans 303,637 323,315 329,497 330,987 Other assets 18,053 17,384 17,343 17,502 ------- ------- ------- ------- Total assets $ 436,719 478,622 497,248 494,068 ======= ======= ======= ======= Deposits $ 276,397 308,294 336,800 334,224 Borrowed funds 118,763 126,734 113,975 113,365 Other liabilities 3,424 3,691 4,359 3,784 Shareholders' equity 38,135 39,903 42,114 42,695 ------- ------- ------- ------- Total liabilities & equity $ 436,719 478,622 497,248 494,068 ======= ======= ======= ======= Income Statements Interest income $ 7,154 7,403 7,513 7,237 Interest expense 2,992 3,077 3,174 2,961 ------- ------- ------- ------- Net interest income 4,162 4,326 4,339 4,276 Provision for loan losses 410 280 255 378 ------- ------- ------- ------- Net interest income after provision 3,752 4,046 4,084 3,898 Non-interest income 919 1,017 1,368 1,647 Non-interest expense 2,619 2,709 3,041 3,176 ------- ------- ------- ------- Income before taxes 2,052 2,354 2,411 2,369 Income taxes 579 708 722 670 ------- ------- ------- ------- Net income $ 1,473 1,646 1,689 1,699 ======= ======= ======= ======= Basic earnings per share $ 0.62 0.69 0.70 0.70 Diluted earnings per share $ 0.60 0.66 0.68 0.70 ------------------------------------------------------------------------------- Page 27 ------------------------------------------------------------------------------- Dollars in thousands 2001 Q1 2001 Q2 2001 Q3 2001 Q4 ------------------------------------------------------------------------------- Balance Sheets Cash $ 6,897 11,121 13,447 10,894 Investments 114,491 111,102 105,791 108,186 Net loans 270,776 279,876 285,515 298,770 Other assets 15,511 16,826 16,951 16,616 ------- ------- ------- ------- Total assets $ 407,675 418,925 421,704 434,466 ======= ======= ======= ======= Deposits $ 240,973 281,370 277,733 262,689 Borrowed funds 128,867 99,353 102,696 131,357 Other liabilities 3,288 2,980 4,297 3,086 Shareholders' equity 34,547 35,222 36,978 37,334 ------- ------- ------- ------- Total liabilities & equity $ 407,675 418,925 421,704 434,466 ======= ======= ======= ======== Income Statements Interest income $ 7,536 7,635 7,541 7,350 Interest expense 4,173 3,975 3,663 3,220 ------- ------- ------- ------- Net interest income 3,363 3,660 3,878 4,130 Provision for loan losses 195 280 215 540 ----- ------- ------- ------- Net interest income after provision 3,168 3,380 3,663 3,590 Non-interest income 740 942 1,153 1,063 Non-interest expense 2,212 2,296 2,776 2,694 ----- ------- ------- ------- Income before taxes 1,696 2,026 2,040 1,959 Income taxes 489 595 594 550 ----- ------- ------- ------- Net income $ 1,207 1,431 1,446 1,409 ======= ======= ======= ======= Basic earnings per share $ 0.51 0.60 0.61 0.58 Diluted earnings per share $ 0.50 0.58 0.59 0.57 ------------------------------------------------------------------------------- Page 28 ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk Market Risk Management Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. First National Lincoln Corporation's market risk is composed primarily of interest rate risk. The Bank's Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to interest rate risk. All guidelines and policies established by ALCO have been approved by the Board of Directors. Asset/Liability Management The primary goal of asset/liability management is to maximize net interest income within the interest rate risk limits set by ALCO. Interest rate risk is monitored through the use of two complementary measures: static gap analysis and earnings simulation modeling. While each measurement has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap analysis measures the amount of repricing risk embedded in the balance sheet at a point in time. It does so by comparing the differences in the repricing characteristics of assets and liabilities. A gap is defined as the difference between the principal amount of assets and liabilities which reprice within a specified time period. The cumulative one-year gap, at year- end, was 4.0% of total assets. ALCO's policy limit for the one-year gap is plus or minus 20% of total assets. Core deposits with non-contractual maturities are presented based upon historical patterns of balance attrition and pricing behavior which are reviewed at least annually. The gap repricing distributions include principal cash flows from residential mortgage loans and mortgage-backed securities in the time frames in which they are expected to be received. Mortgage prepayments are estimated by applying industry median projections of prepayment speeds to portfolio segments based on coupon range and loan age. The Company's summarized static gap, as of December 31, 2002, is presented in the following table: Page 29 ------------------------------------------------------------------------------- 0-90 91-365 1-5 5+ Dollars in thousands days days years years ------------------------------------------------------------------------------- Overnight funds sold $ 9,325 - - - Investment securities at amortized cost 22,168 18,182 44,390 34,046 Loans held for sale 22 101 844 1,646 Loans 128,110 58,026 118,464 27,474 Other interest-earning assets - 4,468 - - Non-rate-sensitive assets - - - 26,802 --------- ------ ------- ------ Total assets $ 159,625 80,777 163,698 89,968 --------- ------ ------- ------ Interest-bearing deposits 100,803 66,054 35,370 106,513 Borrowed funds 22,739 28,125 35,000 27,501 Non-rate-sensitive liabilities and equity 650 2,100 15,000 54,213 -------- ------ ------ ------ Total liabilities and equity $ 124,192 96,279 85,370 188,227 -------- ------ ------ ------- Period gap $ 35,433 (15,502) 78,328 (98,259) ========= ====== ====== ====== Percent of total assets 7.2% (3.1%) 5.9% (19.9%) Cumulative gap (current) $ 35,433 19,931 98,259 - Percent of total assets 7.2% 4.0% 19.9% 0.0% ------------------------------------------------------------------------------- The earnings simulation model forecasts one- and two-year net interest income under a variety of scenarios that incorporate changes in the absolute level of interest rates as well as basis risk, as represented by changes in the shape of the yield curve and changes in interest rate relationships. Management evaluates the effects on income of alternative interest rate scenarios against earnings in a stable interest rate environment. This analysis is also most useful in determining the short-run earnings exposures to changes in customer behavior involving loan payments and deposit additions and withdrawals. The most recent simulation model projects net interest income would increase by approximately 0.8% of stable-rate net interest income if rates fall gradually by one percentage point over the next year, and increase by approximately 0.2% if rates rise gradually by two percentage points. Both scenarios are well within ALCO's policy limit of a decrease in net interest income of no more than 10.0% given a 2.0% move in interest rates, up or down. Management believes this reflects a reasonable interest rate risk position. Within a two-year horizon and assuming no additional movement in rates, the model forecasts that net interest income would be higher than that earned in a stable rate environment by 1.5% in a falling rate scenario and decrease by 1.3% in a rising rate scenario. This dynamic simulation model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. Loans and deposits are projected to maintain stable balances. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in similar assets. Mortgage loan prepayment assumptions are developed from industry median estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Non-contractual deposit volatility and pricing are assumed to follow historical patterns. The sensitivities of key assumptions are analyzed annually and reviewed by ALCO. A summary of the Company's interest rate risk simulation modeling, as of December 31, 2002 and 2001 is presented in the following table: Page 30 ------------------------------------------------------------------------------- Changes in Net Interest Income 2002 2001 ------------------------------------------------------------------------------- Year 1 Projected change if rates decrease by 1.0% +0.8% n/a Projected change if rates decrease by 2.0% n/a -0.6% Projected change if rates increase by 2.0% +0.2% +0.6% ------------------------------------------------------------------------------- Year 2 Projected change if rates decrease by 1.0% +1.5% n/a Projected change if rates decrease by 2.0% n/a -0.5% Projected change if rates increase by 2.0% -1.3% -5.6% ------------------------------------------------------------------------------- Interest Rate Risk Management A variety of financial instruments can be used to manage interest rate sensitivity. These may include the securities in the investment portfolio, interest rate swaps, and interest rate caps and floors. Frequently called interest rate derivatives, interest rate swaps, caps and floors have characteristics similar to securities but possess the advantages of customization of the risk-reward profile of the instrument, minimization of balance sheet leverage and improvement of liquidity. As of December 31, 2002, the Company was not using any derivative instruments for interest rate risk management. The Company engages an independent consultant to periodically review its interest rate risk position, as well as the effectiveness of simulation modeling and reasonableness of assumptions used. As of December 31, 2002, there were no significant differences between the views of the independent consultant and Management regarding the Company's interest rate risk exposure. Management expects interest rates will remain constant for much of 2003 and believes that the current level of interest rate risk is acceptable. Forward-Looking Statements Certain disclosures in Management's Discussion of Financial Condition and Results of Operations contain certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In preparing these disclosures, Management must make assumptions, including, but not limited to, assumptions concerning the level of future interest rates, general local, regional and national economic conditions, competitive pressures, prepayments on loans and investments, required levels of capital, needs for liquidity, and the adequacy of the allowance for loan losses. These forward-looking statements may be subject to significant known and unknown risks and uncertainties, and other factors, including, but not limited to, those matters referred to in the preceding sentence. Although First National Lincoln Corporation believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. Readers are cautioned not to place undue reliance on these forward- looking statements, which speak only as of the date hereof. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are also urged to carefully review and consider the various disclosures made by the Company which attempt to advise interested parties of the factors which affect the Company's business. Page 31 ITEM 8. Financial Statements and Supplementary Data Report of Management The Management of First National Lincoln Corporation is responsible for the preparation, content, and integrity of the financial statements and other statistical data presented in this report. The financial statements have been prepared in conformity with U.S. generally accepted accounting principles and necessarily include amounts based on Management's best estimates and judgment. Management also prepared the other information in this report and is responsible for its accuracy and consistency with the financial statements. First National Lincoln Corporation maintains internal control systems designed to produce reliable financial statements. Management recognizes that although controls established for these systems are applied in a prudent manner, errors and irregularities may occur. However, Management believes that its internal accounting and reporting systems provide reasonable assurance that material errors or irregularities are prevented or would be detected and corrected on a timely basis. The Company's internal auditor continually reviews, evaluates, and monitors internal control systems and recommends programs to Management to further safeguard assets. The Board of Directors discharges its responsibility for financial statements through its Audit Committee. The Audit Committee regularly meets with the independent auditors, internal auditor, and representatives of Management to assure that each is meeting its responsibility. The Committee also reviews the independent and internal auditors' reports and findings as they are submitted throughout the year. Both the independent auditors and internal auditor have direct access to the Audit Committee to discuss the scope and results of their work, the adequacy of internal controls, and the quality of financial reporting. /s/Daniel R. Daigneault /s/F. Stephen Ward Daniel R. Daigneault F. Stephen Ward President & Chief Executive Officer Treasurer & Chief Financial Officer Page 32 Berry, Dunn, McNeil & Parker Certified Public Accountants Independent Auditors' Report The Board of Directors and Shareholders First National Lincoln Corporation We have audited the accompanying consolidated balance sheets of First National Lincoln Corporation and Subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the three-year period ended December 31, 2002. These financial statements are the responsibility of the Company's Management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with U.S. generally accepted auditing standards. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of First National Lincoln Corporation and Subsidiary as of December 31, 2002 and 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the three-year period ended December 31, 2002, in conformity with U.S. generally accepted accounting principles. /s/Berry, Dunn, McNeil and Parker Portland, Maine January 31, 2003 Page 33 Consolidated Balance Sheets First National Lincoln Corporation and Subsidiary ------------------------------------------------------------------------------- As of December 31, 2002 2001 ------------------------------------------------------------------------------- Assets Cash and due from banks $ 14,181,000 $ 10,894,000 Overnight funds sold 9,325,000 - ----------- ----------- Cash and cash equivalents 23,506,000 10,894,000 ----------- ----------- Securities available for sale 56,410,000 50,914,000 Securities to be held to maturity, market value of $67,421,000 at December 31, 2002 and $56,921,000 at December 31, 2001 65,663,000 57,272,000 Loans held for sale at cost, which approximates market value 2,613,000 466,000 Loans 332,074,000 301,304,000 Less allowance for loan losses 3,700,000 3,000,000 ----------- ----------- Net loans 328,374,000 298,304,000 ----------- ----------- Accrued interest receivable 2,642,000 2,635,000 Bank premises and equipment 7,833,000 7,563,000 Other real estate owned 255,000 202,000 Other assets 6,772,000 6,216,000 ----------- ----------- Total assets $ 494,068,000 $ 434,466,000 =========== =========== Page 34 Consolidated Balance Sheets, concluded First National Lincoln Corporation and Subsidiary ------------------------------------------------------------------------------- As of December 31, 2002 2001 ------------------------------------------------------------------------------- Liabilities Demand deposits $ 25,484,000 $ 22,496,000 NOW deposits 46,989,000 43,644,000 Money market deposits 80,805,000 15,878,000 Savings deposits 59,521,000 46,855,000 Certificates of deposit (including certificates of $100,000 or more of $50,256,000 in 2002 and $53,909,000 in 2001) 121,425,000 133,816,000 ----------- ----------- Total deposits 334,224,000 262,689,000 Borrowed funds 113,365,000 131,357,000 Other liabilities 3,784,000 3,086,000 ----------- ----------- Total liabilities 451,373,000 397,132,000 ----------- ----------- Commitments and contingent liabilities (notes 12, 13 and 17) Shareholders' equity Common stock, one cent par value 25,000 25,000 Additional paid-in capital 4,687,000 4,687,000 Retained earnings 38,322,000 34,030,000 Accumulated other comprehensive income Net unrealized gain on securities available for sale, net of tax of $1,118,000 in 2002 and $404,000 in 2001 2,170,000 784,000 Treasury stock, at cost, 66,577 shares in 2002 and 89,895 shares in 2001 (2,509,000) (2,192,000) ----------- ----------- Total shareholders' equity 42,695,000 37,334,000 ----------- ----------- Total liabilities and shareholders' equity $ 494,068,000 $ 434,466,000 =========== =========== ------------------------------------------------------------------------------- Common stock Number of shares authorized 6,000,000 6,000,000 Number of shares issued 2,481,270 2,481,270 Number of shares outstanding 2,414,693 2,391,375 ------------------------------------------------------------------------------- The accompanying footnotes are an integral part of these consolidated financial statements Page 35 Consolidated Statements of Income First National Lincoln Corporation and Subsidiary ------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Interest income Interest and fees on loans $ 22,154,000 $ 22,953,000 $ 21,600,000 Interest on deposits with other banks 62,000 77,000 25,000 Interest and dividends on investments (includes tax-exempt income of $1,075,000 in 2002, $926,000 in 2001, $659,000 in 2000) 7,091,000 7,032,000 6,298,000 ---------- ---------- ---------- Total interest income 29,307,000 30,062,000 27,923,000 ---------- ---------- ---------- Interest expense Interest on deposits 7,702,000 10,006,000 8,625,000 Interest on borrowed funds 4,502,000 5,025,000 6,528,000 ---------- ---------- ---------- Total interest expense 12,204,000 15,031,000 15,153,000 ---------- ---------- ---------- Net interest income 17,103,000 15,031,000 12,770,000 Provision for loan losses 1,323,000 1,230,000 700,000 ---------- ---------- ---------- Net interest income after provision for loan losses 15,780,000 13,801,000 12,070,000 ---------- ---------- ---------- Other operating income Fiduciary and investment management income 728,000 698,000 673,000 Service charges on deposit accounts 985,000 901,000 832,000 Net realized gain on securities available for sale - 73,000 - Other 3,238,000 2,226,000 1,462,000 ---------- ---------- ---------- Total other operating income 4,951,000 3,898,000 2,967,000 ---------- ---------- ---------- Other operating expenses Salaries and employee benefits 5,766,000 4,903,000 4,334,000 Occupancy expense 738,000 573,000 478,000 Furniture and equipment expense 1,286,000 1,023,000 750,000 Other 3,755,000 3,479,000 2,975,000 ---------- ---------- ---------- Total other operating expenses 11,545,000 9,978,000 8,537,000 ---------- ---------- ---------- Income before income taxes 9,186,000 7,721,000 6,500,000 Income tax expense 2,679,000 2,228,000 1,893,000 ---------- ---------- ---------- Net income $ 6,507,000 $ 5,493,000 $ 4,607,000 ========== ========== ========== Page 36 Consolidated Statements of Income, concluded First National Lincoln Corporation and Subsidiary ------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Basic earnings per share $ 2.71 $ 2.30 1.93 Diluted earnings per share $ 2.64 $ 2.24 1.89 Cash dividends declared per share $ 0.98 $ 0.82 0.66 Weighted average number of shares outstanding 2,404,965 2,384,402 2,384,356 ------------------------------------------------------------------------------- The accompanying footnotes are an integral part of these consolidated financial statements Page 37 Consolidated Statements of Changes in Shareholders' Equity First National Lincoln Corporation and Subsidiary
-------------------------------------------------------------------------------------------------------- Year ended December 31, 2000 -------------------------------------------------------------------------------------------------------- Net unrealized gain (loss) Total Number of Additional on securities share- common Common paid-in Retained available Treasury holders' shares stock capital earnings for sale Stock Equity -------------------------------------------------------------------------------------------------------- Balance at December 31, 1999 2,370,047 $25,000 $4,687,000 $27,463,000 $(1,319,000) $(2,194,000) $28,662,000 ========= ====== ========= ========== =========== ========== ========== Net income - - - 4,607,000 - - 4,607,000 Net unrealized gain on securities available for sale, net of tax expense of $784,000 - - - - 1,522,000 - 1,522,000 --------- ------ --------- ---------- ---------- ---------- ---------- Comprehensive income - - - 4,607,000 1,522,000 - 6,129,000 Cash dividends declared - - - (1,575,000) - - (1,575,000) Treasury stock purchases (20,613) - - - - (316,000) (316,000) Treasury stock sales 29,179 - - - - 260,000 260,000 --------- ------ --------- ---------- ---------- ---------- ---------- Balance at December 31, 2000 2,378,613 25,000 4,687,000 30,495,000 203,000 (2,250,000) 33,160,000 ========= ====== ========= ========== ========== ========== ========== Page 38 Consolidated Statements of Changes in Shareholders' Equity, continued First National Lincoln Corporation and Subsidiary -------------------------------------------------------------------------------------------------------- Year ended December 31, 2001 -------------------------------------------------------------------------------------------------------- Net unrealized gain (loss) Total Number of Additional on securities share- common Common paid-in Retained available Treasury holders' shares stock capital earnings for sale Stock Equity -------------------------------------------------------------------------------------------------------- Balance at December 31, 2000 2,378,613 25,000 4,687,000 30,495,000 203,000 (2,250,000) 33,160,000 ========= ====== ========= ========== ======== ========== ========== Net income - - - 5,493,000 - - 5,493,000 Net unrealized gain on securities available for sale, net of tax expense of $299,000 - - - - 581,000 - 581,000 --------- ------ --------- ---------- --------- ---------- --------- Comprehensive income - - - 5,493,000 581,000 - 6,074,000 Cash dividends declared - - - (1,958,000) - - (1,958,000) Treasury stock purchases (13,953) - - - - (254,000) (254,000) Treasury stock sales 26,715 - - - - 312,000 312,000 --------- ------ --------- ---------- -------- ---------- --------- Balance at December 31, 2001 2,391,375 25,000 4,687,000 34,030,000 784,000 (2,192,000) 37,334,000 ========= ====== ========= ========== ======== ========== ========== Page 39 Consolidated Statements of Changes in Shareholders' Equity, concluded First National Lincoln Corporation and Subsidiary -------------------------------------------------------------------------------------------------------- Year ended December 31, 2002 -------------------------------------------------------------------------------------------------------- Net unrealized gain (loss) Total Number of Additional on securities share- common Common paid-in Retained available Treasury holders' shares stock capital earnings for sale Stock Equity -------------------------------------------------------------------------------------------------------- Balance at December 31, 2001 2,391,375 25,000 4,687,000 34,030,000 784,000 (2,192,000) 37,334,000 ========= ====== ========= ========== ======= ========= ========== Net income - - - 6,507,000 - - 6,507,000 Net unrealized gain on securities available for sale, net of tax expense of $714,000 - - - - 1,386,000 - 1,386,000 --------- ------ --------- ---------- --------- --------- --------- Comprehensive income - - - 6,507,000 1,386,000 - 7,893,000 Cash dividends declared - - - (2,363,000) - - (2,363,000) Treasury stock purchases (32,067) - - - - (945,000) (945,000) Treasury stock sales 55,385 - - - - 628,000 628,000 Tax benefit of disqualifying disposition of shares - - - 148,000 - - 148,000 --------- ----- -------- ---------- --------- --------- --------- Balance at December 31, 2002 2,414,693 $25,000 $4,687,000 $38,322,000 $2,170,000 $(2,509,000)$42,695,000 ========== ====== ========= ========== ========= ========== ========== The accompanying footnotes are an integral part of these consolidated financial statements
Page 40 Consolidated Statements of Cash Flows First National Lincoln Corporation and Subsidiary ------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 6,507,000 $ 5,493,000 $4,607,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 952,000 774,000 675,000 Deferred income taxes (255,000) - 148,000 Provision for loan losses 1,323,000 1,230,000 700,000 Loans originated for resale (42,531,000) (18,451,000) (3,426,000) Proceeds from sales of loans 40,384,000 17,985,000 3,553,000 Net gain on sale of credit card portfolio (219,000) - - Net gain on sale or call of securities available for sale - (73,000) - Losses on other real estate owned - 55,000 5,000 Net change in other assets and accrued interest receivable (308,000) 485,000 (1,540,000) Net change in other liabilities 30,000 119,000 223,000 Net accretion of discount on investments (604,000) (278,000) (147,000) ----------- ---------- ---------- Net cash provided by operating activities 5,279,000 7,339,000 4,798,000 ----------- ---------- ---------- Cash flows from investing activities: Proceeds from sales, maturities and calls of securities available for sale 2,255,000 17,629,000 1,496,000 Proceeds from maturities and calls of securities to be held to maturity 40,172,000 31,025,000 4,556,000 Proceeds from sales of other real estate owned 15,000 537,000 35,000 Net proceeds from sale of credit card portfolio 2,718,000 - - Purchases of securities available for sale (5,581,000) (4,585,000) (19,952,000) Purchases of securities to be held to maturity (48,029,000) (45,804,000) (868,000) Net increase in loans (33,960,000) (37,344,000) (32,897,000) Capital expenditures (1,222,000) (2,985,000) (509,000) ----------- ---------- ---------- Net cash used in investing activities (43,632,000) (41,527,000) (48,139,000) ----------- ---------- ---------- Page 41 Consolidated Statements of Cash Flows, concluded First National Lincoln Corporation and Subsidiary ------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Cash flows from financing activities: Net increase (decrease) in demand deposits, savings, and money market accounts 83,926,000 17,733,000 (1,276,000) Net increase (decrease) in certificates of deposit (12,391,000) (9,610,000) 50,384,000 Advances on long-term borrowings 24,000,000 51,500,000 15,000,000 Repayments on long-term borrowings - (7,114,000) (5,440,000) Net decrease in short-term borrowings (41,992,000) (15,948,000) (11,689,000) Purchase of treasury stock (945,000) (254,000) (316,000) Proceeds from sale of treasury stock 628,000 312,000 260,000 Dividends paid (2,261,000) (1,861,000) (1,479,000) ---------- ---------- ---------- Net cash provided by financing activities 50,965,000 34,758,000 45,444,000 ---------- ---------- ---------- Net increase in cash and cash equivalents 12,612,000 570,000 2,103,000 Cash and cash equivalents at beginning of year 10,894,000 10,324,000 8,221,000 ----------- ---------- ---------- Cash and cash equivalents at end of year $ 23,506,000 $10,894,000 $10,324,000 ========== ========== ========== Interest paid $ 12,228,000 $15,003,000 $14,911,000 Income taxes paid 2,668,000 2,526,000 1,935,000 Non-cash transactions: Loans transferred to other real estate owned (68,000) (438,000) (60,000) Change in unrealized gain (loss) on available for sale securities 2,100,000 880,000 2,306,000 ------------------------------------------------------------------------------- The accompanying footnotes are an integral part of these consolidated financial statements Page 42 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies The accounting and reporting policies of First National Lincoln Corporation conform to U.S. generally accepted accounting principles and to general practice within the banking industry. The following is a description of the significant policies. Principles of Consolidation The consolidated financial statements include the accounts of First National Lincoln Corporation (the Company) and its wholly-owned subsidiary, The First National Bank of Damariscotta (the Bank). All intercompany accounts and transactions have been eliminated in consolidation. Business The Bank provides a full range of banking services to individual and corporate customers in Mid-Coast Maine. The Bank is subject to competition from other financial institutions. The Bank is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities. Pemaquid Advisors, a division of the Bank, provides investment management, private banking and financial planning services. Pemaquid Advisors has offices in Damariscotta and Portland, Maine. Basis of Financial Statement Presentation In preparing the financial statements, Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the carrying value of real estate owned, Management obtains independent appraisals for significant properties. Investment Securities Investment securities are classified as available for sale or held to maturity when purchased. There are no trading account securities. Securities available for sale consist primarily of debt securities which Management intends to hold for indefinite periods of time. They may be used as part of the Bank's funds management strategy, and may be sold in response to changes in interest rates or prepayment risk, changes in liquidity needs, to increase capital, or for other similar reasons. These assets are accounted for at fair value, with unrealized gains or losses adjusted through shareholders' equity, net of related income taxes. Securities to be held to maturity consist primarily of debt securities which Management has acquired solely for long-term investment purposes, rather than for purposes of trading or future sale. For securities to be held to maturity, Management has the intent and the Company has the ability to hold such securities until their respective maturity dates. Such securities are carried at cost adjusted for the amortization of premiums and accretion of discounts. Page 43 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Investment securities transactions are accounted for on a settlement date basis; reported amounts would not be materially different from those accounted for on a trade date basis. Gains and losses on the sales of investment securities are determined using the amortized cost of the specific security sold. Loans Held for Sale Loans held for sale consist of residential real estate mortgage loans and are carried at the lower of aggregate cost or market value, as determined by current investor yield requirements. Loan Fees and Costs Loan origination fees and certain direct loan origination costs are deferred and recognized in interest income as an adjustment to the loan yield over the life of the related loans. The unamortized net deferred fees and costs are included on the balance sheets with the related loan balances, and the amortization is included with the related interest income. Allowance for Loan Losses Loans considered to be uncollectible are charged against the allowance for loan losses. The allowance for loan losses is maintained at a level determined by Management to be adequate to absorb probable losses. This allowance is increased by provisions charged to operating expenses and recoveries on loans previously charged off. Arriving at an appropriate level of allowance for loan losses necessarily involves a high degree of judgment. In determining the appropriate level of allowance for loan losses, Management takes into consideration the following factors: reviews of individual non-performing loans and performing watch-report loans, loan portfolio size by category, recent loss experience, delinquency trends and current economic conditions. Loans more than 30 days past due are considered delinquent. Although Management utilizes its best judgment in providing for possible losses, there can be no assurance the Bank will not have to increase its provision for possible losses in the future due to increases in non- performing assets or otherwise, which would adversely affect the results of operations. Impaired loans, including restructured loans, are measured at the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral if the loan is collateral dependent. Management takes into consideration impaired loans in addition to the above mentioned factors in determining the appropriate level of allowance for loan losses. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax bases. 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 of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period the change is enacted. Page 44 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Accrual of Interest Income and Expense Interest on loans and investment securities is taken into income using methods which relate the income earned to the balances of loans and investment securities outstanding. Interest expense on liabilities is derived by applying applicable interest rates to principal amounts outstanding. Recording of interest income on problem loans, which includes impaired loans, ceases when collectibility of principal and interest within a reasonable period of time becomes doubtful. Cash payments received on non-accrual loans, which includes impaired loans, are applied to reduce the loan's principal balance until the remaining principal balance is deemed collectible, after which interest is recognized when collected. As a general rule, a loan may be restored to accrual status when payments are current and repayment of the remaining contractual amounts is expected or when it otherwise becomes well secured and in the process of collection. Bank Premises and Equipment Premises, furniture and equipment are stated at cost, less accumulated depreciation. Depreciation expense is computed by straight-line and accelerated methods over the asset's estimated useful life. Other Real Estate Owned (OREO) Real estate acquired by foreclosure or deed in lieu of foreclosure is transferred to 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. An allowance for losses on OREO is maintained for subsequent valuation adjustments on a specific property basis. Earnings Per Share Basic earnings per share data are based on the weighted average number of common shares outstanding during each year. Diluted earnings per share gives effect to the stock options outstanding, determined by the treasury stock method. Post-Retirement Benefits The cost of providing post-retirement benefits is accrued during the active service period of the employee. Segments First National Lincoln Corporation, through the branch network of its subsidiary, The First National Bank of Damariscotta, provides a broad range of financial services to individuals and companies in Mid-Coast Maine. These services include demand, time, and savings deposits; lending; credit card servicing; ATM processing; and investment management and trust services. Operations are managed and financial performance is evaluated on a corporate- wide basis. Accordingly, all of the Company's banking operations are considered by Management to be aggregated in one reportable operating segment. Comprehensive Income Comprehensive income includes both net income and other comprehensive income. Other comprehensive income includes the change in unrealized gains and losses on securities available for sale and is disclosed in the consolidated statements of changes in shareholders' equity. Page 45 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Stock Options The Company established a stock option plan in 1995. Under the plan, the Company may grant options to its employees for up to 200,000 shares of common stock. Only incentive stock options may be granted under the plan. The option price of each option grant is determined by the Options Committee of the Board of Directors, and in no instance shall be less than the fair market value on the date of the grant. An option's maximum term is ten years from the date of grant. The Company applies Accounting Principles Board Opinion No.25 and related interpretations in accounting for the stock option plan. Accordingly, no compensation cost has been recognized. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation. ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Net income As reported $ 6,507,000 5,493,000 4,607,000 Value of option grants, net of tax 60,000 - 11,000 Pro forma 6,447,000 5,493,000 4,596,000 ------------------------------------------------------------------------------- Basic earnings per share As reported 2.71 2.30 1.93 Value of option grants, net of tax 0.03 - - Pro forma 2.68 2.30 1.93 ------------------------------------------------------------------------------- Diluted earnings per share As reported 2.64 2.24 1.89 Value of option grants, net of tax 0.02 - 0.01 Pro forma 2.62 2.24 1.88 ------------------------------------------------------------------------------- The fair market value of options granted, net of tax, was $60,000 in 2002, and $11,000 in 2000. No options were granted in 2001. The weighted average fair market value of options granted was $8.32 in 2002 and $3.24 in 2000. The fair market value is estimated using the Black-Scholes option pricing model and the following assumptions: quarterly dividends of $0.22 in 2002 and $0.18 in 2000, risk-free interest rate of 1.59% in 2002 and 6.00% in 2000, volatility of 37.73% in 2002 and 25.11% in 2000, and an expected life of 10 years. Loan Servicing Servicing rights are recognized when they are acquired through sale of loans. 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 rights are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum. Page 46 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Effect of New Financial Accounting Standards Statement of Financial Accounting Standards (SFAS) No. 147, "Acquisitions of Certain Financial Institutions," amends SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," to exclude from its scope most acquisitions of financial institutions. Such transactions should be accounted for in accordance with SFAS No. 141, "Business Combinations." This Statement had no impact on the Company's consolidated financial condition and results of operations. SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," contains enhanced disclosure requirements for stock-based compensation. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. Adoption of the Statement in 2002 had no impact on the Company's consolidated financial condition and results of operations. Statement of Position (SOP) 01-6, "Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others," was issued in December 2001. The SOP is effective for financial statements issued for the fiscal year beginning after December 15, 2001. The SOP reconciles and conforms the accounting and financial reporting provisions established by various Audit and Accounting Industry Guides. Adoption of this Statement had no impact on the Company's consolidated financial condition and results of operations. Note 2. Cash and Cash Equivalents For the purposes of reporting consolidated cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. At December 31, 2002 the Company had a contractual clearing balance of $500,000 and a reserve balance requirement of $4,056,000 at the Federal Reserve Bank, which are satisfied by both cash on hand at branches and balances held at the Federal Reserve Bank of Boston. The Company maintains a portion of its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant risk with respect to these accounts. Page 47 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 3. Investment Securities The following tables summarize the amortized cost and estimated fair value of investment securities at December 31, 2002 and 2001:
----------------------------------------------------------------------------------------------------------------- Amortized Unrealized Unrealized Fair Value December 31, 2002 Cost Gains Losses (Estimated) ----------------------------------------------------------------------------------------------------------------- Securities available for sale: Mortgage-backed securities $ 6,275,000 152,000 (30,000) 6,397,000 State and political subdivisions 13,899,000 727,000 - 14,626,000 Corporate securities 25,860,000 2,531,000 (103,000) 28,288,000 Federal Home Loan Bank stock 6,195,000 - - 6,195,000 Federal Reserve Bank stock 53,000 - - 53,000 Other equity securities 841,000 21,000 (11,000) 851,000 ---------- --------- ------- ---------- $ 53,123,000 3,431,000 (144,000) 56,410,000 ========== ========= ======= ========== Securities to be held to maturity U.S. Treasury and agency $ 30,952,000 923,000 - 31,877,000 Mortgage-backed securities 16,090,000 445,000 (78,000) 16,456,000 State and political subdivisions 12,032,000 508,000 (22,000) 12,518,000 Corporate securities 6,589,000 - (18,000) 6,570,000 ---------- --------- ------- ---------- $ 65,663,000 1,876,000 (118,000) 67,421,000 ========== ========= ======= ========== ----------------------------------------------------------------------------------------------------------------- Amortized Unrealized Unrealized Fair Value December 31, 2001 Cost Gains Losses (Estimated) ----------------------------------------------------------------------------------------------------------------- Securities available for sale: Mortgage-backed securities $ 2,395,000 75,000 ( 45,000) 2,425,000 State and political subdivisions 13,821,000 198,000 (249,000) 13,770,000 Corporate securities 26,647,000 1,419,000 (205,000) 27,861,000 Federal Home Loan Bank stock 6,005,000 - - 6,005,000 Federal Reserve Bank stock 53,000 - - 53,000 Other equity securities 805,000 12,000 (17,000) 800,000 ---------- --------- -------- ---------- $ 49,726,000 1,704,000 (516,000) 50,914,000 ========== ========= ======= ========== Securities to be held to maturity U.S. Treasury and agency 35,444,000 73,000 (422,000) 35,095,000 Mortgage-backed securities 13,851,000 201,000 (263,000) 13,789,000 State and political subdivisions 6,393,000 147,000 (112,000) 6,428,000 Corporate securities 1,584,000 43,000 (18,000) 1,609,000 --------- --------- ------- ---------- $ 57,272,000 464,000 (815,000) 56,921,000 ========== ========= ======= ========== -----------------------------------------------------------------------------------------------------------------
Page 48 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued The contractual maturities of investment securities at December 31, 2002 are shown below. For purposes of this table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of the underlying collateral. ------------------------------------------------------------------------------- Securities Securities to be available for sale: held to maturity: ------------------------- ------------------------- Amortized Fair Value Amortized Fair Value Cost (Estimated) Cost (Estimated) ------------------------------------------------------------------------------- Due in 1 year or less $ 500,000 502,000 27,000 26,000 Due in 1 to 5 years 9,385,000 10,277,000 125,000 125,000 Due in 5 to 10 years 15,004,000 16,510,000 12,750,000 13,202,000 Due after 10 years 21,145,000 22,022,000 52,761,000 54,068,000 Equity securities 7,089,000 7,099,000 - - ---------- ---------- ---------- ---------- $53,123,000 56,410,000 65,663,000 67,421,000 ========== ========== ========== ========== ------------------------------------------------------------------------------- At December 31, 2002 securities carried at $44,327,000, with a fair value of $44,714,000, were pledged to secure borrowings from the Federal Home Loan Bank, public deposits, and for other purposes as required by law. Gains and losses on the sale of securities available for sale are computed by subtracting the amortized cost at the time of sale from the security's selling price, net of accrued interest to be received. Information regarding gains and losses arising from the sales and calls of securities available for sale is summarized below: ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Proceeds from sales and calls $ - 1,000,000 - ===== ========= ===== Gross gains - 73,000 - Gross losses - - - ----- --------- ----- Net gain - 73,000 - ===== ========= ===== Related income taxes $ - 25,000 - ------------------------------------------------------------------------------- The realized gain on securities in 2001 was the result of a security which was called at par value by the issuer. Page 49 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 4. Loan Servicing At December 31, 2002 and 2001, the Bank serviced loans for others totaling $70,097,000 and $46,723,000, respectively. Net gains from the sale of loans totaled $482,000 in 2002, $161,000 in 2001 and $47,000 in 2000. In 2002, mortgage servicing rights of $315,000 were capitalized, and amortization for the year totaled $183,000. After deducting for a valuation allowance of $190,000, at December 31, 2002, mortgage servicing rights had a fair value of $303,000, which is included in other assets. In 2001, mortgage servicing rights of $245,000 were capitalized, and amortization for the year totaled $95,000. After deducting for a valuation allowance of $127,000, at December 31, 2001, mortgage servicing rights had a fair value of $234,000. Note 5. Loans The following table shows the composition of the Company's loan portfolio as of December 31, 2002 and 2001: ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Real estate loans Residential $ 174,070,000 159,743,000 Commercial 37,082,000 32,638,000 Commercial and industrial loans 82,504,000 68,378,000 State and municipal loans 9,474,000 7,296,000 Consumer loans 27,925,000 30,727,000 Residential construction loans 1,019,000 2,522,000 ----------- ----------- Total loans $ 332,074,000 301,304,000 =========== =========== ------------------------------------------------------------------------------- Loan balances include net deferred loan costs of $807,000 in 2002 and $681,000 in 2001. At December 31, 2002 and 2001, loans on non-accrual status totaled $1,070,000 and $667,000, respectively. Interest income which would have been recognized on these loans, if interest had been accrued, was $108,000 for 2002, $77,000 for 2001 and $185,000 for 2000. Loans past due greater than 90 days which are accruing interest totaled $406,000 at December 31, 2002 and $452,000 at December 31, 2001. The Company continues to accrue interest on these loans because it believes collection of principal and interest is reasonably assured. Page 50 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Transactions in the allowance for loan losses for the years ended December 31, 2002, 2001 and 2000 were as follows: ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Balance at beginning of year $ 3,000,000 2,301,000 2,035,000 Provision charged to operating expenses 1,323,000 1,230,000 700,000 --------- --------- --------- 4,323,000 3,531,000 2,735,000 --------- --------- --------- Loans charged off (724,000) (635,000) (557,000) Recoveries on loans 101,000 104,000 123,000 --------- --------- --------- Net loans charged off (623,000) (531,000) (434,000) --------- --------- --------- Balance at end of year $ 3,700,000 3,000,000 2,301,000 ========= ========= ========= ------------------------------------------------------------------------------- Information regarding impaired loans is as follows: ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Average investment in impaired loans $ 1,367,000 1,055,000 654,000 Interest income recognized on impaired loans, including cash basis 17,000 38,000 16,000 ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Balance of impaired loans $1,070,000 667,000 Less portion for which no allowance for loan losses is allocated (309,000) (247,000) --------- ------- Portion of impaired loan balance for which an allowance for loan losses is allocated 761,000 420,000 ========= ======= Portion of allowance for loan losses allocated to the impaired loan balance $ 297,000 202,000 ------------------------------------------------------------------------------- Page 51 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Loans to directors, officers and employees totaled $11,730,000 at December 31, 2002 and $10,431,000 at December 31, 2001. A summary of loans to directors and executive officers, which in the aggregate exceed $60,000, is as follows: ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Balance at beginning of year $ 5,925,000 7,000,000 New loans 3,397,000 1,892,000 Repayments (2,041,000) (2,967,000) --------- --------- Balance at end of year $ 7,281,000 5,925,000 ========= ========= ------------------------------------------------------------------------------- Note 6. Premises and Equipment Bank premises and equipment are carried at cost and consist of the following: ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Land $ 1,551,000 1,309,000 Land improvements 444,000 414,000 Bank buildings 5,963,000 5,579,000 Equipment 7,233,000 6,730,000 ---------- ---------- 15,191,000 14,032,000 Less accumulated depreciation 7,358,000 6,469,000 ---------- ---------- $ 7,833,000 7,563,000 ========== ========== ------------------------------------------------------------------------------- Note 7. Other Real Estate Owned The following summarizes other real estate owned: ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Real estate acquired in settlement of loans $ 255,000 202,000 ------------------------------------------------------------------------------- Changes in the allowance for each of the three years ended December 31 were as follows: ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Beginning balance $ - 36,000 36,000 Losses charged to allowance - (36,000) - Provision charged to income - - - ----- ------ ------ Ending balance $ - - 36,000 ===== ====== ====== ------------------------------------------------------------------------------- First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 8. Income Taxes The current and deferred components of income tax expense were as follows: ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Federal income tax Current $ 2,830,000 2,138,000 1,650,000 Deferred (255,000) - 148,000 --------- --------- --------- 2,575,000 2,138,000 1,798,000 State income tax 104,000 90,000 95,000 --------- --------- --------- $ 2,679,000 2,228,000 1,893,000 ========= ========= ========= ------------------------------------------------------------------------------- The actual tax expense differs from the expected tax expense (computed by applying the applicable U.S. Federal corporate income tax rate to income before income taxes) as follows: ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Expected tax expense $ 3,123,000 2,625,000 2,210,000 Non-taxable income (484,000) (452,000) (431,000) State income taxes 69,000 59,000 63,000 Qualified housing tax credit - (8,000) (30,000) Other (29,000) 4,000 81,000 --------- -------- --------- $ 2,679,000 2,228,000 1,893,000 ========= ========= ========= ------------------------------------------------------------------------------- Items that give rise to the deferred income tax assets and liabilities and the tax effect of each at December 31 are as follows: ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Allowance for loan losses and OREO $ 1,092,000 887,000 Deferred loan fees (329,000) (285,000) Accrued pension and post-retirement 281,000 240,000 Depreciation (93,000) (111,000) Unrealized gain on securities available for sale (1,118,000) (404,000) Mortgage servicing rights (103,000) (80,000) Other assets (14,000) (102,000) Other liabilities 6,000 36,000 --------- ------- Net deferred income tax asset (liability) $ (278,000) 181,000 ========= ======= ------------------------------------------------------------------------------- Page 53 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued These amounts are included in other assets on the balance sheets, except for the deferred tax liability on unrealized gains on securities available for sale which is included in other liabilities. The deferred income tax asset and liability at December 31, 2002 and 2001 are as follows: ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Asset $ 1,379,000 1,163,000 ========= ========= Liability $ 1,657,000 982,000 ========= ========= ------------------------------------------------------------------------------- No valuation allowance is deemed necessary for the deferred tax asset. Note 9. Certificates of Deposit At December 31, 2002, the scheduled maturities of certificates of deposit are as follows ------------------------------------------------------------------------------- 2003 $ 86,017,000 2004 21,398,000 2005 4,695,000 2006 4,731,000 2007 4,584,000 ----------- Total $ 121,425,000 =========== ------------------------------------------------------------------------------- Interest on certificates of deposit of $100,000 or more was $2,343,000, $3,680,000 and $2,732,000 in 2002, 2001 and 2000, respectively. Note 10. Borrowed Funds Borrowed funds consists of advances from the Federal Home Loan Bank (FHLB), Treasury Tax & Loan Notes, and securities sold under agreements to repurchase with municipal and commercial customers. Pursuant to collateral agreements, FHLB advances are collateralized by all stock in the Home Loan Bank, with a value of $6,195,000 at December 31, 2002 and $6,005,000 at December 31, 2001; qualifying first mortgage loans, which were valued at $155,348,000 and $153,607,000 in 2002 and 2001, respectively; U.S. Government and Agency securities not pledged to others, which were valued at $26,620,000 in 2002 and $25,677,000 in 2001; and funds on deposit with FHLB. As of December 31, 2002, the Bank's total FHLB borrowing capacity was $140,468,000, of which $49,968,000 was unused and available for additional borrowings. All FHLB advances as of December 31, 2002 had fixed rates of interest until their respective maturity dates, except for the FHLB overnight line of credit, which has an interest rate which can fluctuate daily. Under the Treasury Tax & Loan Note program, the Bank accumulates tax deposits made by customers and is eligible to receive Treasury Direct investments up to an established maximum balance. Securities sold under Page 54 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued agreements to repurchase include U.S. Treasury and Agency securities with an aggregate amortized cost of $19,290,000 and $32,185,000 at December 31, 2002 and 2001, respectively, and an aggregate fair value of $19,670,000 and $32,514,000 at December 31, 2002 and 2001, respectively. Repurchase agreements have maturity dates ranging from 1 to 365 days. The Bank also has in place a $5.0 million credit line with a correspondent bank which is currently not in use. Borrowed funds at December 31, 2002 and 2001 have the following range of interest rates and maturity dates: ------------------------------------------------------------------------------- December 31, 2002 ------------------------------------------------------------------------------- Federal Home Loan Bank Advances Maturities within one year 4.19%-4.81% $ 28,000,000 Maturities within two years 2.01%-4.89% 23,000,000 Maturities within five years 3.99%-4.47% 12,000,000 Maturities over five years 3.93%-5.41% 27,500,000 ----------- 90,500,000 Treasury Tax & Loan Notes (rate in effect at December 31, 2002 was 0.99%) variable 3,548,000 Repurchase agreements Municipal and commercial customers 1.14%-2.65% 19,317,000 ----------- $ 113,365,000 =========== ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- December 31, 2001 ------------------------------------------------------------------------------- Federal Home Loan Bank Advances Maturities within one year 1.83%-2.53% $ 32,500,000 Maturities within two years 4.19%-4.81% 28,000,000 Maturities within three years 4.75%-4.89% 11,000,000 Maturities over five years 3.93%-5.41% 27,500,000 ----------- 99,000,000 Treasury Tax & Loan Notes (rate in effect at December 31, 2001 was 1.39%) variable 166,000 Repurchase agreements Municipal and commercial customers 2.25% - 3.65% 22,424,000 Brokers 2.05% 9,767,000 ----------- $ 131,357,000 =========== ------------------------------------------------------------------------------- Page 55 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 11. Employee Benefit Plans 401(k) Plan The Bank has a defined contribution plan available to substantially all employees who have completed six months of service. Employees may contribute up to 50.0% of their compensation (not to exceed $11,000 if under age 50 and $12,000 if over age 50), and the Bank may provide a match of up to 3.0% of compensation. Subject to a vote of the Board of Directors, the Bank may also make a profit-sharing contribution to the Plan. Such contribution equaled 3.0% of each eligible employee's compensation in 2002, 3.0% in 2001, and 2.5% in 2000. The expense related to the 401(k) plan was $216,000, $146,000, and $160,000 in 2002, 2001, and 2000, respectively. Pension Plan The Bank also sponsors an unfunded, non-qualified supplemental retirement plan for certain officers. The agreement provides supplemental retirement benefits payable in installments over 20 years upon retirement or death. The costs for this plan are recognized over the service periods of the participating officers. The expense of this supplemental plan was $113,000 in 2002, $141,000 in 2001, and $123,000 in 2000. As of December 31, 2002 and 2001, the accrued liability of this plan was $591,000 and $484,000, respectively. Post-Retirement Benefit Plans The Bank sponsors two post-retirement benefit plans. One plan provides health insurance benefits to employees hired prior to June 30, 1988 and who retired before June 30, 1996. The other plan provides life insurance coverage to full- time employees who work until retirement. The Bank also provides health insurance for retired directors. None of these plans are pre-funded. The Bank elected to recognize the accumulated post-retirement benefit obligation as of January 1, 1993 of $578,000 as a component of net periodic post-retirement benefit cost over a 20-year period. The following tables set forth the accumulated post-retirement benefit obligation, funded status, and net periodic pension cost: ------------------------------------------------------------------------------- At December 31, 2002 2001 ------------------------------------------------------------------------------- Change in benefit obligation: Benefit obligation at beginning of year: $ 428,000 445,000 Service cost 5,000 5,000 Interest cost 34,000 32,000 Benefits paid (52,000) (54,000) ------- ------- Benefit obligation at end of year $ 415,000 428,000 ======= ======= Funded status: Benefit obligation at end of year $ (415,000) (428,000) Unrecognized prior service cost (43,000) (60,000) Unamortized net actuarial gain (46,000) (24,000) Unrecognized transition obligation 290,000 319,000 ------- ------- Accrued benefit cost $ (214,000) (193,000) ======= ======= ------------------------------------------------------------------------------- Page 56 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued ------------------------------------------------------------------------------- Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Components of net periodic benefit cost: Service cost $ 5,000 5,000 5,000 Interest cost 34,000 32,000 32,000 Amortization of unrecognized transition obligation 29,000 29,000 29,000 Amortization of prior service cost (3,000) (5,000) (5,000) Amortization of accumulated gains 2,000 (2,000) (3,000) ------ ------ ------ Net periodic benefit cost $ 67,000 59,000 58,000 ====== ====== ====== Weighted average assumptions as of December 31: Discount rate 7.0% 7.0% 7.0% ------------------------------------------------------------------------------- Note 12. Shareholders' Equity The Company has reserved 160,000 shares of its common stock to be made available to directors and employees who elect to participate in the stock purchase or savings and investment plans. As of December 31, 2002, 110,523 shares had been issued pursuant to these plans, leaving 49,477 shares available for future use. The issuance price is based on the market price of the stock at issuance date. Sales of stock to directors and employees amounted to 5,157 shares in 2002, 7,573 shares in 2001, and 29,179 shares in 2000. Stock sold to directors and employees in 2002 was all from treasury shares. In 2001, the Company established a dividend reinvestment plan to allow its shareholders to use their cash dividends for the automatic repurchase of shares in the Company. When the plan was established, 200,000 shares were registered with the Securities Exchange Commission, and as of December 31, 2002, 9,179 shares have been issued, leaving 190,821 shares for future use. Participation in this plan is optional and at the individual discretion of each shareholder. Shares are purchased for the plan from the Company at a price per share equal to the average of the daily bid and asked prices reported on the NASDAQ System for the five trading days immediately preceding, but not including, the dividend payment date. Sales of stock under the Dividend Reinvestment Plan amounted to 7,028 shares in 2002 and 2,151 shares in 2001. All stock sold in 2002 was from treasury shares. In 1995, the Company's shareholders adopted a Stock Option Plan and authorized 200,000 shares to be reserved for options to be granted to certain key officers of the Company and the Bank. The option exercise price is equal to or exceeds the fair market value of the shares on the date of the grant, and options are generally not exercisable before two years from the date granted. All options expire ten years from the date of grant. Page 57 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued The following table sets forth the status of the plan as of December 31, 2002, 2001 and 2000, and changes during the years then ended: ------------------------------------------------------------------------------- Number Weighted Average of Shares Exercise Price ------------------------------------------------------------------------------- Balance at December 31, 1999 178,000 $ 9.21 Granted in 2000 5,000 16.50 Exercised in 2000 (22,000) 6.98 Forfeited in 2000 (6,000) 12.96 ------- ------ Balance at December 31, 2000 155,000 9.62 Exercised in 2001 (17,000) 7.84 ------- ------ Balance at December 31, 2001 138,000 9.84 Granted in 2002 11,000 28.00 Exercised in 2002 (43,200) 6.81 Forfeited in 2002 (1,000) 22.50 ------- ------ Balance at December 31, 2002 104,800 $ 12.88 ======= ====== ------------------------------------------------------------------------------- The number and weighted average exercise price of exercisable options was 68,300 and $9.55 at December 31, 2002, 93,500 and $8.28 at December 31, 2001, and 81,700 and $7.45 at December 31, 2000. The range of prices for outstanding and exercisable stock options at December 31, 2002 was as follows: ------------------------------------------------------------------------------- Weighted Average Weighted Remaining Average Number Contractual Exercise Outstanding Life Price ------------------------------------------------------------------------------- Options Outstanding $6.38 to $10.00 43,000 2.4 $ 7.15 $10.01 to $15.00 24,000 4.1 10.25 $15.01 to $20.00 23,800 6.9 17.67 $20.01 to $25.00 3,000 6.0 22.50 $25.01 to $28.00 11,000 9.1 28.00 ------- ---- ------ 104,800 4.6 $ 12.88 ======= ==== ====== Options Exercisable $6.38 to $10.00 35,000 2.3 $ 6.90 $10.01 to $15.00 24,000 4.1 10.25 $15.01 to $20.00 8,800 7.1 17.41 $20.01 to $25.00 500 6.0 22.50 $25.01 to $28.00 - 9.1 28.00 ------- ---- ------ 68,300 3.6 $ 9.55 ======= ==== ====== ------------------------------------------------------------------------------- Page 58 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 13. Off-Balance Sheet Financial Instruments and Concentrations of Credit Risk The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to originate loans, commitments for unused lines of credit, and standby letters of credit. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. Commitments for unused lines are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Loan commitments are recorded when funded. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on Management's credit evaluation of the borrower. Standby letters of credit are conditional commitments issued by the Bank to guarantee a customer's performance to a third party, with the customer being obligated to repay (with interest) any amounts paid out by the Bank under the letter of credit. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. At December 31, the Company had the following off-balance sheet financial instruments, whose contract amounts represent credit risk: ------------------------------------------------------------------------------- 2002 2001 ------------------------------------------------------------------------------- Unused lines, collateralized by residential real estate $ 22,472,000 10,445,000 Unused credit card lines - 11,718,000 Other unused commitments 30,890,000 22,367,000 Standby letters of credit 50,000 60,000 Commitments to extend credit 11,253,000 15,718,000 Unused portion of foreign exchange forward contract, US$ equivalent - 319,000 ------------------------------------------------------------------------------- The Company grants residential, commercial and consumer loans to customers principally located in the Mid-Coast region of Maine. Collateral on these loans typically consists of residential or commercial real estate, or personal property. Although the loan portfolio is diversified, a substantial portion of borrowers' ability to honor their contracts is dependent on the economic conditions in the area, especially in the real estate sector. Page 59 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 14. Earnings Per Share The following tables provide detail for basic earnings per share and diluted earnings per share for the years ended December 31, 2002, 2001 and 2000: ------------------------------------------------------------------------------- Income Shares Per-Share For the Year Ended December 31, 2002 (Numerator) (Denominator) Amount ------------------------------------------------------------------------------- Net income as reported $ 6,507,000 ========= ========= ======== Basic EPS: Income available to common shareholders $ 6,507,000 2,404,965 $ 2.71 Effect of dilutive securities: incentive stock options 56,804 --------- --------- -------- Diluted EPS: Income available to common shareholders plus assumed conversions $ 6,507,000 2,461,769 $ 2.64 ========= ========= ======== ------------------------------------------------------------------------------- Income Shares Per-Share For the Year Ended December 31, 2001 (Numerator) (Denominator) Amount ------------------------------------------------------------------------------- Net income as reported $ 5,493,000 ========= ========= ========= Basic EPS: Income available to common shareholders $ 5,493,000 2,384,402 $ 2.30 Effect of dilutive securities: incentive stock options 70,547 --------- --------- --------- Diluted EPS: Income available to common shareholders plus assumed conversions $ 5,493,000 2,454,949 $ 2.24 ========= ========= ========= ------------------------------------------------------------------------------- Income Shares Per-Share For the Year Ended December 31, 2000 (Numerator) (Denominator) Amount ------------------------------------------------------------------------------- Net income as reported $ 4,607,000 ========= ========= ========= Basic EPS: Income available to common shareholders $ 4,607,000 2,384,356 $ 1.93 Effect of dilutive securities: incentive stock options 56,752 --------- --------- --------- Diluted EPS: Income available to common shareholders plus assumed conversions $ 4,607,000 2,441,108 $ 1.89 ========= ========= ========= ------------------------------------------------------------------------------- All earnings per share calculations have been made using the weighted average number of shares outstanding for each year. All of the dilutive securities are incentive stock options granted to certain key members of Management. The dilutive number of shares has been calculated using the treasury method, assuming that all granted options were exercisable at each year end. Page 60 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 15. Fair Value of Financial Instruments Fair value estimates, methods, and assumptions are set forth below for the Company's financial instruments. Cash and Cash Equivalents The carrying values of cash, cash equivalents, due from banks and federal funds sold approximate their relative fair values. Investment Securities The fair values of investment securities are estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. Fair values are calculated based on the value of one unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications, or estimated transaction costs. If these considerations had been incorporated into the fair value estimates, the aggregate fair value could have been changed. The carrying values of restricted equity securities approximate fair values. Loans Held for Sale The fair value of loans held for sale is determined by the current investor yield requirements. Loans Fair values are estimated for portfolios of loans with similar financial characteristics. The fair values of performing loans are calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest risk inherent in the loan. The estimates of maturity are based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions, and the effects of estimated prepayments. The fair value estimate for credit card loans is based on the carrying value of existing loans. This estimate does not include the value that relates to estimated cash flows from new loans generated from existing cardholders over the remaining life of the portfolio. Fair values for significant non-performing loans are based on estimated cash flows and are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information. Management has made estimates of fair value using discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, Management has no basis to determine whether the fair value presented above would be indicative of the value negotiated in an actual sale. Page 61 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Cash Surrender Value of Life Insurance The fair value is based on the actual cash surrender value of life insurance policies. Accrued Interest Receivable The fair value estimate of this financial instrument approximates the carrying value as this financial instrument has a short maturity. It is the Company's policy to stop accruing interest on loans for which it is probable that the interest is not collectible. Therefore, this financial instrument has been adjusted for estimated credit loss. Deposits The fair value of deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates do not include the benefit that results from the low-cost funding provided by the deposits compared to the cost of borrowing funds in the market. If that value were considered, the fair value of the Company's net assets could increase. Borrowed Funds The fair value of borrowed funds is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently available for borrowings of similar remaining maturities. Accrued Interest Payable The fair value estimate approximates the carrying amount as this financial instrument has a short maturity. Off-Balance-Sheet Instruments Off-balance-sheet instruments include loan commitments. Fair values for loan commitments have not been presented as the future revenue derived from such financial instruments is not significant. Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These values do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on Management's judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial instruments include the deferred tax asset, bank premises and equipment, and other real estate owned. In addition, tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. Page 62 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued The estimated fair values for the Company's financial instruments as of December 31, 2002 and 2001 were as follows: ------------------------------------------------------------------------------- December 31, 2002 December 31, 2001 ------------------------- ------------------------- Carrying Estimated Carrying Estimated amount fair value amount fair value ------------------------------------------------------------------------------- Financial assets Cash and due from banks $ 14,181,000 14,181,000 10,894,000 10,894,000 Overnight funds sold 9,325,000 9,325,000 - - Securities available for sale 56,410,000 56,410,000 50,914,000 50,914,000 Securities to be held to maturity 65,663,000 67,421,000 57,272,000 56,921,000 Loans held for sale 2,613,000 2,613,000 466,000 466,000 Loans (net of allowance for loan losses) 328,374,000 334,928,000 298,304,000 303,828,000 Cash surrender value of life insurance 4,468,000 4,468,000 4,250,000 4,250,000 Accrued interest receivable 2,642,000 2,642,000 2,635,000 2,635,000 ------------------------------------------------------------------------------- Financial liabilities Deposits $ 334,224,000 329,671,000 262,689,000 258,697,000 Borrowed funds 113,365,000 115,938,000 131,357,000 133,285,000 Accrued interest payable 786,000 786,000 891,000 891,000 ------------------------------------------------------------------------------- Note 16. Other Operating Income and Expense Other operating income includes the following items greater than 1% of revenues. ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Merchant discount fees $ 967,000 880,000 743,000 Mortgage origination and servicing 685,000 357,000 71,000 ------------------------------------------------------------------------------- Other operating expense includes the following items greater than 1% of revenues. ------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------------------- Stationery and supplies $ 293,000 215,000 160,000 Merchant interchange fees 681,000 620,000 551,000 Postage, freight and express 182,000 186,000 169,000 Exams and audits 233,000 231,000 190,000 ------------------------------------------------------------------------------- Page 63 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 17. Regulatory Capital Requirements The ability of the Company to pay cash dividends to its shareholders depends primarily on receipt of dividends from its subsidiary, the Bank. The subsidiary may pay dividends to its parent out of so much of its net income as the Bank's directors deem appropriate, subject to the limitation that the total of all dividends declared by the Bank in any calendar year may not exceed the total of its net income of that year combined with its retained net income of the preceding two years and subject to minimum regulatory capital requirements. The amount available for dividends in 2003 will be 2003 earnings plus retained earnings of $7,043,000 from 2002 and 2001. The payment of dividends by the Company is also affected by various regulatory requirements and policies, such as the requirements to maintain adequate capital. In addition, if, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), that authority may require, after notice and hearing, that such bank cease and desist from that practice. The Federal Reserve Bank and the Comptroller of the Currency have each indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve Bank, the Comptroller and the Federal Deposit Insurance Corporation have issued policy statements which provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. In addition to the effect on the payment of dividends, failure to meet minimum capital requirements can also result in mandatory and discretionary actions by regulators that, if undertaken, could have an impact on the Company's operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measurements of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital and Tier 2 or total capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2002, the most recent notification from the Office of the Comptroller of the Currency classified the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since this notification that Management believes have changed the institution's category. Page 64 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued The actual and minimum capital amounts and ratios for the Bank are presented in the following table: ------------------------------------------------------------------------------- To be well- capitalized For under prompt capital corrective adequacy action Actual purposes provisions ------------------------------------------------------------------------------- As of December 31, 2002 Tier 2 capital to $ 42,086,000 26,143,000 32,679,000 risk-weighted assets 12.88% 8.00% 10.00% Tier 1 capital to 38,386,000 13,072,000 19,607,000 risk-weighted assets 11.75% 4.00% 6.00% Tier 1 capital to 38,386,000 19,667,000 24,584,000 average assets 7.81% 4.00% 5.00% ------------------------------------------------------------------------------- As of December 31, 2001 Tier 2 capital to $ 37,533,000 22,494,000 28,118,000 risk-weighted assets 13.35% 8.00% 10.00% Tier 1 capital to 34,533,000 11,247,000 16,871,000 risk-weighted assets 12.28% 4.00% 6.00% Tier 1 capital to 34,533,000 16,967,000 21,208,000 average assets 8.14% 4.00% 5.00% ------------------------------------------------------------------------------- The actual and minimum capital amounts and ratios for the Company, on a consolidated basis, are presented in the following table: ------------------------------------------------------------------------------- To be well- capitalized For under prompt capital corrective adequacy action Actual purposes provisions ------------------------------------------------------------------------------- As of December 31, 2002 Tier 2 capital to $ 44,070,000 26,222,000 32,778,000 risk-weighted assets 13.45% 8.00% 10.00% Tier 1 capital to 40,370,000 13,111,000 19,667,000 risk-weighted assets 12.32% 4.00% 6.00% Tier 1 capital to 40,370,000 19,707,000 24,633,000 average assets 8.19% 4.00% 5.00% ------------------------------------------------------------------------------- As of December 31, 2001 Tier 2 capital to $ 39,402,000 22,603,000 28,254,000 risk-weighted assets 13.95% 8.00% 10.00% Tier 1 capital to 36,402,000 11,302,000 16,952,000 risk-weighted assets 12.88% 4.00% 6.00% Tier 1 capital to 36,402,000 17,016,000 21,270,000 average assets 8.56% 4.00% 5.00% ------------------------------------------------------------------------------- Page 65 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, continued Note 18. Condensed Financial Information of Parent Condensed financial information for First National Lincoln Corporation exclusive of its subsidiary is as follows: ------------------------------------------------------------------------------- Balance Sheet December 31, 2002 2001 ------------------------------------------------------------------------------- Assets Cash $ 560,000 656,000 Dividends receivable 750,000 550,000 Investments 766,000 750,000 Investment in subsidiary 40,704,000 35,469,000 Other assets 565,000 479,000 ---------- ---------- $ 43,345,000 37,904,000 ========== ========== Liabilities and shareholders' equity Dividends payable $ 628,000 526,000 Other liabilities 22,000 44,000 Shareholders' equity 42,695,000 37,334,000 ---------- ---------- $ 43,345,000 37,904,000 ========== ========== ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- Statements of Income Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Investment income $ 56,000 56,000 57,000 Operating expense 84,000 47,000 50,000 --------- --------- --------- Income (loss) before Bank earnings (28,000) 9,000 7,000 Equity in earnings of Bank: Remitted 2,590,000 2,200,000 1,600,000 Unremitted 3,917,000 3,284,000 3,000,000 --------- --------- --------- Net income $ 6,507,000 5,493,000 4,607,000 ========= ========= ========= ------------------------------------------------------------------------------- Page 66 First National Lincoln Corporation and Subsidiary Notes to Consolidated Financial Statements, concluded ------------------------------------------------------------------------------- Statements of Cash Flows Years ended December 31, 2002 2001 2000 ------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 6,507,000 5,493,000 4,607,000 Adjustments to reconcile net income to net cash provided by operating activities: (Increase) decrease in other assets (86,000) 5,000 23,000 Increase (decrease) in other liabilities (22,000) 23,000 (1,000) Unremitted earnings of Bank (3,917,000) (3,284,000) (3,000,000) --------- --------- --------- Net cash provided by operating activities 2,482,000 2,237,000 1,629,000 ---------- --------- --------- Cash flows from financing activities: Purchase of Treasury stock (945,000) (254,000) (316,000) Sale of Treasury stock 628,000 312,000 260,000 Dividends paid (2,261,000) (1,861,000) (1,479,000) --------- --------- --------- Net cash used in financing activities (2,578,000) (1,803,000) (1,535,000) --------- --------- --------- Net increase (decrease) in cash (96,000) 434,000 94,000 Cash, beginning of year 656,000 222,000 128,000 --------- --------- --------- Cash, end of year $ 560,000 656,000 222,000 ========= ========= ========= ------------------------------------------------------------------------------- Page 67 ITEM 9. Changes in and/or Disagreements with Accountants None. Page 68 ITEM 10. Directors and Executive Officers of the Registrant The Articles of Incorporation of the Company provide that the Board of Directors shall consist of not fewer than five (5) nor more than twenty-five (25) persons as determined by the Board prior to each Annual Meeting, with Directors serving for "staggered terms" of three years. A resolution of the Board of Directors adopted pursuant to the Company's Articles of Incorporation has established the number of Directors at ten. Each person listed below has consented to be named as a nominee, and the Board of Directors knows of no reason why any of the nominees listed below may not be able to serve as a Director if elected. The following Directors' terms expire in 2003, and each will be nominated for a re-election for a three-year term as Director expiring in 2006: Daniel R. Daigneault has served as President, Chief Executive Officer and as a member of the Board of Directors of both the Company and The First National Bank of Damariscotta (the "Bank"), the Company's wholly owned subsidiary, since 1994. Prior to being employed by the Bank, Mr. Daigneault was Vice President, Senior Commercial Loan Officer and Chief Financial Officer at Camden National Bank, Camden, Maine. Mr. Daigneault is past Chairman of the Maine Bankers Association and past President of the Boothbay Region YMCA Board of Trustees. Dana L. Dow has served as a Director of the Company and the Bank since 1999. Mr. Dow is President of Dow Furniture, located in Waldoboro, Maine, which he purchased from his father in 1977 and Dow's Fine Furniture located in Rockland, Maine. Prior to purchasing Dow Furniture, Mr. Dow taught chemistry and physics at Medomak Valley High School. Robert B. Gregory has served as a Director of the Company and the Bank since 1987 and has served as Chairman of both the Company and the Bank since September 1998. Mr. Gregory has been a practicing attorney since 1980, first in Lewiston, Maine and since 1983 in Damariscotta, Maine. The following Directors' terms will expire in 2004: Bruce A. Bartlett has served as a Director of the Company since its organization in 1985 and as a Director of the Bank, since 1981. Mr. Bartlett served as President and Chief Executive Officer of the Company and the Bank until his retirement in 1994. Malcolm E. Blanchard has served as a Director of the Company since its organization in 1985 and has served as a Director of the Bank since 1976. Mr. Blanchard has been actively involved, either as sole proprietor or as a partner, in real estate development since 1970. Stuart G. Smith has served as a Director of the Company and the Bank since 1997. A resident of Camden, he and his wife own and operate Maine Sport Outfitters in Rockport and Lord Camden Inn and Bayview Landing in Camden, Maine. Mr. Smith is also on the board and part owner of the Mid Coast Recreation Center in Rockport. He also serves on the Five Town CSD High School Board and the SAD 28 Camden/Rockport School Board. Page 69 The following Directors' terms will expire in 2005: Katherine M. Boyd has served as a Director of the Company and the Bank since 1993. A resident of Boothbay Harbor, she owns the Boothbay Region Greenhouses with her husband. Ms. Boyd serves as Vice President of the Boothbay Region YMCA, and is chairperson of the YMCA Annual Fund Drive. Carl S. Poole, Jr. has served as a Director of the Company since its organization in 1985 and has served as a Director of the Bank since 1984. Mr. Poole is President, Secretary, and Treasurer of Poole Brothers Lumber, a lumber and building supply company with locations in Damariscotta, Pemaquid and Boothbay Harbor, Maine. David B. Soule, Jr. has served as a Director of the Company and the Bank since 1989. Mr. Soule has been practicing law in Wiscasset since 1971. He served two terms in the Maine House of Representatives, is a past President of the Lincoln County Bar Association and is a former Public Administrator, Lincoln County. Bruce B. Tindal has served as a Director of the Company and the Bank since 1999. Mr. Tindal formed and is owner of Tindal & Callahan Real Estate in Boothbay Harbor, which has been in operation since 1985. Mr. Tindal serves on the Board of Directors of the Boothbay Region Land Trust, the Lincoln County Board of Realtors and the St. Andrews Village Association. Mr. Tindal is also a member of the National Association of Realtors, the Maine Association of Realtors, the Council of Residential Specialists and the Boothbay Harbor Rotary Club. There are no family relationships among any of the Directors of the Company, and there are no arrangements or understandings between any Director and any other person pursuant to which that Director has been or is to be elected. No Director of the Bank or the Company serves as a Director on the board of any other corporation with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934 or that is subject to the reporting requirements of Section 15(d) of the Securities Exchange Act of 1934, or of any company registered as an investment company under the Investment Company Act of 1940, as amended. Page 70 Executive Officers Each Executive Officer of the Company and the Bank is identified in the following table, which also sets forth their respective ages, offices and periods served as an Executive Officer of the Company or the Bank: ------------------------------------------------------------------------------- Name & Age(1) Office & Position Period Served ------------------------------------------------------------------------------- Daniel R. Daigneault President & Chief Executive Officer 1994 to date 50 of the Company and of the Bank F. Stephen Ward Treasurer & Chief Financial Officer 1993 to date 49 of the Company; Senior Vice President and Chief Financial Officer of the Bank; Principal of Pemaquid Advisors Charles A. Wootton Clerk of Company; Senior Vice President, 2000 to date 46 Banking Services Officer and Senior Loan Officer of the Bank Walter F. Vietze Senior Vice President and Senior 1984 to date 61 Operations Officer of the Bank Michael T. Martin Senior Vice President and Credit 1993 to date 47 Administration Officer of the Bank Richard M. Elder Vice President, Retail Services 2002 to date 37 Susan A. Norton Vice President, Human Resources and 2002 to date 42 Compliance John E. Thien Vice President, Controller 2003 to date 53 William M. Hunter,II Managing Principal, Pemaquid Advisors 2003 to date 53 ----------------------------------------------------------------------------- (1) As of December 31, 2002 Daniel R. Daigneault has served as President, Chief Executive Officer and as a member of the Board of Directors of both the Company and the Bank since 1994. Prior to being employed by the Company and the Bank, Mr. Daigneault was Vice President, Senior Commercial Loan Officer and Chief Financial Officer at Camden National Bank, Camden, Maine. F. Stephen Ward has served as Treasurer & Chief Financial Officer of the Company since 1994 and as Chief Financial Officer of the Bank since 1993. Mr. Ward has been employed by the Bank since 1990 and served as Assistant Vice President and Marketing Officer from 1990 to 1993. From 1978 to 1990 Mr. Ward was employed by Down East Enterprises, Inc. Charles A. Wootton has been employed by the Bank since January 2000. In 2001, Mr. Wootton was promoted to Senior Vice President for Banking Services and Senior Loan Officer. From 1981 to 2000 Mr. Wootton was employed by Camden National Bank, serving as branch manager, commercial loan and business development officer. In 1996, Mr. Wootton became Vice President responsible for branch administration. Walter F. Vietze has been employed by the Bank since 1984. From 1979 to 1984, Mr. Vietze was employed by Casco Bank, Portland, Maine. His primary responsibilities involved providing online banking services to correspondent banks. Prior to 1979, Mr. Vietze was affiliated with BayBanks in Massachusetts. Michael T. Martin has been employed by the Bank since 1993. In 2001, Mr. Martin was promoted to Senior Vice President for Credit Administration. He was employed by Fleet Bank from 1980 to 1992, and by Canal National Bank from 1977 to 1980. His primary responsibilities were in Loan Review and Credit Administration. Page 71 Susan A. Norton became a member of the Executive Leadership Team in 2002 when she was promoted to Vice President Human Resources and Compliance. In 1995, Ms. Norton was the Assistant Compliance Officer and Education Officer. She also holds the position of Assistant Director of Strategic Planning and CRA Officer as well as being the Compliance Officer for the Company. Ms. Norton has been employed by the Bank since 1992. John E. Thien has been employed by the Bank since 2000. In 2001, he was promoted to Vice President, Controller. Prior to joining the Bank, Mr. Thien worked at Kingfield Bank as Chief Financial Officer. Richard M. Elder has served as Vice President Retail Services since 2000 and became a member of the Executive Leadership Team in 2002. Mr. Elder previously served as Manager of the Bank's Boothbay Harbor branch and Senior Commercial Loan Officer. Mr. Elder has been employed by the Bank since 1993. William M. Hunter, II joined the Company in 2001 with the merger of Pemaquid Advisors and White Pine Asset Management. In 2002, Mr. Hunter was named as Chief Investment Officer and in 2003 he was promoted to Managing Principal of Pemaquid Advisors. Prior to joining the Company, Mr. Hunter was Executive Vice President in charge of KeyCorp's national trust business. There are no family relationships among any of the Executive Officers, nor are there any arrangements or understandings between any Executive Officer and any other person pursuant to which that Executive Officer has been or is to be elected. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act requires that the Company's directors, executive officers, and any person holding more than ten percent of the Company's Common Stock file with the SEC reports of ownership changes, and that such individuals furnish the Company with copies of the reports. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons, the Company believes that all of its executive officers and directors complied with all Section 16(a) filing requirements applicable to them in 2002. Page 72 ITEM 11. Executive Compensation Executive Compensation The table below sets forth cash compensation paid to the President & Chief Executive Officer as well as the Treasurer & Chief Financial Officer and the Senior Vice President/Senior Loan Officer during 2002, 2001 and 2000. No other Executive Officers of the Company received compensation in excess of $100,000 for the years ended December 31, 2002, 2001 and 2000 ------------------------------------------------------------------------------- Name Annual Long-Term and Compensation Compensation Principal ----------------------------- ------------ Position Year Salary Bonus(1) Other(2) # Options ------------------------------------------------------------------------------- Daniel R. Daigneault 2002 $ 230,000 $ 49,960 $ 19,217 -0- President and CEO 2001 $ 195,000 $ 48,750 $ 14,660 -0- 2000 $ 184,000 $ 17,112 $ 14,005 -0- ------------------------------------------------------------------------------- F. Stephen Ward 2002 $ 125,000 $ 25,000 $ 11,283 -0- Treasurer and CFO 2001 $ 115,000 $ 10,560 $ 11,972 -0- 2000 $ 85,000 $ 8,670 $ 5,387 -0- ------------------------------------------------------------------------------- Charles A. Wootton 2002 $ 110,000 $ 22,720 $ 11,800 5,000 SVP and Senior Loan 2001 $ 80,000 $ 11,200 $ 10,000 -0- Officer 2000 $ 70,000 $ 6,510 $ 5,500 5,000 ------------------------------------------------------------------------------- (1) Bonuses are listed in the year earned and normally accrued. Such bonuses may be paid in the following year. (2) Amounts shown include contributions paid by the Company to the respective accounts of the Named Executive Officers in the 401(k) Plan. In 2002 the Company and the Bank contributed to the Bank's Savings and Investment Plan a matching amount for the salary deferred by Mr. Daigneault, Mr. Ward and Mr. Wootton equal to 3.0% of their respective earnings and a profit-sharing component of 3.0% of their respective earnings, which were subject to IRS regulations limiting the maximum amount of an officer's earnings eligible for matching or profit-sharing 401(k) contributions to $200,000. These percentages were equivalent to the 401(k) Plan match and profit sharing contributions made for all eligible employees. This figure also recognizes the value to the officers of a Company-provided vehicle. Compensation of the Chief Executive Officer The Compensation Committee consists of four outside members of the Board of Directors. This Committee has the responsibility for conducting the annual evaluation and determining the compensation level of the Chief Executive Officer. The compensation of the Chief Executive Officer consists of a base salary plus a bonus, under an approved plan adopted for all employees of the Bank, and other cash bonuses which the Committee may deem appropriate based on the overall performance of the Chief Executive Officer and the achievement of prescribed goals. These goals are a combination of financial targets and corporate objectives such as implementation of the strategic plan, satisfactorily addressing issues identified as priorities by the banking regulators and overall performance of the management team and the Company. The financial goals pertain to profitability, loan and deposit growth as well as loan portfolio quality. Page 73 The compensation philosophy of the Company for all management personnel is to pay a competitive base salary commensurate with salaries paid by other similar financial institutions, plus a short-term incentive bonus which is tied to the achievement of certain performance goals. In 1994, the Company instituted a formal performance-based compensation program called "Performance Compensation for Stakeholders". The overall objective of the program is to shift a portion of employee compensation from base salary to performance-based payments. In 2002, total cash payout under this Stakeholder Performance Compensation program was 15.20% of the participating employees' base salaries. This performance compensation program's overall objective is to maximize the long-term viability of the Company and increase shareholder value. It addresses this by tying the bonus payout to multiple goals which include profitability, growth, productivity and loan quality. The guiding principle is to reach a balance of profitability, growth, productivity and loan quality which should have a positive impact on maximizing long-term shareholder value. It rewards current performance which contributes toward the achievement of long-term goals. Each year specific key performance indicators are chosen along with financial performance levels. In 2002 some of the indicators were: loan volume, deposit volume, non-performing loan levels, non-interest income, net interest income and operating expenses as a percentage of net income. The amount of base compensation potentially payable to the Chief Executive Officer and other executive officers was determined by reviewing independent salary surveys of compensation of officers for similar financial institutions located in New England. The committee took into consideration the actual salaries paid to Presidents and CEOs of these peer banks and the performance of the Company in comparison to this peer group in establishing the 2002 base salary for the Chief Executive Officer. The Chief Executive Officer is given annual goals relating to both financial performance and corporate objectives, which are established by the Committee pursuant to discussions with the Chief Executive Officer. On an annual basis, the Committee conducts a formal evaluation of the Chief Executive Officer, compares his performance to the established goals, assesses the overall performance of the Company and makes recommendations as appropriate. The Chief Executive Officer's base compensation for 2002 was reflective of the Company's overall financial performance in 2001, which, in the opinion of the Compensation Committee, was considered excellent. All 2001 goals set for the Chief Executive Officer were met or exceeded, which included reaching certain targets for asset growth, asset quality, and overall profitability. Taking these various factors into consideration and in recognition of his overall performance, the committee increased his base salary by $35,000 or 18.00% to $230,000 for 2002. The Chief Executive Officer's 2002 bonus compensation was 21.70% of base compensation, of which 15.20% was paid in accordance with the Company's Stakeholder Performance Compensation program for all employees. The additional bonus for 2002 is a reflection of the exceptional year the Company had in exceeding its financial performance goals, most notably a $1,014,000 increase in net income or 18.50% and a return on average equity of 16.34%. 2002 Compensation Committee Members: Malcolm E. Blanchard, Chair Robert B. Gregory Carl S. Poole, Jr. Stuart G. Smith Page 74 Compensation Committee Interlocks and Insider Participation in Compensation Decisions During 2002, Directors Gregory, Blanchard, Poole and Smith served as members of the Compensation Committee. No member of the Committee was, or ever has been, an officer or employee of the Company or the Bank. All Committee members are customers of and engage in banking transactions with the Bank in the ordinary course of business. As described in the section entitled "Certain Relationships and Related Transactions", all loans to such individuals were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and, in the opinion of Management, did not involve more than the normal risk of collectibility or present other unfavorable features. Director Compensation Each of the outside directors of the Bank, with the exception of the Chairman of the Board, received a director's fee in the amount of $500 for each meeting attended and $300 for each meeting attended of a committee of which the director is a member. The Chairman of the Board received an annual fee of $18,000. The Chairman of the Executive Committee also received a stipend of $4,500 in addition to meeting fees paid for meetings attended. Certain Board members were also paid fees for appraisals, consulting services and legal services, and such fees are on terms no more favorable to the recipient than are generally paid by the Bank for such services to other providers in the area. Fees paid by the Bank to its Directors as a group totaled $91,700 in 2002, but no fees are paid to Directors of the Company. President Daigneault, who is the only director who is also an officer of the Company, receives no additional compensation for serving on the Board of Directors of the Company or the Bank. The Company has three standing committees of the Board of Directors: Audit, Options and Nominating. The Bank has seven standing committees of the Board of Directors: Executive, Audit, Asset/Liability, Trust, Directors' Loan, Compensation and Nominating. Certain members of management also serve on some committees. All directors attended at least 75% of Board meetings and meetings held by Committees of which they were members, and the aggregate attendance of Board and Committee meetings by all members of the Board of Directors in 2002 was in excess of 90%. Page 75 Stock Option Plan In April 1995, the stockholders approved a Stock Option Plan. The purpose of the Stock Option Plan is to encourage the retention of key employees by facilitating their purchase of a stock interest in the Company and to align their interest with those of the shareholders. The 1995 Stock Option Plan provides for grants of options to purchase Company common stock and is administered by an Options Committee which consists of four outside directors. During 2002, 11,000 stock options were granted under the 1995 Stock Option Plan. The following table sets forth the status of the Stock Option Plan as of December 31, 2002: ------------------------------------------------------------------------------- Options approved by Shareholders 200,000 ------------------------------------------------------------------------------- Options granted (194,000) Options forfeited 7,000 ------------------------------------------------------------------------------- Ungranted options remaining 13,000 ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- Outstanding Weighted average Number of unexercised options exercise price options ------------------------------------------------------------------------------- Exercisable $ 9.55 68,300 Non-exercisable 19.12 36,500 ------------------------------------------------------------------------------- $ 12.88 104,800 ------------------------------------------------------------------------------- 2002 Option Committee Members: Malcolm E. Blanchard, Chair Robert B. Gregory Carl S. Poole, Jr. Stuart G. Smith Long-Term Compensation Long-term compensation may be distinguished from annual compensation by the time frame for which performance results are measured to determine awards. While annual compensation covers a calendar year, long-term compensation is provided through the Company's stock option plan, which covers a period of two to ten years. The following table sets forth information with respect to the named executives and all other employees concerning grants of stock options during 2002: Page 76 ------------------------------------------------------------------------------- Option Grants During the Year Ended December 31, 2002 ------------------------------------------------------------------------------- % of Potential realizable Number of options value at assumed rates securities granted Exercise of stock appreciation underlying in price for option term(1) options fiscal per Expiration --------------------- granted year Share(2) Date 5% 10% ------------------------------------------------------------------------------- Daniel R. Daigneault -0- 0.0% $ -0- - $ -0- $ -0- F. Stephen Ward -0- 0.0% $ -0- - $ -0- $ -0- Charles A. Wootton 5,000 45.5% $ 28.00 4/2012 $ 88,000 $ 223,000 All other employees 6,000 54.5% $ 28.00 4/2012 $ 106,000 $ 268,000 ------------------------------------------------------------------------------- All 11,000 100.0% $ 28.00 4/2012 $ 194,000 $ 491,000 ------------------------------------------------------------------------------- 1) The dollar gains under these columns result from calculations assuming 5% and 10% growth rates compounded over a 10-year period as set by the Securities and Exchange Commission and are not intended to forecast future price appreciation of the Company's common stock. The gains reflect a future value based upon growth at these prescribed rates. The values have not been discounted to present value. It is important to note that options have value to the listed executive and to all option recipients only if the stock price advances beyond the exercise price shown on the table during the effective option period. 2) Under the Stock Option Plan, the exercise price may not be less than the fair market value of the common stock on the date the option is granted. The following table sets forth information with respect to exercisable and unexercisable options held as of December 31, 2002: ------------------------------------------------------------------------------- Aggregated Option Exercises in 2002 and December 31, 2002 Option Values ------------------------------------------------------------------------------- Number of securities underlying Value of unexercised unexercised options in-the-money Shares at year end options at year end acquired ------------------ --------------------- on Value Exer- Unexer- Exer- Unexer- exercise realized cisable cisable cisable cisable ------------------------------------------------------------------------------- Daniel R. Daigneault 35,000 $798,000 31,000 12,000 $ 729,000 $ 238,000 F. Stephen Ward -0- -0- 10,500 2,500 209,000 31,000 Charles A. Wootton -0- -0- 5,000 10,000 74,000 92,000 All other employees 8,200 165,000 21,800 12,000 486,000 91,000 ------------------------------------------------------------------------------- All optionees 43,200 $963,000 68,300 36,500 $1,498,000 $ 452,000 ------------------------------------------------------------------------------- Page 77 Description of the Company's Benefit Plans The Company has reserved 160,000 shares of its common stock to be made available to directors and employees who elect to participate in the directors' deferral, employee stock purchase, or 401(k) savings and investment plans. As of December 31, 2002, 110,523 shares had been issued pursuant to these plans, leaving 49,477 shares available for future issuance. The issuance price is based on the market price of the stock at issuance date. All shares issued under the 401(k) savings and investment plans are issued pursuant to an exemption from registration under the Securities Act of 1933, as amended (the "Securities Act"), contained in Section 3(a)(11) thereof and Rule 147 promulgated thereunder. During the period ending nine months after the date of issuance of these shares, these shares may be transferred only to residents of the State of Maine. Each certificate issued for these plan shares bears a legend referring to this restriction. Shares issued under the employee stock purchase plan prior to September 11, 1998, were issued pursuant to exemptions from registration under Section 3(a)(11) and Rule 147 of the Securities Act. Shares issued under the employee stock purchase plan on or after September 11, 1998, have been issued pursuant to a registration statement filed under the Securities Act. The members of the Board of Directors and certain officers of the Company, who may be deemed to be "affiliates", may resell shares of the Company's common stock purchased or acquired under this plan only in accordance with certain restrictions imposed by the Securities Act and Rule 144 promulgated thereunder. The Bank's 401(k) Plan (The First National Bank of Damariscotta Savings and Investment Plan) is the Bank's sole retirement plan, and was modified in 1996 after termination of the Bank's traditional defined benefit pension plan. It is available to any employee who has attained the age of 21 and completed six months of continuous service. Employees may contribute up to 50.0% of their compensation (not to exceed $11,000 if under age 50 and $12,000 if over age 50), and the Bank may provide a match of up to 3.0% of compensation. Subject to a vote of the Board of Directors, the Bank may also make a profit-sharing contribution to the Plan, and in 2002 this contribution equaled 3.0% of each eligible employee's compensation. The 401(k) Plan is administered by a special committee appointed by the Board of Directors. Employee contributions are 100% vested at all times, while employer contributions are vested over a five-year period. Upon termination of employment for any reason, a plan participant may receive his or her contribution account and earnings allocated to it, as well as the vested portion of his or her employer-matching account and earnings allocated to it. Non-vested amounts are forfeited and are used by the Bank to help defray plan administration expenses incurred by the Bank. The Bank paid $95,000 in matching contributions and $121,000 in profit-sharing contributions to this plan in 2002. Plan participants may direct the trustees of the 401(k) Plan to purchase specific assets for their accounts from a selection which includes seven mutual funds as well as the Company's stock. As of December 31, 2002, 57,321 shares of the Company's stock had been purchased by the 401(k) Plan at the direction of plan participants. The Bank instituted an employee stock purchase plan effective February 1, 1987, and the Board of Directors has allocated 80,000 shares of stock to be available for purchase under this plan. Employees who have been employed by the Bank for three consecutive calendar months are eligible to purchase shares on a quarterly basis through payroll deduction. The price per share for shares sold pursuant to the plan is defined as the closing price on the day the shares are purchased. As of December 31, 2002, 53,202 shares of the Company's stock had been purchased pursuant to the plan. Page 78 The Bank provides all full-time employees with group life, health, and long-term-disability insurance through the Independent Bankers' Employee Benefits Trust of Maine. A Flexible Benefits Plan is available to all full-time employees after satisfying eligibility requirements and to part-time employees scheduled to work 20 or more hours a week. The Bank also sponsors an un-funded, non-qualified supplemental retirement plan for certain officers. The plan provides supplemental retirement benefits payable in installments over 20 years upon retirement or death. The costs for this plan are recognized over the service lives of the participating officers. The projected retirement benefit for Mr. Daigneault, assuming he remains employed by the Bank until normal retirement age of 65, is $169,329 per year, with such payments beginning in the year 2017. The projected retirement benefit for Mr. Ward, assuming he remains employed by the Bank until normal retirement age of 65, is $61,127 per year, with such payments beginning in the year 2018. The expense for all participants in this supplemental plan was $112,000 in 2002, $141,000 in 2001, and $123,000 in 2000. As of December 31, 2002 and 2001, the accrued liability of this plan was $591,000 and $484,000, respectively. On December 15, 1994, the Company's board of directors adopted a Stock Option Plan (the "Option Plan") for the benefit of officers and other full-time employees of the Company and the Bank. This plan was approved by the Company's shareholders at the 1995 Annual Meeting. Under the Option Plan, 200,000 shares (subject to adjustment to reflect stock splits and similar events) are reserved from the authorized but unissued common stock of the Company for future issuance by the Company for exercise of stock options granted to certain key employees of the Company and the Bank from time to time. The purpose of the Option Plan is to encourage the retention of such key employees by facilitating their purchase of a stock interest in the Company. The Option Plan is intended to provide for the granting of incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code") to employees of the Company or the Bank. The Option Plan is administered by the Options Committee of the Company's board of directors, which is comprised solely of directors who are ineligible to receive grants of stock options under the Option Plan and who have not received grants of options within the 12 months preceding their appointment to the Options Committee. The Options Committee selects the employees of the Bank and the Company to whom options are to be granted and designates the number of options to be granted. The Option Plan may be amended only by the vote of the holders of a majority of the Company's outstanding common stock if such amendment would increase the number of shares available for issuance under the Option Plan, change the eligibility criteria for grants of options under the Option Plan, change the minimum option exercise price or increase the maximum term of options. Other amendments may be effected by the Options Committee. Employees selected by the Options Committee receive, at no cost to them, options under the Option Plan. The option exercise prices are equal to or exceed the fair market value of the shares on the date of the grant, and no option is exercisable after the expiration of 10 years from the date it is granted. The fair market value of the shares is determined by the Options Committee as specified in the Option Plan. The optionee cannot transfer or assign any option other than by will or in accordance with the laws of descent and distribution, and the option may be exercised only by the employee during the employee's lifetime. After an employee's death, options may be exercised by the employee's estate or heirs up to one year following the date of death. Code Section 422 limits option grants by providing that during the term of the Option Plan, no grant may be made to any employee owning more than 10% of the Company's outstanding shares unless the exercise price is at least 110% of the underlying shares' fair market value and such option is not exercisable more than five years following the option grant. The aggregate fair market value of the stock for which any employee may be granted incentive stock options which Page 79 are first exercisable in any calendar year may generally not exceed $100,000. While generally no options may be exercisable before the second anniversary of the grant date, in the event of a change in control involving the Company all options (other than those held by officers or directors of the Company or the Bank for less than six months) shall become immediately exercisable. Also, an employee whose employment is terminated in connection with or within two years after such a change in control event shall be entitled to exercise all options for up to three months following the date of termination; provided that options held by officers or directors shall not be exercisable until six months after the grant date. Employees whose services are terminated, other than following a change in control as described above, shall thereupon forfeit any options held; provided, however, that following termination due to disability an employee shall be entitled to exercise options for up to one year (provided, further, that officers may exercise only with respect to options held for at least six months). The Company receives no monetary consideration for the granting of incentive stock options. Upon the exercise of options, the Company receives payment in cash from optionees in exchange for shares issued. No federal income tax consequences are incurred by the Company at the time incentive stock options are granted or exercised, unless the optionee incurs liability for ordinary income tax treatment upon exercise of the option, as discussed below, in which event the Company would be entitled to a deduction equal to the optionee's ordinary income attributable to the options. Provided the employee holds the shares received on exercise of a stock option for the longer of two years after the option was granted or one year after it was exercised, the optionee will realize capital gains income (or loss) in the year of sale in an amount equal to the difference between the sale price and the option exercise price paid for shares. If the employee sells the shares prior to the expiration of the period, the employee realizes ordinary income in the year of disposition equal to the difference between the fair market value of the shares on the date of exercise and the exercise price and capital gains income (or loss) equal to the difference (if any) between the sale price of the shares and the fair market value of the shares on the date of exercise. In addition to the tax consequences discussed above, the excess of the option price over the fair market value of the optioned stock at the time of option exercise is required to be treated by an incentive optionee as an item of tax preference for purposes of the alternative minimum tax. Performance Graph Set forth below is a line graph comparing the five-year cumulative total return of $100.00 invested in the Company's common stock ("FNLC"), assuming reinvestment of all cash dividends and retention of all stock dividends, with a comparable amount invested in the Standard & Poor's 500 Index ("S&P 500") and the NASDAQ Combined Bank Index ("NASD Bank"). The NASD Bank index is a capitalization-weighted index designed to measure the performance of all NASDAQ stocks in the banking sector. The following information is presented in a line graph in the printed form 10_K: ------------------------------------------------------------------------------- Performance graph data 1997 1998 1999 2000 2001 2002 ------------------------------------------------------------------------------- FNLC 100.00 166.18 123.71 123.03 184.42 271.97 NASD Bank 100.00 88.23 81.19 93.10 102.48 107.11 S&P 500 100.00 128.34 155.08 141.08 124.36 96.87 ------------------------------------------------------------------------------- Page 80 ITEM 12. Security Ownership of Certain Beneficial Owners and Management Security Ownership of Directors, Management and Principal Shareholders(1) The following table sets forth the number of shares of common stock of the Company beneficially owned as of March 10, 2003 by (i) each person known by the Company to own beneficially more than five percent of the Company's common stock, (ii) each current director of the Company and nominee for a position on the Board, (iii) the named executive officers, and (iv) all executive officers and directors of the Company as a group. Except as otherwise indicated below, each of the directors, executive officers and shareholders owning more than five percent of the Company's stock has sole voting and investment power with respect to all shares of stock beneficially owned as set forth opposite his or her name. Page 81 ------------------------------------------------------------------------------- Shares Percent Owners of 5% or More Owned Owned ------------------------------------------------------------------------------- Daniel P. & Edith I. Thompson 157,804 6.52% 20 Pounds Road New Harbor, ME 04545 ------------------------------------------------------------------------------- Directors & Executive Officers ------------------------------------------------------------------------------- Name Position Term Shares Percent Age(2) Expires Owned Owned ------------------------------------------------------------------------------- Bruce A. Bartlett Director of the Bank and the Company; 2004 8,571 * 69 Chairman, Trust Committee Malcolm E. Blanchard Director of the Bank and the Company; 2004 28,440 1.18% 68 Chairman, Executive Committee Katherine M. Boyd Director of the Bank and the Company 2005 11,015 * 51 Daniel R. Daigneault President, Chief Executive Officer 2003 78,920(3) 3.26% 50 and Director of the Bank and the Company Dana L. Dow Director of the Bank and the Company 2003 1,631 * 51 Robert B. Gregory Chairman of the Boards of Directors 2003 14,856 * 49 of the Bank and the Company Carl S. Poole, Jr. Director of the Bank and the Company; 2005 90,305 3.73% 57 Chairman, Asset/Liability Committee Stuart G. Smith Director of the Bank and the Company; 2004 27,391 1.13% 50 Chairman, Directors' Loan Committee David B. Soule, Jr. Director of the Bank and the Company; 2005 5,721 * 57 Chairman, Audit Committees of the Bank and the Company Bruce B. Tindal Director of the Bank and the Company 2005 1,985 * 52 F. Stephen Ward Treasurer & Chief Financial Officer n/a 26,965(3) 1.11% 49 of the Company; Senior Vice President and Chief Financial Officer of the Bank; Principal of Pemaquid Advisors Charles A. Wootton Clerk of Company; Senior Vice n/a 5,075(3) * 46 President Banking Services Officer and Senior Loan Officer of the Bank ------------------------------------------------------------------------------- Total Ownership of all Directors and Executive Officers as a group 335,848 13.88% ------------------------------------------------------------------------------- * Less than one percent of total outstanding shares (1)For purposes of this table, beneficial ownership has been determined in accordance with the provisions of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended. In general, a person is deemed to be the beneficial owner of a security if he/she has or shares the power to vote or to direct the voting of the security or the power to dispose or direct the disposition of the security, or if he/she has the right to acquire beneficial ownership of the security within 60 days. The figure set forth includes director's qualifying shares owned by each person. (2)As of December 31, 2002. (3)Includes exercisable stock options. Page 82 ITEM 13. Certain Relationships and Related Transactions The Federal Reserve Act permits the Bank to contract for or purchase property from any of its Directors only when such purchase is made in the regular course of business upon terms not less favorable to the Bank than those offered by others unless the purchase has been authorized by a majority of the Board of Directors not interested in the transaction. Similarly, the Federal Reserve Act prohibits loans to Executive Officers of the Bank unless such loans are on terms not more favorable than those afforded other borrowers and certain other prescribed conditions have been met. The Bank has had, and expects to have in the future, banking transactions in the ordinary course of its business with Directors, Officers and principal shareholders of the Company and their affiliates. All such transactions have been made upon substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with others. In the opinion of Management, such loans have not involved more than the normal risk of collectibility nor have they presented other unfavorable features. The total amount of loans outstanding at December 31, 2002 to the Company's Directors, Executive Officers and their associates was $7,324,141, which constituted 2.21% of the Bank's total loans outstanding at that date. Page 83 ITEM 14. Controls and Procedures Evaluation of disclosure controls and procedures. As required by Rule 13a-15 under the Securities Exchange Act of 1934, within the 90 days prior to the date of this report, the Company carried out an evaluation under the supervision and with the participation of the Company's Management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. In connection with the new rules, the Company is currently in the process of further reviewing and documenting disclosure controls and procedures, including internal controls and procedures for financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that these systems evolve with the Company's business. Changes in internal controls. None. Page 84 ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Exhibits Exhibit 3 Articles of Incorporation and Bylaws, filed as Exhibit 3 to Company's Registration Statement No. 2-96573. Exhibit 3.1 Articles of Amendment, filed as part of Exhibit 3 to the Company's Registration Statement No. 2-96573. Exhibit 3.2 Amendments to Articles of Incorporation filed as part of Exhibit 3 to the Company's quarterly filing on Form 10-Q for the second quarter of 1996. Exhibit 4.1 Articles of Incorporation and Bylaws, filed as Exhibit 3 to the Company's Registration Statement No. 2-96573. Exhibit 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K The Company's press release announcing its third quarter earnings was filed on Form 8-K under item 5 on October 16, 2002. Pursuant to section 906 of the Sarbanes-Oxley Act of 2002, the certifications of Daniel R. Daigneault, President & Chief Executive Officer, and F. Stephen Ward, Treasurer & Chief Financial Officer, were filed on Form 8-K under item 9 on November 8, 2002. The certifications were filed in connection with the filing of the Company's report on Form 10-Q for the period ended September 30, 2002. The Company's press release announcing the fourth quarter 2002 dividend declaration was filed on Form 8-K under item 5 on December 20, 2002. Page 85 SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ------------------------------------------------ FIRST NATIONAL LINCOLN COPORATION By /s/Daniel R. Daigneault Daniel R. Daigneault, President March 20, 2003 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title and Date /s/Daniel R. Daigneault President and Director Daniel R. Daigneault (Principal Executive Officer) March 20, 2003 /s/F. Stephen Ward Treasurer F. Stephen Ward (Principal Financial Officer, Principal Accounting Officer) March 20, 2003 /s/Robert B. Gregory Director and Robert B. Gregory Chairman of the Board March 20, 2003 /s/Bruce A. Bartlett Director Bruce A. Bartlett March 20, 2003 /s/Malcolm E. Blanchard Director Malcolm E. Blanchard March 20, 2003 /s/Katherine M. Boyd Director Katherine M. Boyd March 20, 2003 /s/Dana L. Dow Director Dana L. Dow March 20, 2003 /s/Carl S. Poole, Jr. Director Carl S. Poole, Jr. March 20, 2003 /s/Stuart G. Smith Director Stuart G. Smith March 20, 2003 /s/David B. Soule, Jr. Director David B. Soule, Jr. March 20, 2003 /s/Bruce A. Tindal Director Bruce A. Tindal March 20, 2003 Page 86 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Daniel R. Daigneault, certify that: 1. I have reviewed this annual report on Form 10-K of First National Lincoln Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 20, 2003 /s/ Daniel R. Daigneault Daniel R. Daigneault President & Chief Executive Officer First National Lincoln Corporation Page 87 CERTIFICATION OF CHIEF FINANCIAL OFFICER I, F. Stephen Ward, certify that: 1. I have reviewed this annual report on Form 10-K of First National Lincoln Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 20, 2003 /s/ F. Stephen Ward F. Stephen Ward Treasurer & Chief Financial Officer First National Lincoln Corporation Page 88