UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
___
TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number:
841105-D
BAR HARBOR BANKSHARES
(Exact name of registrant as specified in its charter)
Maine
|
01-0393663
|
(State
or other jurisdiction of
incorporation or organization)
|
(I.R.S.
Employer
Identification Number)
|
|
|
PO
Box 400
|
|
82 Main Street, Bar Harbor, ME
|
04609-0400
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(207) 288-3314
(Registrant's telephone number, including area code)
Inapplicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90
days. YES
X
NO
___
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer" and "large accelerated filer" in Rule 12b-2 of the
Exchange Act.
Large accelerated filer ___ Accelerated filer
X
Non-accelerated filer ___
Indicate by check mark whether the registrant is a shell company (as
defined in exchange act rule 12b-2): YES: ___ NO:
X
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date:
Class of Common Stock
|
Number of Shares Outstanding November 7, 2007
|
$2.00 Par Value
|
3,024,514
|
TABLE OF CONTENTS
|
|
Page No.
|
PART I
|
FINANCIAL INFORMATION
|
|
|
|
|
Item
1.
|
Financial
Statements (
unaudited)
:
|
|
|
|
|
|
Consolidated
Balance Sheets at September 30, 2007, and December 31, 2006
|
3
|
|
|
|
|
Consolidated
Statements of Income for the three and nine months ended
September 30, 2007 and 2006
|
4
|
|
|
|
|
Consolidated
Statements of Changes in Shareholders' Equity for the nine months ended
September 30, 2007 and 2006
|
5
|
|
|
|
|
Consolidated
Statements of Cash Flows for the nine months ended
September 30, 2007 and 2006
|
6
|
|
|
|
|
Consolidated
Statements of Comprehensive Income for the three and nine months ended September 30, 2007
and 2006
|
7
|
|
|
|
|
Notes
to Consolidated Interim Financial Statements
|
8-16
|
|
|
|
Item
2.
|
Management's
Discussion and Analysis of Financial Condition and Results of Operations
|
16-45
|
|
|
|
Item
3.
|
Quantitative and Qualitative Disclosures About Market Risk
|
46-49
|
|
|
|
Item
4.
|
Controls and Procedures
|
49
|
|
|
|
|
|
|
PART II
|
OTHER INFORMATION
|
|
|
|
|
Item
1.
|
Legal Proceedings
|
49
|
|
|
|
Item
1A.
|
Risk Factors
|
49
|
|
|
|
Item
2.
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
50
|
|
|
|
Item
3.
|
Defaults Upon Senior Securities
|
50
|
|
|
|
Item
4.
|
Submission of Matters to a Vote of Security Holders
|
50
|
|
|
|
Item
5.
|
Other Information
|
50
|
|
|
|
Item
6.
|
Exhibits
|
50-51
|
|
|
|
Signatures
|
|
51
|
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2007 AND DECEMBER 31, 2006
(Dollars in thousands, except share data)
(
unaudited
)
|
September 30,
2007
|
|
December 31,
2006
|
Assets
|
|
|
|
Cash and due from banks
|
$ 9,642
|
|
$ 11,838
|
Overnight interest bearing money market funds
|
1,414
|
|
7,709
|
Total cash and cash equivalents
|
11,056
|
|
19,547
|
Securities available for sale, at fair value
|
244,457
|
|
213,252
|
Federal Home Loan Bank stock
|
12,832
|
|
11,849
|
Loans
|
566,012
|
|
555,099
|
Allowance for loan losses
|
(4,630)
|
|
(4,525)
|
Loans, net of allowance for loan losses
|
561,382
|
|
550,574
|
Premises and equipment, net
|
10,857
|
|
11,368
|
Goodwill
|
3,158
|
|
3,158
|
Bank owned life insurance
|
6,285
|
|
6,116
|
Other assets
|
8,728
|
|
9,013
|
TOTAL ASSETS
|
$858,755
|
|
$824,877
|
|
|
|
|
Liabilities
|
|
|
|
Demand and other non-interest bearing deposits
|
$ 63,210
|
|
$ 53,872
|
NOW accounts
|
68,747
|
|
63,588
|
Savings and money market deposits
|
139,975
|
|
164,213
|
Time deposits
|
131,246
|
|
132,285
|
Brokered time deposits
|
123,684
|
|
82,361
|
Total deposits
|
526,862
|
|
496,319
|
Short-term borrowings
|
147,672
|
|
175,246
|
Long-term debt
|
115,007
|
|
85,466
|
Other liabilities
|
5,234
|
|
6,795
|
TOTAL LIABILITIES
|
794,775
|
|
763,826
|
|
|
|
|
Shareholders' equity
|
|
|
|
Capital stock, par value $2.00; authorized
10,000,000 shares;
issued 3,643,614 shares at
September 30, 2007 and December 31, 2006
|
7,287
|
|
7,287
|
Surplus
|
4,600
|
|
4,365
|
Retained earnings
|
62,310
|
|
59,339
|
Accumulated other comprehensive loss:
|
|
|
|
Prior service cost
and unamortized net actuarial (losses) gains on employee
benefit plans, net of tax of ($65) and $80, at September 30, 2007,
and
December 31, 2006, respectively
|
(126)
|
|
156
|
Net unrealized
depreciation on securities available for sale, net of tax of
$181
and $351, at September 30, 2007 and December 31, 2006, respectively
|
(351)
|
|
(680)
|
Net unrealized
depreciation on derivative instruments, net of tax of
$87
and $221 at September 30, 2007 and December 31, 2006, respectively
|
(170)
|
|
(429)
|
Total accumulated
other comprehensive loss
|
(647)
|
|
(953)
|
Less: cost of 614,900
and 596,169 shares of treasury stock at
September 30, 2007,
and December 31, 2006, respectively
|
(9,570)
|
|
(8,987)
|
|
|
|
|
TOTAL SHAREHOLDERS' EQUITY
|
63,980
|
|
61,051
|
|
|
|
|
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
|
$858,755
|
|
$824,877
|
The accompanying notes are an integral part of these unaudited consolidated interim
financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Dollars in thousands, except share data)
(unaudited)
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2007
|
2006
|
|
2007
|
2006
|
Interest and dividend income:
|
|
|
|
|
|
Interest and fees on loans
|
$ 9,681
|
$ 9,137
|
|
$28,281
|
$26,143
|
Interest and dividends on securities and other
earning assets
|
3,685
|
2,943
|
|
10,051
|
7,955
|
Total interest and dividend income
|
13,366
|
12,080
|
|
38,332
|
34,098
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
Deposits
|
4,207
|
3,561
|
|
12,084
|
9,271
|
Short-term borrowings
|
1,967
|
1,684
|
|
4,919
|
4,737
|
Long-term borrowings
|
1,279
|
1,287
|
|
4,538
|
3,787
|
Total interest expense
|
7,453
|
6,532
|
|
21,541
|
17,795
|
|
|
|
|
|
|
Net interest income
|
5,913
|
5,548
|
|
16,791
|
16,303
|
Provision for loan losses
|
214
|
81
|
|
247
|
124
|
Net interest income after provision for loan losses
|
5,699
|
5,467
|
|
16,544
|
16,179
|
|
|
|
|
|
|
Non-interest income:
|
|
|
|
|
|
Trust and other financial services
|
564
|
486
|
|
1,747
|
1,558
|
Service charges on deposit accounts
|
454
|
440
|
|
1,242
|
1,188
|
Other service charges, commissions and fees
|
57
|
61
|
|
162
|
171
|
Credit and debit card service charges and fees
|
871
|
776
|
|
1,579
|
1,399
|
Net securities gains (losses)
|
231
|
357
|
|
(671)
|
667
|
Other operating income
|
86
|
79
|
|
240
|
345
|
Total non-interest income
|
2,263
|
2,199
|
|
4,299
|
5,328
|
|
|
|
|
|
|
Non-interest expenses:
|
|
|
|
|
|
Salaries and employee benefits
|
2,386
|
2,360
|
|
6,885
|
7,077
|
Postretirement plan settlement
|
---
|
---
|
|
(832)
|
---
|
Occupancy expense
|
294
|
329
|
|
987
|
978
|
Furniture and equipment expense
|
396
|
456
|
|
1,284
|
1,378
|
Credit and debit card expenses
|
621
|
577
|
|
1,079
|
993
|
Other operating expense
|
1,099
|
1,135
|
|
3,743
|
3,766
|
Total non-interest expenses
|
4,796
|
4,857
|
|
13,146
|
14,192
|
|
|
|
|
|
|
Income before income taxes
|
3,166
|
2,809
|
|
7,697
|
7,315
|
Income taxes
|
1,019
|
845
|
|
2,332
|
2,142
|
|
|
|
|
|
|
Net income
|
$ 2,147
|
$ 1,964
|
|
$ 5,365
|
$ 5,173
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings Per Share:
|
|
|
|
|
|
Basic earnings per share
|
$ 0.71
|
$ 0.64
|
|
$ 1.76
|
$ 1.70
|
Diluted earnings per share
|
$ 0.69
|
$ 0.63
|
|
$ 1.72
|
$ 1.66
|
The accompanying notes are an integral part of these unaudited consolidated interim
financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Dollars in thousands, except share data)
(unaudited)
|
Capital
Stock
|
Surplus
|
Retained
Earnings
|
Accumulated
Other
Comprehensive
Loss
|
Treasury
Stock
|
Total
Shareholders'
Equity
|
|
|
|
|
|
|
|
Balance December 31, 2005
|
$7,287
|
$4,002
|
$55,181
|
$(1,738)
|
$(8,628)
|
$56,104
|
Cumulative effect adjustment from the adoption of SAB No. 108
|
---
|
---
|
331
|
---
|
---
|
331
|
Adjusted balance December 31, 2005
|
7,287
|
4,002
|
55,512
|
(1,738)
|
(8,628)
|
56,435
|
Net income
|
---
|
---
|
5,173
|
---
|
---
|
5,173
|
Total other comprehensive income
|
---
|
---
|
---
|
259
|
---
|
259
|
Cash dividends declared ($0.675 per share)
|
---
|
---
|
(2,060)
|
---
|
---
|
(2,060)
|
Purchase of treasury stock (35,377 shares)
|
---
|
---
|
---
|
---
|
(1,014)
|
(1,014)
|
Stock options exercised
(23,401 shares), net of tax effects
|
---
|
---
|
(239)
|
---
|
672
|
433
|
Recognition of stock option expense
|
---
|
109
|
---
|
---
|
---
|
109
|
Balance September 30, 2006
|
$7,287
|
$4,111
|
$58,386
|
$(1,479)
|
$(8,970)
|
$59,335
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2006
|
$7,287
|
$4,365
|
$59,339
|
$ (953)
|
$(8,987)
|
$61,051
|
Net income
|
---
|
---
|
5,365
|
---
|
---
|
5,365
|
Total other comprehensive income
|
---
|
---
|
---
|
306
|
---
|
306
|
Cash dividends declared ($0.71 per share)
|
---
|
---
|
(2,161)
|
---
|
---
|
(2,161)
|
Purchase of treasury stock (36,947 shares)
|
---
|
---
|
---
|
---
|
(1,152)
|
(1,152)
|
Stock options exercised
(18,216 shares), net of tax effects
|
---
|
78
|
(233)
|
---
|
569
|
414
|
Recognition of stock option expense
|
---
|
157
|
---
|
---
|
---
|
157
|
Balance September 30, 2007
|
$7,287
|
$4,600
|
$62,310
|
$ (647)
|
$(9,570)
|
$63,980
|
The accompanying notes are an integral part of these unaudited consolidated interim
financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Dollars in thousands)
(unaudited)
|
2007
|
2006
|
Cash flows from operating activities:
|
|
|
Net income
|
$ 5,365
|
$ 5,173
|
Adjustments to reconcile net income to net cash
provided by operating activities:
|
|
|
Depreciation and amortization of premises and
equipment
|
919
|
1,001
|
Amortization of core deposit intangible
|
50
|
50
|
Provision for loan losses
|
247
|
124
|
Net securities losses (gains)
|
671
|
(667)
|
Net amortization of bond premiums
|
132
|
209
|
Recognition of stock option expense
|
157
|
109
|
Postretirement plan settlement
|
(832)
|
---
|
Net change in other assets
|
(93)
|
41
|
Net change in other liabilities
|
(763)
|
(402)
|
Net cash provided by operating activities
|
5,853
|
5,638
|
|
|
|
Cash flows from investing activities:
|
|
|
Purchases of securities available for sale
|
(117,581)
|
(44,995)
|
Proceeds from maturities, calls and principal
paydowns of securities available for sale
|
31,559
|
24,580
|
Proceeds from sales of securities available for
sale
|
54,513
|
6,628
|
Net increase in Federal Home Loan Bank stock
|
(983)
|
(1,325)
|
Net loans made to customers
|
(11,055)
|
(32,799)
|
Capital expenditures
|
(408)
|
(682)
|
Net cash used in investing activities
|
(43,955)
|
(48,593)
|
|
|
|
Cash flows from financing activities:
|
|
|
Net increase in deposits
|
30,543
|
68,650
|
Net increase (decrease) in securities sold under
repurchase agreements and fed funds purchased
|
7,545
|
(2,738)
|
Proceeds from Federal Home Loan Bank advances
|
79,000
|
30,000
|
Repayments of Federal Home Loan Bank advances
|
(84,578)
|
(51,780)
|
Purchases of treasury stock
|
(1,152)
|
(1,014)
|
Proceeds from stock option exercises, including
excess tax benefits
|
414
|
433
|
Payments of dividends
|
(2,161)
|
(2,060)
|
Net cash provided by financing activities
|
29,611
|
41,491
|
|
|
|
Net decrease in cash and cash equivalents
|
(8,491)
|
(1,464)
|
Cash and cash equivalents at beginning of period
|
19,547
|
14,000
|
Cash and cash equivalents at end of period
|
$ 11,056
|
$ 12,536
|
|
|
|
Supplemental disclosures of cash flow information:
|
|
|
Cash paid during the period for:
|
|
|
Interest
|
$ 20,822
|
$ 17,202
|
Income taxes
|
1,508
|
1,362
|
The accompanying notes are an integral part of these unaudited consolidated interim
financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Dollars in thousands)
(unaudited)
|
Three Months Ended
September 30,
|
|
2007
|
2006
|
|
|
|
Net income
|
$2,147
|
$1,964
|
Net unrealized appreciation on securities
available for sale, net of tax of $847 and $1,233, respectively
|
1,645
|
2,395
|
Less reclassification adjustment for net gains
related to securities available for sale included in
net income, net of tax of $78 and
$121, respectively
|
(153)
|
(236)
|
Net unrealized appreciation and other amounts for
interest rate derivatives, net of tax of $84 and $99,
respectively
|
163
|
192
|
Amortization of actuarial gain for supplemental
retirement plan, net of tax of $4
|
6
|
---
|
Total other
comprehensive income
|
1,661
|
2,351
|
Total comprehensive income
|
$3,808
|
$4,315
|
|
|
|
|
Nine Months Ended
September 30,
|
|
2007
|
2006
|
|
|
|
Net income
|
$5,365
|
$5,173
|
Net unrealized (depreciation) appreciation on
securities available for sale, net of tax of ($59) and $342,
respectively
|
(113)
|
664
|
Less reclassification adjustment for net losses
(gains) related to securities available for sale
included in net income, net of tax
of $229 and ($227), respectively
|
442
|
(440)
|
Net unrealized appreciation on interest rate
derivatives, net of tax of $134 and $18, respectively
|
259
|
35
|
Reversal of actuarial gain upon post retirement
plan settlement, net of tax of ($151)
|
(291)
|
---
|
Amortization of actuarial gain for supplemental
executive retirement plan, net of tax of $6
|
9
|
---
|
Total other
comprehensive income
|
306
|
259
|
Total comprehensive income
|
$5,671
|
$5,432
|
The accompanying notes are an integral part of these unaudited consolidated interim
financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
SEPTEMBER 30, 2007
(Dollars in thousands, except share data)
(
unaudited
)
Note 1: Basis of Presentation
The accompanying consolidated interim financial statements are
unaudited. In the opinion of management, all adjustments considered necessary for a fair
presentation have been included. All inter-company transactions have been eliminated in
consolidation. Amounts in the prior period financial statements are reclassified whenever
necessary to conform to current period presentation. The net income reported for the three
and nine months ended September 30, 2007 is not necessarily indicative of the results that
may be expected for the year ending December 31, 2007, or any other interim periods.
The consolidated balance sheet at December 31, 2006 has been derived
from audited consolidated financial statements at that date. The accompanying unaudited
interim consolidated financial statements have been prepared in accordance with United
States generally accepted accounting principles for interim financial information and with
the instructions to Form 10-Q and Rule 10-01 of Regulation S-X (17 CFR Part 218).
Accordingly, they do not include all of the information and footnotes required by U.S.
generally accepted accounting principles for complete financial statements. For further
information, refer to the consolidated financial statements included in the Companys
Annual Report on Form 10-K for the year ended December 31, 2006, and notes thereto.
Note 2: Managements Use of Estimates
The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Material estimates that are particularly susceptible to significant
change in the near term relate to the determination of the allowance for loan losses,
income tax estimates, and the valuation of intangible assets.
Allowance For Loan Losses:
The allowance for loan losses (the
"allowance") at the Companys wholly owned banking subsidiary, Bar Harbor
Bank & Trust (the "Bank") is a significant accounting estimate used in the
preparation of the Companys consolidated financial statements. The allowance is
available to absorb losses on loans. The allowance is maintained at a level that, in
managements judgment, is appropriate for the amount of risk inherent in the loan
portfolio, given past and present conditions. The allowance is increased by provisions
charged to operating expense and by recoveries on loans previously charged-off.
Arriving at an appropriate level of allowance for loan losses involves
a high degree of judgment. The determination of the adequacy of the allowance and
provisioning for estimated losses is evaluated regularly based on review of loans, with
particular emphasis on non-performing and other loans that management believes warrant
special consideration. The ongoing evaluation process includes a formal analysis, which
considers among other factors: the character and size of the loan portfolio, business and
economic conditions, real estate market conditions, collateral values, changes in product
offerings or loan terms, changes in underwriting and/or collection policies, loan growth,
previous charge-off experience, delinquency trends, non-performing loan trends, the
performance of individual loans in relation to contract terms, and estimated fair values
of collateral.
The allowance for loan losses consists of reserves established for
specific loans including impaired loans; a pool of reserves based on historical
charge-offs by loan types; and supplemental reserves that adjust historical loss
experience to reflect current economic conditions, industry specific risks, and other
observable data.
While management uses available information to recognize losses on
loans, changing economic conditions and the economic prospects of the borrowers may
necessitate future additions or reductions to the allowance. In addition, various
regulatory agencies, as an integral part of their examination process, periodically review
the Banks allowance, which also may necessitate future additions or reductions to
the allowance, based on information available to them at the time of their examination.
Income Taxes:
As further discussed in note 7,
on
January 1, 2007, the Company adopted Financial Accounting Interpretation Number 48
("FIN 48") to account for uncertain tax positions. FIN 48 prescribes a
recognition threshold of more-likely-than-not, and a measurement attribute for all tax
positions taken or expected to be taken on a tax return, in order for those tax positions
to be recognized in the financial statements.
The Company estimates its income taxes for each period for which a
statement of income is presented.
The Company uses the asset and liability
method of accounting for income taxes. Under this method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. If current available information indicates that it is more
likely than not that deferred tax assets will not be realized, a valuation allowance is
established. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the enactment
date.
Significant management judgment is required in determining income tax
expense, and related tax assets and liabilities. As of September 30, 2007 and December 31,
2006, there was no valuation allowance for deferred tax assets. Deferred tax assets are
included in other assets on the consolidated balance sheet.
Goodwill and Identifiable Intangible Assets:
In connection with
acquisitions, the Company generally records as assets on its consolidated financial
statements both goodwill and identifiable intangible assets, such as core deposit
intangibles.
The Company evaluates whether the carrying value of its goodwill has
become impaired, in which case the value is reduced through a charge to its earnings.
Goodwill is evaluated for impairment at least annually, or upon a triggering event as
defined by Statement of Financial Accounting Standards ("SFAS") No. 142, using
certain fair value techniques.
Identifiable intangible assets, included in other assets on the
consolidated balance sheet, consist of core deposit intangibles amortized over their
estimated useful lives on a straight-line method, which approximates the amount of
economic benefits to the Company. These assets are reviewed for impairment at least
annually, or whenever management believes events or changes in circumstances indicate that
the carrying amount of the asset may not be recoverable. Furthermore, the determination of
which intangible assets have finite lives is subjective, as is the determination of the
amortization period for such intangible assets.
Any changes in the estimates used by the Company to determine the
carrying value of its goodwill and identifiable intangible assets, or which otherwise
adversely affect their value or estimated lives, would adversely affect the Companys
consolidated results of operations.
Note 3: Earnings Per Share
Earnings per share have been computed in accordance with
SFAS No. 128, "Earnings Per Share."
Basic earnings per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential dilution
that could occur if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company, such as the Companys dilutive stock options.
The following is a reconciliation of basic and diluted earnings per
share for the three and nine months ended September 30, 2007 and 2006:
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2007
|
2006
|
|
2007
|
2006
|
|
|
|
|
|
|
Net income
|
$ 2,147
|
$ 1,964
|
|
$ 5,365
|
$ 5,173
|
|
|
|
|
|
|
|
|
|
|
|
|
Computation of Earnings Per Share:
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of capital stock shares outstanding
|
|
|
|
|
|
Basic
|
3,039,585
|
3,049,211
|
|
3,043,442
|
3,050,814
|
Effect of dilutive employee stock options
|
70,369
|
70,872
|
|
76,349
|
72,049
|
Diluted
|
3,109,954
|
3,120,083
|
|
3,119,791
|
3,122,863
|
|
|
|
|
|
|
EARNINGS PER SHARE:
|
|
|
|
|
|
Basic
|
$ 0.71
|
$ 0.64
|
|
$ 1.76
|
$ 1.70
|
Diluted
|
$
0.69
|
$
0.63
|
|
$
1.72
|
$
1.66
|
|
|
|
|
|
|
Anti-dilutive options excluded from earnings per share calculation
|
103,286
|
82,161
|
|
72,434
|
82,541
|
Note 4: Retirement Benefit Plans
Prior to the first quarter of 2007, the Company sponsored a limited
post-retirement benefit program, which funded medical coverage and life insurance benefits
to a closed group of active and retired employees who met minimum age and service
requirements. It was the Company's policy to record the cost of post-retirement health
care and life insurance plans based on actuarial estimates, which were dependent on claims
and premiums paid. The cost of providing these benefits was accrued during the active
service period of the employee.
The following table summarizes the net periodic benefit costs for the
three and nine months ended September 30, 2006:
Three Months Ended
|
|
|
|
Interest cost
|
$21
|
Amortization of actuarial gain
|
(4)
|
Net periodic benefit cost
|
$17
|
|
|
Nine Months Ended
|
|
|
|
Interest cost
|
$62
|
Amortization of actuarial gain
|
(12)
|
Net periodic benefit cost
|
$50
|
In the first quarter of 2007, the Company settled its limited
post-retirement benefit program. The Company voluntarily paid out $700 to plan
participants, representing 64% of the accrued post retirement benefit obligation. This
payment fully settled all Company obligations related to this program. In connection with
the settlement of the postretirement program, the Company recorded a reduction in
non-interest expense of $832, representing the elimination of the $390 remaining accrued
benefit obligation included in other liabilities on the consolidated balance sheet, and
the $442 actuarial gain ($291, net of tax) related to the program. The actuarial gain was
previously included in accumulated other comprehensive income, net of tax effect of $151.
The Company has non-qualified supplemental executive retirement plans
for certain retired officers. These plans provide supplemental retirement benefits payable
in installments over a period of years upon retirement or death. The Company recognized
the net present value of payments associated with the agreements over the service periods
of the participating officers. Interest costs continue to be recognized on the benefit
obligations.
The Company also has supplemental executive retirement plans for
certain current executive officers. These plans provide a stream of future payments in
accordance with individually defined vesting schedules upon retirement, termination,
death, or in the event that the executive leaves the Company following a change of control
event.
The following table summarizes the net periodic benefit costs for the
three and nine months ended September 30, 2007 and 2006:
|
Supplemental Executive Retirement Plans
|
|
|
|
Three Months Ended
|
2007
|
2006
|
|
|
|
Service cost
|
$ 50
|
$ 53
|
Interest cost
|
40
|
58
|
Amortization of actuarial loss (gain)
|
2
|
---
|
Net periodic benefit cost
|
$ 92
|
$111
|
|
|
|
|
|
|
Nine Months Ended
|
2007
|
2006
|
|
|
|
Service cost
|
$148
|
$140
|
Interest cost
|
121
|
153
|
Amortization of actuarial loss (gain)
|
7
|
---
|
Net periodic benefit cost
|
$276
|
$293
|
The Company expects to contribute $222 to the supplemental plans in
2007. As of September 30, 2007, the Company had contributed $169.
Note 5: Commitments and Contingent Liabilities
The Bank is a party to financial instruments in the normal course of
business to meet financing needs of its customers. These financial instruments include
commitments to extend credit, unused lines of credit, and standby letters of credit.
Commitments to originate loans, including unused lines of credit, are
agreements to lend to a customer provided there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank uses the same credit policy to
make such commitments as it uses for on-balance-sheet items, such as loans. The Bank
evaluates each customers creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on
managements credit evaluation of the borrower.
The Bank guarantees the obligations or performance of customers by
issuing standby letters of credit to third parties. These standby letters of credit are
primarily issued in support of third-party debt or obligations. The risk involved in
issuing standby letters of credit is essentially the same as the credit risk involved in
extending loan facilities to customers, and they are subject to the same credit
origination, portfolio maintenance and management procedures in effect to monitor other
credit and off-balance sheet instruments. Exposure to credit loss in the event of
non-performance by the counter-party to the financial instrument for standby letters of
credit is represented by the contractual amount of those instruments. Typically, these
standby letters of credit have terms of five years or less and expire unused; therefore,
the total amounts do not necessarily represent future cash requirements.
The following table summarizes the contractual amounts of commitments
and contingent liabilities as of September 30, 2007 and December 31, 2006:
|
September 30,
2007
|
December 31,
2006
|
|
|
|
Commitments to originate loans
|
$40,024
|
$13,340
|
Unused lines of credit
|
$81,762
|
$81,800
|
Un-advanced portions of construction loans
|
$10,893
|
$ 7,638
|
Standby letters of credit
|
$ 306
|
$ 442
|
As of September 30, 2007, and December 31, 2006, the fair values of the
standby letters of credit were not significant to the Companys consolidated
financial statements.
Note 6: Financial Derivative Instruments
As part of its overall asset and liability management strategy, the
Bank periodically uses derivative instruments to minimize significant unplanned
fluctuations in earnings and cash flows caused by interest rate volatility. The
Banks interest rate risk management strategy involves modifying the re-pricing
characteristics of certain assets and liabilities so that changes in interest rates do not
have a significant effect on net income.
The Company recognizes all of its derivative instruments on the
consolidated balance sheet at fair value. On the date the derivative instrument is entered
into, the Bank designates whether the derivative is part of a hedging relationship (i.e.,
cash flow or fair value hedge). The Bank formally documents relationships between hedging
instruments and hedged items, as well as its risk management objective and strategy for
undertaking hedge transactions. The Bank also assesses, both at the hedges inception
and on an ongoing basis, whether the derivatives used in hedging transactions are highly
effective in offsetting the changes in cash flows or fair values of hedged items.
Changes in fair value of derivative instruments that are highly
effective and qualify as a cash flow hedge are recorded in other comprehensive income or
loss. Any ineffective portion is recorded in earnings. For fair value hedges that are
highly effective, the gain or loss on the hedge and the loss or gain on the hedged item
attributable to the hedged risk are both recognized in earnings, with the differences (if
any) representing hedge ineffectiveness. The Bank discontinues hedge accounting when it is
determined that the derivative is no longer highly effective in offsetting changes of the
hedged risk on the hedged item, or management determines that the designation of the
derivative as a hedging instrument is no longer appropriate.
At September 30, 2007, the Bank had three outstanding derivative
instruments with notional principal amounts totaling $40,000. These derivative instruments
were interest rate swap agreements and interest rate floor agreements, with notional
principal amounts totaling $10,000 and $30,000, respectively. The details are summarized
as follows:
Interest Rate Swap Agreement:
Description
|
Maturity
|
Notional
Amount
|
Fixed
Interest
Rate
|
Variable Interest Rate
|
|
|
|
|
|
Receive
fixed rate, pay variable rate
|
01/24/09
|
$10,000
|
6.25%
|
Prime
(7.75%)
|
The Bank is required to pay a counter-party monthly variable rate
payments indexed to Prime, while receiving monthly fixed rate payments based upon an
interest rate of 6.25% over the term of the agreement.
Prior to September 30, 2007 the Bank had a second interest rate swap
agreement with a notional principal amount of $10,000. This agreement was also indexed to
Prime, with the Bank receiving monthly fixed rate payments based upon an interest rate of
6.04%. This agreement matured on September 1, 2007.
The interest rate swap agreements were designated as a cash flow hedge
in accordance with SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges:
Using the First-Payments Received Technique in Hedging the Variable Interest
Payments on a Group of Non-Benchmark-Rate-Based Loans."
At September 30, 2007, the fair market value of the interest rate swap
agreement was an unrealized loss of $130, compared with unrealized losses on interest rate
swap agreements of $473 and $534 at December 31 and September 30, 2006, respectively. The
fair market values of the interest rate swap agreements were included in other liabilities
on the consolidated balance sheets.
During the three and nine months ended September 30, 2007, the total
net cash flows paid to counter-parties amounted to $107 and $316, compared with $97 and
$223 during the same periods in 2006. The net cash flows paid to counter-parties were
recorded as adjustments to the interest income on the hedged loans.
At September 30, 2007, the net unrealized loss on interest rate swap
agreements included in accumulated other comprehensive loss, net of tax, amounted to $86,
compared with $313 and $352 at December 31 and September 30, 2006, respectively.
Interest Rate Floor Agreements:
Notional Amount
|
Termination
Date
|
Prime
Strike Rate
|
Premium
Paid
|
|
|
|
|
$20,000
|
08/01/10
|
6.00%
|
$186
|
$10,000
|
11/01/10
|
6.50%
|
$ 69
|
During 2005, interest rate floor agreements were purchased to limit the
Banks exposure to falling interest rates on two pools of loans indexed to the Prime
interest rate. Under the terms of the agreements, the Bank paid premiums of $186 and $69
for the right to receive cash flow payments if the Prime interest rate falls below the
floors of 6.00% and 6.50%, thus effectively ensuring interest income on the pools of
prime-based loans at minimum rates of 6.00% and 6.50% for the duration of the agreements.
The interest rate floor agreements were designated as cash flow hedges in accordance with
SFAS 133.
At September 30, 2007, the total fair market value of the interest rate
floor agreements was $81 compared with $40 at December 31, 2006. The fair market values of
the interest rate floor agreements are included in other liabilities on the Companys
consolidated balance sheets. Pursuant to SFAS 133, changes in the fair market value,
representing unrealized gains or losses, are recorded in accumulated other comprehensive
loss.
The premiums paid on the interest rate floor agreements are included in
accumulated other comprehensive loss on the consolidated balance sheets and are being
recognized as reductions of interest income over the duration of the agreements using the
floorlet method, in accordance with SFAS 133. During the three and nine months ended
September 30, 2007, $11 and $29 of the premium was recognized in interest income,
respectively. At September 30, 2007, the remaining unamortized premiums, net of tax,
totaled $136, compared with $154 at December 31, 2006. During the next twelve months, $49
of the premiums will be recognized in interest income, decreasing the interest income
related to the hedged pool of Prime-based loans.
At September 30, 2007, and December 31, 2006, the unamortized premium
net of the unrealized gain on the interest rate floor agreements amounted to $83 and $129,
net of tax, respectively, and was recorded in accumulated other comprehensive loss on the
balance sheet.
A summary of the hedging related balances follows:
|
September 30, 2007
|
|
December 31, 2006
|
|
Gross
|
Net of Tax
|
|
Gross
|
Net of Tax
|
|
|
|
|
|
|
Unrealized gain on interest rate floors
|
$ 81
|
$ 53
|
|
$ 68
|
$ 44
|
Unrealized loss on interest rate swaps
|
(132)
|
(87)
|
|
(483)
|
(319)
|
Unamortized premium on interest rate floors
|
(206)
|
(136)
|
|
(235)
|
(155)
|
Total
|
$(257)
|
$(170)
|
|
$(650)
|
$(429)
|
Note 7: Recently Adopted Accounting Standards
The Company recently adopted the following accounting standards:
Accounting for Uncertainty in Income Taxes:
In June 2006, the Financial Accounting Standards Board
("FASB") issued Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement 109" ("FIN 48"). This
statement clarifies the criteria that an individual tax position must satisfy for some or
all of the benefits of that position to be recognized in a company's financial statements.
FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement
attribute for all tax positions taken or expected to be taken on a tax return, in order
for those tax positions to be recognized in the financial statements. FIN 48 also provides
guidance on de-recognition, classification, interest and penalties, accounting in interim
periods, and disclosure and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006.
On January 1, 2007 the Company adopted the provisions of FIN 48 and
there was no impact on the consolidated financial statements. Upon the adoption of this
standard, the Company performed an analysis of its tax positions to determine whether
there may be uncertainties that require further analysis under FIN 48 based upon their
specific facts and circumstances. The Company did not identify any uncertain tax positions
for which tax benefits should not be recognized under FIN 48 upon adoption or as of
September 30, 2007. The Company accounts for interest and penalties related to uncertain
tax positions as part of its provision for federal and state income taxes.
The Company is currently open to audit under the statute of limitations
by the Internal Revenue Service for the years ended December 31, 2004 through 2006. The
Companys state income tax returns are also open to audit under the statute of
limitations for the years ended December 31, 2004 through 2006.
Accounting for Servicing of Financial Assets:
In March 2006,
the FASB issued Statement of Financial Accounting Standards No. 156 ("SFAS
156"), "Accounting for Servicing of Financial Assets." This statement
amends Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities," with respect
to the accounting for separately recognized servicing assets and servicing liabilities.
SFAS 156 requires companies to recognize a servicing asset or servicing liability each
time it undertakes an obligation to service a financial asset by entering into a servicing
contract. The statement permits a company to choose either the amortized cost method or
fair value measurement method for each class of separately recognized servicing assets.
This statement is effective as of the beginning of a company's first fiscal year after
September 15, 2006 (January 1, 2007 for the Company). The Companys adoption of SFAS
156 did not have an impact on its financial condition or results of operations.
Prior Year Financial Statement Misstatements:
In September
2006, the SEC staff issued Staff Accounting Bulletin No. 108, "Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements" ("SAB 108"). SAB 108 was issued in order to eliminate
the diversity of practice surrounding how public companies quantify financial statement
misstatements. There are two widely recognized methods for quantifying the effects of
financial statement misstatements: the "roll-over" and "iron curtain"
methods. The roll-over method, the method the Company historically used, focuses primarily
on the impact of a misstatement on the income statement, including the reversing effect of
prior year misstatements. Because the focus is on the income statement, the roll-over
method can lead to the accumulation of misstatements in the balance sheet that may become
material. The iron curtain method focuses primarily on the effect of correcting the
accumulated misstatement as of the balance sheet date, with less emphasis on the reversing
effects of prior year errors on the income statements. In SAB 108, the SEC staff
established an approach that requires quantification of financial statement misstatements
based on the effects of the misstatements under both the roll-over and iron curtain
methods. This framework is referred to as the "dual approach." SAB 108 permits
companies to initially apply its provisions either by restating prior financial statements
as if the dual approach had always been used or recording the cumulative effect of
initially applying the dual approach as adjustments to the balance sheet as of the first
day of the fiscal year with an offsetting adjustment recorded to retained earnings.
The Company completed an analysis under the "dual approach"
and adopted SAB 108 effective as of January 1, 2006. The Company applied the SAB 108
provisions using the cumulative effect transition method. Upon adoption of SAB 108, the
Company reversed $331 of income taxes payable resulting from cumulative over accruals of
income tax expense. These misstatements primarily resulted from the incorrect
determination of depreciation and deferred loan origination costs for tax purposes and
principally occurred prior to 2004, with certain amounts dating back to the 1990s.
After considering all of the quantitative and qualitative factors, the Company determined
these misstatements had not previously been material to any of those prior periods when
measured using the roll-over method. Given that the effect of correcting these
misstatements during 2006 would be material to the Companys 2006 financial
statements, the Company concluded that the cumulative effect adjustment method of
initially applying the guidance in SAB 108 was appropriate. In accordance with the
transition provisions of SAB 108, the Company recorded this cumulative effect adjustment,
resulting in a $331 increase in other assets and a $331 increase in retained earnings as
of January 1, 2006.
Note 8: Recently Issued Accounting Pronouncements
The following information addresses new or
proposed accounting pronouncements that could have an impact on the Companys
financial condition, results of operations, earnings per share, or cash flows.
Fair Value Measurements for Financial Assets and Liabilities:
In
February 2007, the FASB issued Statement of Financial Accounting Standards No. 159
("SFAS 159"), "The Fair Value Option for Financial Assets and Financial
Liabilities, including an amendment of FASB Statement No. 115." This standard
provides companies with an option to report selected financial assets and liabilities at
fair value. The Standards objective is to reduce both complexity in accounting for
financial instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. Generally accepted accounting principles have required
different measurement attributes for different assets and liabilities that can create
volatility in earnings. SFAS 159 helps to mitigate this volatility by enabling companies
to report related assets and liabilities at fair value, which would likely reduce the need
for companies to comply with detailed rules for hedge accounting. This new standard also
establishes presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar types of assets
and liabilities. SFAS 159 requires companies to provide additional information that will
help investors and other users of financial statements to more easily understand the
effect of the companys choice to use fair value on its earnings. It also requires
entities to display the fair value of those assets and liabilities for which the company
has chosen to use fair value on the face of the balance sheet. The new Statement
does not eliminate disclosure requirements included in other accounting standards,
including requirements for disclosures about fair value measurements included in FASB
Statements No. 157, "Fair Value Measurements," and No. 107, "Disclosures
about Fair Value of Financial Instruments."
SFAS 159 is effective as of the
beginning of an entitys first fiscal year beginning after November 15, 2007 (January
1, 2008 for the Company). Early adoption is permitted as of the beginning of the
previous fiscal year provided that the entity makes that choice in the first 120 days of
that fiscal year and also adopts the provisions of SFAS 157 at the same time. The Company
did not adopt SFAS 159 early and is currently evaluating the impact of adopting this
statement.
Fair Value Measurements:
In September 2006, the FASB issued
Statement of Financial Accounting Standards No. 157, "Fair Value Measurements."
This statement establishes a single authoritative definition of fair value, sets out a
framework for measuring fair value, and requires additional disclosures about fair value
measurements. The statement is effective for fair value measures already required or
permitted by other standards for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within that fiscal year (January 1, 2008 for
the Company). The Company is currently evaluating the impact of adopting SFAS 157, but
does not anticipate that the adoption of this standard will have a material impact on its
financial condition or results of operations.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS
OF OPERATIONS
The following discussion and analysis of the financial condition and
results of operations of the Company and its subsidiaries should be read in conjunction
with the consolidated financial statements and notes thereto, and selected financial and
statistical information appearing elsewhere in this report on Form 10-Q. The purpose of
this discussion is to highlight significant changes in the financial condition and results
of operations of the Company and its subsidiaries, and provide supplemental information
and analysis.
Amounts in the prior period financial statements are reclassified
whenever necessary to conform to current period presentation.
Unless otherwise noted, all dollars are expressed in thousands, except
per share data.
Use of Non-GAAP Financial Measures:
Certain information
discussed below is presented on a fully taxable equivalent basis. Specifically, included
in third quarter 2007 and 2006 interest income was $341 and $474, respectively, of
tax-exempt interest income from certain investment securities and loans. For the nine
months ended September 30, 2007 and 2006, the amount of tax-exempt income included in
interest income was $1,132 and $1,426, respectively. An amount equal to the tax benefit
derived from this tax-exempt income has been added to the interest income totals discussed
in certain sections of this Managements Discussion and Analysis, representing
tax-equivalent adjustments of $149 and $209 in the third quarter of 2007 and 2006,
respectively, and $495 and $638 for the nine months ended September 30, 2007 and 2006,
respectively, which increased net interest income accordingly. The analysis of net
interest income tables included in this Form 10-Q provide a reconciliation of
tax-equivalent financial information to the Company's consolidated financial statements,
which have been prepared in accordance with U.S. generally accepted accounting principles.
Management believes the disclosure of tax-equivalent net interest
income information improves the clarity of financial analysis, and is particularly useful
to investors in understanding and evaluating the changes and trends in the Company's
results of operations. Other financial institutions commonly present net interest income
on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one
financial institution's net interest income to that of another institution, as each will
have a different proportion of tax-exempt interest from their earning asset portfolios.
Moreover, net interest income is a component of a second financial measure commonly used
by financial institutions, net interest margin, which is the ratio of net interest income
to average earning assets. For purposes of this measure as well, other financial
institutions generally use tax-equivalent net interest income to provide a better basis of
comparison from institution to institution. The Company follows these practices.
FORWARD LOOKING STATEMENTS DISCLAIMER
Certain statements, as well as certain other discussions contained in
this report on Form 10-Q, or incorporated herein by reference, contain statements which
may be considered to be forward-looking within the meaning of Section 27A of the
Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. You can identify these forward-looking statements by the use of words like
"strategy," "expects," "plans," "believes,"
"will," "estimates," "intends," "projects,"
"goals," "targets," and other words of similar meaning. You can also
identify them by the fact that they do not relate strictly to historical or current facts.
Investors are cautioned that forward-looking statements are inherently
uncertain. Forward-looking statements include, but are not limited to, those made in
connection with estimates with respect to the future results of operation, financial
condition, and the business of the Company which are subject to change based on the impact
of various factors that could cause actual results to differ materially from those
projected or suggested due to certain risks and uncertainties. Those factors include but
are not limited to:
(i)
|
The
Company's success is dependent to a significant extent upon general economic conditions in
Maine, and Maine's ability to attract new business, as well as factors that affect
tourism, a major source of economic activity in the Companys immediate market areas;
|
|
|
(ii)
|
The
Company's earnings depend to a great extent on the level of net interest income (the
difference between interest income earned on loans and investments and the interest
expense paid on deposits and borrowings) generated by the Bank, and thus the Bank's
results of operations may be adversely affected by increases or decreases in interest
rates;
|
|
|
(iii)
|
The
banking business is highly competitive and the profitability of the Company depends on the
Bank's ability to attract loans and deposits in Maine, where the Bank competes with a
variety of traditional banking and non-traditional institutions, such as credit unions and
finance companies;
|
|
|
(iv)
|
A
significant portion of the Bank's loan portfolio is comprised of commercial loans and
loans secured by real estate, exposing the Company to the risks inherent in financings
based upon analysis of credit risk, the value of underlying collateral, and other
intangible factors which are considered in making commercial loans and, accordingly, the
Company's profitability may be negatively impacted by judgment errors in risk analysis, by
loan defaults, and the ability of certain borrowers to repay such loans during a downturn
in general economic conditions;
|
|
|
(v)
|
A
significant delay in or inability to execute strategic initiatives designed to increase
revenues and or control expenses;
|
|
|
(vi)
|
The
potential need to adapt to changes in information technology systems, on which the Company
is highly dependent, could present operational issues or require significant capital
spending;
|
|
|
(vii)
|
Significant
changes in the Companys internal controls, or internal control failures;
|
|
|
(viii)
|
Acts
or threats of terrorism and actions taken by the United States or other governments as a
result of such threats, including military action, could further adversely affect business
and economic conditions in the United States generally and in the Companys markets,
which could have an adverse effect on the Companys financial performance and that of
borrowers and on the financial markets and the price of the Companys common stock;
|
|
|
(ix)
|
Significant
changes in the extensive laws, regulations, and policies governing bank holding companies
and their subsidiaries could alter the Company's business environment or affect its
operations; and
|
|
|
(x)
|
The
Companys success in managing the risks involved in all of the foregoing matters.
|
The forward-looking statements contained herein represent the Company's
judgment as of the date of this report on Form 10-Q, and the Company cautions readers not
to place undue reliance on such statements. The Company disclaims any obligation to
publicly update or revise any forward-looking statement contained in the succeeding
discussion, or elsewhere in this report on Form 10-Q, except to the extent required by
federal securities laws.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Managements discussion and analysis of the Companys
financial condition are based on the Consolidated Financial Statements, which are prepared
in accordance with U.S. generally accepted accounting principles. The preparation of such
financial statements requires management to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. Management evaluates its estimates, including those
related to the allowance for loan losses, on an ongoing basis. Management bases its
estimates on historical experience and various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis in making
judgments about the carrying values of assets that are not readily apparent from other
sources. Actual results could differ from the amount derived from managements
estimates and assumptions under different assumptions or conditions.
The Companys significant accounting policies are more fully
enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of its
December 31, 2006 report on Form 10-K. The reader of the financial statements should
review these policies to gain a greater understanding of how the Companys financial
performance is reported. Management believes the following critical accounting policies
represent the more significant estimates and assumptions used in the preparation of the
Consolidated Financial Statements:
Allowance for Loan Losses
-
Management believes the allowance
for loan losses ("allowance") is a significant accounting estimate used in the
preparation of the Companys consolidated financial statements. The allowance, which
is established through a provision for loan loss expense, is based on managements
evaluation of the level of allowance required in relation to the estimated inherent risk
of loss in the loan portfolio. Management regularly evaluates the allowance for loan
losses for adequacy by taking into consideration factors such as previous loss experience,
the size and composition of the portfolio, current economic and real estate market
conditions and the performance of individual loans in relation to contract terms and
estimated fair values of collateral. The use of different estimates or assumptions could
produce different provisions for loan losses. A smaller provision for loan losses results
in higher net income, and when a greater amount of provision for loan losses is necessary
the result is lower net income. Refer to Part I, Item 2 below,
Allowance for Loan
Losses and Provision
in this report on Form 10-Q, for further discussion and analysis
concerning the allowance.
Income Taxes
The Company estimates its income taxes for
each period for which a statement of income is presented. This involves estimating the
Companys actual current tax liability, as well as assessing temporary differences
resulting from differing timing of recognition of expenses, income and tax credits, for
tax and accounting purposes. These differences result in deferred tax assets and
liabilities, which are included in the Companys consolidated balance sheets. The
Company must also assess the likelihood that any deferred tax assets will be recovered
from historical taxes paid and future taxable income and, to the extent that the recovery
is not likely, a valuation allowance must be established. Significant management judgment
is required in determining income tax expense, and deferred tax assets and liabilities. As
of September 30, 2007 and December 31, 2006, there was no valuation allowance for deferred
tax assets, which are included in other assets on the consolidated balance sheet.
Goodwill and Other Intangible Assets -
The valuation techniques
used by the Company to determine the carrying value of tangible and intangible assets
acquired in acquisitions and the estimated lives of identifiable intangible assets involve
estimates for discount rates, projected future cash flows and time period calculations,
all of which are susceptible to change based upon changes in economic conditions and other
factors. Any changes in the estimates used by the Company to determine the carrying
value of its goodwill and identifiable intangible assets, or which otherwise adversely
affect their value or estimated lives, may have an adverse affect on the Company's results
of operations. Refer to Note 2 of the consolidated financial statements in Part I, Item 1
of this report on Form 10-Q for further details of the Companys accounting policies
and estimates covering goodwill and other intangible assets.
EXECUTIVE OVERVIEW
Summary Results of Operations
The Company reported consolidated net income of $2,147 or fully diluted
earnings per share of $0.69 for the three months ended September 30, 2007 compared with
$1,964 or fully diluted earnings per share of $0.63 for the same quarter in 2006,
representing increases of $183 and $0.06, or 9.3% and 9.5%, respectively. The annualized
return on average shareholders equity ("ROE") and average assets
("ROA") amounted to 13.68% and 1.00%, respectively, compared with 13.68% and
0.97% for the same quarter in 2006.
As more fully enumerated below, the increase in third quarter 2007 net
income compared with the same quarter in 2006 was attributed to a $365 or 6.6% increase in
net interest income, a $64 or 2.9% increase in non-interest income and a $61 or 1.3%
decline in non-interest expense. Partially offsetting these results was a $133 increase in
the provision for loan losses and a $174 increase in income tax expense.
For the nine months ended September 30, 2007, consolidated net income
amounted to $5,365 or fully diluted earnings per share of $1.72, compared with $5,173 or
fully diluted earnings per share of $1.66 for the same period in 2006, representing
increases of $192 and $0.06, or 3.7% and 3.6%, respectively. The annualized ROE and ROA
amounted to 11.52% and 0.86%, respectively, compared with 12.19% and 0.88% for the same
period in 2006.
As more fully discussed below, in connection with the restructuring of
a portion of the Banks securities portfolio, during the nine months ended September
30, 2007 the Company recorded net securities losses amounting to $671, compared with net
securities gains of $667 for the same period in 2006, representing a decline of $1,338.
Partially offsetting the decline in net securities gains was an $832 reduction in
non-interest expense recorded in the first quarter of 2007, related to the Companys
settlement of its limited postretirement benefit program. Excluding the impact of net
securities gains and losses and the settlement of the postretirement program, non-interest
income was up $309 or 6.6% and non-interest expense was down $214 or 1.5%, compared with
the first nine months of 2006.
-
Net Interest Income: For the quarter ended September 30, 2007, net interest income
amounted to $5,913, representing an increase of $365 or 6.6%, compared with the same
quarter in 2006. The increase in net interest income was principally attributed to average
earning asset growth of $52,474, or 6.8%, as the net interest margin was unchanged.
Additionally, in the third quarter of 2006 the Federal Home Loan Bank of Boston, of which
the Bank is a member and shareholder, declared a dividend that was equivalent to an amount
for both the second and third quarters of 2006. This non-recurring action favorably
impacted the Banks third quarter 2006 net interest income and net interest margin by
$168 and 9 basis points, respectively.
For the nine months ended September 30, 2007, net interest income
amounted to $16,791, representing an increase of $488, or 3.0%, compared with the same
period in 2006. The increase in net interest income was principally attributed to average
earning asset growth of $47,916 or 6.4%, as the net interest margin declined 9 basis
points. As has widely been the situation throughout the banking industry, the decline in
the net interest margin was largely attributed to the flat-to-inverted U.S. Treasury yield
curve over most of the past 21 months, the impact of which has caused the Banks
funding costs to increase at a faster pace than the yield on its earning asset portfolios.
In late September 2007, the Federal Reserve reduced short-term interest rates by 50 basis
points. In November 2007, the Federal Reserve reduced short-term interest rates by an
additional 25 basis points. Company management anticipates these rate cuts, if sustained,
will have a favorable impact on future levels of net interest income, given the liability
sensitivity of the Companys balance sheet.
-
Non-interest income:
For the quarter ended September 30, 2007, total
non-interest income inclusive of net securities amounted to $2,263, representing an
increase of $64 or 2.9% compared with the same quarter in 2006. Trust and financial
service fees, debit and credit card fees and service charges on deposit accounts led the
increase in non-interest income, posting increases of 16.0%, 12.2% and 3.2%, respectively.
For the nine months ended September 30, 2007, total non-interest income
amounted to $4,299, representing a decline of $1,029, or 19.3%, compared with the same
period in 2006. The decline in non-interest income was principally attributed to a $1,338
decline in net securities gains. During the first nine months of 2007, net securities
losses of $671 were recorded, principally resulting from the Companys restructuring
of a portion of its securities portfolio, compared with net securities gains of $667
recorded during the same period in 2006. The decline in non-interest income also reflects
a $150 gain on the sale of Bank owned real estate recorded in the first quarter of 2006.
For the nine months ended September 30, 2007, debit and credit card
fees, trust and financial service fees and service charges on deposit accounts were up
12.9%, 12.1% and 4.5% compared with the same period last year, respectively.
-
Non-interest expense:
For the quarter ended September 30, 2007, total
non-interest expense amounted to $4,796, representing a decline of $61 or 1.3%, compared
with the same quarter in 2006. A variety of expense categories posted declines, which were
offset in part by a $44 increase in debit and credit card expenses, reflecting higher
transaction volumes and corresponding revenue. Salaries and employee benefits showed a
small increase, up $26, or 1.1%.
For the nine months ended September 30, 2007, total non-interest
expense amounted to $13,146, representing a decline of $1,046, or 7.4%. The decline in
non-interest expense was principally attributed to the settlement of the Companys
limited postretirement benefit program, the financial impact of which reduced first
quarter 2007 non-interest expense by $832. The decline in non-interest expense was also
aided by a $192 or 2.7% decline in salaries and employee benefits, which was principally
attributed to changes in overall staffing levels and mix, changes to certain employee
benefit programs, and lower levels of incentive compensation.
Summary Financial Condition
The Companys total assets ended the third quarter at $858,755,
representing increases of $33,878 and $63,376, or 4.1% and 8.0%, compared with December 31
and September 30, 2006, respectively.
-
Loans:
Total loans ended the third quarter at $566,012, representing increases
of $10,913 and $18,525, or 2.0% and 3.4%, compared with December 31 and September 30,
2006, respectively. Commercial loans continued to drive the overall growth of the
Banks loan portfolio, posting increases of $14,315 and $19,923, or 6.0% and 8.5%,
compared with December 31 and September 30, 2006, respectively.
-
Credit Quality:
The Banks non-performing loans remained at low levels at
quarter-end, representing $872 or 0.15% of total loans. The Banks loan loss
experience continued at low levels during the first nine months of 2007, with net
charge-offs amounting to $142, or annualized net charge-offs to average loans outstanding
of 0.03%. For the three and nine months ended September 30, 2007, the Bank recorded
provisions for loan losses of $214 and $247, compared with $81 and $124 during the same
periods in 2006.
-
Securities:
Total securities ended the third quarter at $244,457, representing
increases of $31,205 and $46,573, or 14.6% and 23.5%, compared with December 31 and
September 30, 2006, respectively.
In the second quarter of 2007, the Bank completed the restructuring of
a portion of its securities portfolio, selling a total of $46,170 in securities with below
market yields while paying down short-term borrowings. During the later part of the second
quarter, market yields climbed to a five-year high, with the benchmark 10-year U.S.
Treasury advancing from 4.63% in mid May to 5.30% in mid June. The increase in market
yields presented opportunities for replacing the securities sold, increasing the
Banks earning assets, and generating higher levels of net interest income.
-
Deposits:
Total deposits ended the third quarter at $526,862, representing
increases of $30,543 and $12,481, or 6.2% and 2.4% compared with December 31 and September
30, 2006, respectively. Deposit growth was largely attributed to certificates of deposit
obtained in the national market, which were used to help fund the Banks earning
asset growth and replace retail deposit declines.
At September 30, 2007, retail deposits totaled $403,178, representing
declines of $10,780 and $25,277, or 2.6% and 5.9%, compared with December 31 and September
30, 2006, respectively. The declines in retail deposits were principally attributed to
declines in money market accounts offered to clients of Bar Harbor Trust Services, a Maine
chartered non-depository trust company subsidiary of the Company, reflecting a
reallocation of cash within certain managed asset portfolios in the course of normal
operations. Comparing September 30, 2007, with December 31 and September 30, 2006, these
money market deposits accounted for $30,793 and $33,134 of the overall retail deposit
declines, respectively. Excluding the deposit accounts offered to clients of Bar Harbor
Trust Services, at September 30, 2007 total retail deposits were showing increases of
$20,013 and $7,857, or 5.3% and 2.0%, compared with December 31 and September 30, 2006,
respectively.
-
Shareholders Equity:
The Company continued to exceed regulatory
requirements for "well capitalized" institutions. At September 30, 2007, the
Companys Tier I Leverage, Tier I Risk-based, and Total Risk-based capital ratios
amounted to 7.21%, 11.11% and 11.95% respectively. Total shareholders equity ended
the third quarter at $63,980, representing increases of $2,929 and $4,645, or 4.8% and
7.8%, compared with December 31 and September 30, 2006, respectively.
-
Tangible Book Value:
At September 30, 2007, the Companys tangible book
value per share of common stock outstanding amounted to $20.04, compared with $18.96 and
$18.36 at December 31 and September 30, 2006, representing increases of 5.7% and 9.2%,
respectively.
-
Shareholder Dividends:
On October 16, 2007 the Company declared a cash dividend
of 24.5 cents per share of common stock for the quarter ended September 30, 2007,
representing an increase of 1.5 cents per share, or 6.5% compared with the dividend paid
for the same quarter in 2006.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the principal component of the Company's income
stream and represents the difference or spread between interest generated from earning
assets and the interest expense paid on deposits and borrowed funds. Net interest income
is entirely generated by the Bank. Fluctuations in market interest rates as well as volume
and mix changes in earning assets and interest bearing liabilities can materially impact
net interest income.
For the three months ended September 30, 2007, net interest income on a
fully tax-equivalent basis amounted to $6,062, compared with $5,757 in the third quarter
of 2006, representing an increase of $305, or 5.3%. The increase in third quarter net
interest income was principally attributed to average earning asset growth of $52,474 or
6.8%, as the tax-equivalent net interest margin declined 4 basis points to 2.93% compared
with the same quarter in 2006.
Additionally, in the second quarter of 2006 the Federal Home Loan Bank
of Boston (the "FHLB"), of which the Bank is a member and shareholder, did not
declare a dividend on its stock. Pursuant to its "Dividend Schedule Transition
Plan", in the third quarter of 2006, the FHLB declared a dividend that was equivalent
to an amount for both the second and third quarters of 2006. This non-recurring action
favorably impacted the Banks third quarter 2006 net interest income and net interest
margin by $168 and 9 basis points, respectively. Excluding the impact of the grossed up
FHLB dividend, third quarter net interest income increased $473 or 8.5%, while the net
interest margin increased 5 basis points, compared with the third quarter of 2006.
For the nine months ended September 30, 2007, net interest income on a
fully tax-equivalent basis amounted to $17,286, compared with $16,941 during the same
period in 2006, representing an increase of $345, or 2.0%. The increase in net interest
income was principally attributed to average earning asset growth of $47,916 or 6.4%, as
the tax-equivalent net interest margin declined 13 basis points to 2.89%, compared with
the nine months ended September 30, 2006.
Factors contributing to the changes in net interest income and the net
interest margin are further enumerated in the following discussion and analysis.
Net Interest Income Analysis:
The following tables summarize
the Companys average balance sheets and components of net interest income, including
a reconciliation of tax equivalent adjustments, for the three and nine months ended
September 30, 2007 and 2006, respectively:
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
SEPTEMBER 30, 2007 AND 2006
|
|
2007
|
|
|
|
2006
|
|
|
Average
Balance
|
Interest
|
Average
Rate
|
|
Average
Balance
|
Interest
|
Average
Rate
|
Interest Earning Assets:
|
|
|
|
|
|
|
|
Loans (1,3)
|
$559,499
|
$9,707
|
6.88%
|
|
$545,092
|
$9,165
|
6.67%
|
Taxable securities
|
222,083
|
3,163
|
5.65%
|
|
172,657
|
2,135
|
4.91%
|
Non-taxable securities (3)
|
24,139
|
405
|
6.66%
|
|
34,784
|
591
|
6.74%
|
Total securities
|
246,222
|
3,568
|
5.75%
|
|
207,441
|
2,726
|
5.21%
|
Federal Home Loan Bank stock
|
12,569
|
203
|
6.41%
|
|
12,649
|
352
|
11.04%
|
Fed funds sold, money market funds,
and time deposits with other banks
|
2,829
|
37
|
5.19%
|
|
3,463
|
46
|
5.27%
|
|
|
|
|
|
|
|
|
Total Earning Assets
|
821,119
|
13,515
|
6.53%
|
|
768,645
|
12,289
|
6.34%
|
|
|
|
|
|
|
|
|
Non-Interest Earning Assets:
|
|
|
|
|
|
|
|
Cash and due from banks
|
8,213
|
|
|
|
10,356
|
|
|
Allowance for loan losses
|
(4,547)
|
|
|
|
(4,539)
|
|
|
Other assets (2)
|
29,184
|
|
|
|
27,913
|
|
|
Total Assets
|
$853,969
|
|
|
|
$802,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Deposits
|
$463,273
|
$4,207
|
3.60%
|
|
$439,085
|
$3,561
|
3.22%
|
Securities sold under repurchase agreements
and fed funds purchased
|
15,614
|
129
|
3.28%
|
|
13,711
|
96
|
2.78%
|
Borrowings from Federal Home Loan Bank
|
246,367
|
3,117
|
5.02%
|
|
227,495
|
2,875
|
5.01%
|
Total Borrowings
|
261,981
|
3,246
|
4.92%
|
|
241,206
|
2,971
|
4.89%
|
Total Interest
Bearing Liabilities
|
725,254
|
7,453
|
4.08%
|
|
680,291
|
6,532
|
3.81%
|
Rate Spread
|
|
|
2.45%
|
|
|
|
2.53%
|
|
|
|
|
|
|
|
|
Non-Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Demand and other non-interest bearing deposits
|
61,517
|
|
|
|
58,800
|
|
|
Other liabilities
|
4,953
|
|
|
|
6,313
|
|
|
Total Liabilities
|
791,724
|
|
|
|
745,404
|
|
|
Shareholders' equity
|
62,245
|
|
|
|
56,971
|
|
|
Total Liabilities and Shareholders' Equity
|
$853,969
|
|
|
|
$802,375
|
|
|
Net interest income and net interest margin (3)
|
|
6,062
|
2.93%
|
|
|
5,757
|
2.97%
|
Less: Tax Equivalent adjustment
|
|
(149)
|
|
|
|
(209)
|
|
Net Interest Income
|
|
$5,913
|
2.86%
|
|
|
$5,548
|
2.86%
|
(1) For purposes of these computations, non-accrual loans
are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale
securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent
basis.
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
NINE MONTHS ENDED
SEPTEMBER 30, 2007 AND 2006
|
|
2007
|
|
|
|
2006
|
|
|
Average
Balance
|
Interest
|
Average
Rate
|
|
Average
Balance
|
Interest
|
Average
Rate
|
Interest Earning Assets:
|
|
|
|
|
|
|
|
Loans (1,3)
|
$554,522
|
$28,358
|
6.84%
|
|
$533,954
|
$26,217
|
6.56%
|
Taxable securities
|
202,438
|
8,406
|
5.55%
|
|
167,169
|
6,117
|
4.89%
|
Non-taxable securities (3)
|
27,110
|
1,370
|
6.76%
|
|
35,195
|
1,819
|
6.91%
|
Total securities
|
229,548
|
9,776
|
5.69%
|
|
202,364
|
7,936
|
5.24%
|
Federal Home Loan Bank stock
|
12,483
|
607
|
6.50%
|
|
12,315
|
501
|
5.44%
|
Fed funds sold, money market funds, and time
deposits with other banks
|
2,178
|
86
|
5.28%
|
|
2,182
|
82
|
5.02%
|
|
|
|
|
|
|
|
|
Total Earning Assets
|
798,731
|
38,827
|
6.50%
|
|
750,815
|
34,736
|
6.19%
|
|
|
|
|
|
|
|
|
Non-Interest Earning Assets:
|
|
|
|
|
|
|
|
Cash and due from banks
|
6,983
|
|
|
|
8,622
|
|
|
Allowance for loan losses
|
(4,549)
|
|
|
|
(4,564)
|
|
|
Other assets (2)
|
30,340
|
|
|
|
28,356
|
|
|
Total Assets
|
$831,505
|
|
|
|
$783,229
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Deposits
|
$454,191
|
$12,084
|
3.56%
|
|
$423,531
|
$ 9,271
|
2.93%
|
Securities sold under repurchase agreements
and fed funds purchased
|
14,271
|
340
|
3.19%
|
|
13,878
|
269
|
2.59%
|
Borrowings from Federal Home Loan Bank
|
242,189
|
9,117
|
5.03%
|
|
230,234
|
8,255
|
4.79%
|
Total Borrowings
|
256,460
|
9,457
|
4.93%
|
|
244,112
|
8,524
|
4.67%
|
Total Interest
Bearing Liabilities
|
710,651
|
21,541
|
4.05%
|
|
667,643
|
17,795
|
3.56%
|
Rate Spread
|
|
|
2.45%
|
|
|
|
2.63%
|
|
|
|
|
|
|
|
|
Non-Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Demand and other non-interest bearing deposits
|
53,761
|
|
|
|
52,628
|
|
|
Other liabilities
|
4,828
|
|
|
|
6,230
|
|
|
Total Liabilities
|
769,240
|
|
|
|
726,501
|
|
|
Shareholders' equity
|
62,265
|
|
|
|
56,728
|
|
|
Total Liabilities
and Shareholders' Equity
|
$831,505
|
|
|
|
$783,229
|
|
|
Net interest income and net interest margin (3)
|
|
17,286
|
2.89%
|
|
|
16,941
|
3.02%
|
Less: Tax Equivalent adjustment
|
|
(495)
|
|
|
|
(638)
|
|
Net Interest Income
|
|
$16,791
|
2.81%
|
|
|
$16,303
|
2.90%
|
(1) For purposes of these computations, non-accrual
loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale
securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent
basis.
Net Interest Margin:
The net interest margin, expressed on a
tax-equivalent basis, represents the difference between interest and dividends earned on
interest-earning assets and interest paid to depositors and other creditors, expressed as
a percentage of average earning assets.
The net interest margin is determined by dividing tax-equivalent net
interest income by average interest-earning assets. The interest rate spread represents
the difference between the average tax-equivalent yield earned on interest earning-assets
and the average rate paid on interest bearing liabilities. The net interest margin is
generally higher than the interest rate spread due to the additional income earned on
those assets funded by non-interest bearing liabilities, primarily demand deposits and
shareholders equity.
For the three months ended September 30, 2007, the tax-equivalent net
interest margin amounted to 2.93%, compared with 2.97% for the same quarter in 2006,
representing a decline of 4 basis points. Comparing the quarter ended September 30, 2007
with the same quarter in 2006 the weighted average yield the Banks earning assets
increased 19 basis points, while the weighted average cost of funds increased 27 basis
points. As discussed above, the decline in the net interest margin was attributed to the
FHLB paying a cash dividend on its stock in the third quarter of 2006 that was equivalent
to two quarterly dividends. Excluding this factor, the third quarter 2007 net interest
margin increased 5 basis points compared with the same quarter in 2006.
For the nine months ended September 30, 2007, the tax-equivalent net
interest margin amounted to 2.89%, compared with 3.02% for the same period in 2006,
representing a decline of 13 basis points. Over most of the past 21 months the U. S.
Treasury yield curve (the "yield curve") has been flat-to-inverted, meaning
short-term interest rates have generally been equal to or greater than long-term interest
rates.
The decline in the net interest margin was principally attributed to
the increases in the Banks cost of funds outpacing the increases in yields on its
interest earning assets, reflecting the re-pricing of a large portion of the Banks
funding base during a period of rising short-term interest rates, combined with highly
competitive pricing pressures with respect to loans and deposits, a higher utilization of
wholesale funding, and the inherent net interest margin challenges widely associated with
a flat or inverted yield curve. Comparing the nine months ended September 30, 2007 with
the same period in 2006, the increase in the cost of the Banks interest bearing
liabilities exceeded the increase in yields on its earning asset portfolios by 18 basis
points.
While the yield curve began to show a slight positive slope in the
third quarter, the impact on the year-to-date net interest margin was minimal. However,
Company management anticipates that the recent declines in short term interest rates and a
steeper yield curve, if sustained, will have a positive impact on the Banks net
interest margin and future levels of net interest income, given the Banks liability
sensitive balance sheet.
The Banks interest rate sensitivity position is more fully
described below in Part I, Item 3 of this report on Form 10-Q,
Quantitative and
Qualitative Disclosures About Market Risk.
The following table summarizes the net interest margin
components, on a quarterly basis, over the past eight quarters.
NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED
|
2007
Average Rate
|
|
2006
Average Rate
|
|
2005
Average Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
3rd Qtr
|
2nd Qtr
|
1st Qtr
|
|
4th Qtr
|
3rd Qtr
|
2nd Qtr
|
1st Qtr
|
|
4th Qtr
|
Interest Earning Assets:
|
|
|
|
|
|
|
|
|
|
|
Loans (1,2)
|
6.88%
|
6.88%
|
6.74%
|
|
6.68%
|
6.67%
|
6.57%
|
6.45%
|
|
6.35%
|
Taxable securities
|
5.65%
|
5.62%
|
5.38%
|
|
5.03%
|
4.91%
|
4.97%
|
4.79%
|
|
4.47%
|
Non-taxable securities (2)
|
6.66%
|
6.79%
|
6.80%
|
|
6.80%
|
6.74%
|
6.96%
|
7.02%
|
|
6.87%
|
Total securities
|
5.75%
|
5.77%
|
5.56%
|
|
5.30%
|
5.21%
|
5.31%
|
5.21%
|
|
4.94%
|
Federal Home Loan Bank stock
|
6.41%
|
6.56%
|
6.54%
|
|
6.13%
|
11.04%
|
0.00%
|
5.12%
|
|
4.85%
|
Fed Funds sold, money market funds, and time
deposits with other banks
|
5.19%
|
5.67%
|
4.88%
|
|
5.20%
|
5.27%
|
5.01%
|
3.41%
|
|
3.92%
|
Total Earning Assets
|
6.53%
|
6.57%
|
6.40%
|
|
6.29%
|
6.34%
|
6.11%
|
6.09%
|
|
5.96%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Demand and other non-interest bearing deposits
|
3.60%
|
3.56%
|
3.51%
|
|
3.37%
|
3.22%
|
2.92%
|
2.62%
|
|
2.27%
|
Securities sold under repurchase agreements
|
3.28%
|
3.24%
|
3.03%
|
|
2.96%
|
2.78%
|
2.55%
|
2.46%
|
|
2.15%
|
Other borrowings
|
5.02%
|
5.02%
|
5.06%
|
|
5.01%
|
5.01%
|
4.81%
|
4.54%
|
|
4.39%
|
Total Borrowings
|
4.92%
|
4.93%
|
4.95%
|
|
4.87%
|
4.89%
|
4.69%
|
4.42%
|
|
4.21%
|
Total Interest
Bearing Liabilities
|
4.08%
|
4.04%
|
4.04%
|
|
3.89%
|
3.81%
|
3.58%
|
3.29%
|
|
2.96%
|
|
|
|
|
|
|
|
|
|
|
|
Rate Spread
|
2.45%
|
2.53%
|
2.36%
|
|
2.40%
|
2.53%
|
2.53%
|
2.80%
|
|
3.00%
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Margin (2)
|
2.93%
|
2.96%
|
2.79%
|
|
2.87%
|
2.97%
|
2.90%
|
3.19%
|
|
3.38%
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Margin without Tax Equivalent
Adjustments
|
2.86%
|
2.88%
|
2.70%
|
|
2.77%
|
2.86%
|
2.79%
|
3.06%
|
|
3.26%
|
(1) For purposes of these computations, non-accrual
loans are included in average loans.
(2) For purposes of these computations, reported on a tax equivalent basis.
Interest Income
:
For the three and nine months ended September
30, 2007, total interest income, on a fully tax-equivalent basis, amounted to $13,515 and
$38,827 compared with $12,289 and $34,736 during the same periods in 2006, representing
increases of $1,226 and $4,091, or 10.0% and 11.8%, respectively.
The increases in interest income were principally attributed to average
earning asset growth of $52,474 and $47,916 or 6.8% and 6.4% respectively, combined with
19 and 31 basis point increases in the weighted average earning asset yields, when
comparing the three and nine month periods ended September 30, 2007, with the same periods
in 2006, respectively. Principally reflecting increases in market yields and reinvestment
of earning asset cash flows in a higher interest rate environment, the weighted average
yield on average earning assets amounted to 6.53% and 6.50% for the three and nine months
ended September 30, 2007, compared with 6.34% and 6.19% for the same periods in 2006,
respectively.
Comparing the three and nine months ended September 30, 2007, with the
same periods in 2006, the weighted average yield on the Banks loan portfolio
increased 21 and 28 basis points to 6.88% and 6.84%, respectively, while the weighted
average yield on the securities portfolio increased 54 and 45 basis points to 5.75% and
5.69%, respectively. The increase in yield on the securities portfolio reflects, in part,
the restructuring of a portion of the securities portfolio in the second quarter of 2007.
As depicted on the rate/volume analysis tables below, comparing the
three and nine months ended September 30, 2007 with the same periods in 2006, the
increased volume of average earning assets on the balance sheet contributed $729 and
$2,025 to the increases in interest income, while the increases attributed to the impact
of higher weighted average earning asset yields contributed $497 and $2,066, respectively.
Interest Expense:
For the three and nine months ended September
30, 2007, total interest expense amounted to $7,453 and $21,541, compared with $6,532 and
$17,795 during the same periods in 2006, representing increases of $921 and $3,746, or
14.1% and 21.1%, respectively.
The increases in interest expense were principally attributed to 27 and
49 basis point increases in the weighted average cost of funds, combined with increases in
average interest bearing liabilities amounting to $44,963 and $43,008, or 6.6% and 6.4%,
when comparing the three and nine months ended September 30, 2007 with the same periods in
2006, respectively. The increase in the average cost of interest bearing funds was
principally attributed to increases in short-term market interest rates between periods
and, to a lesser extent, a proportionately higher utilization of wholesale funding. In
addition, given highly competitive pricing pressures and the need to strengthen customer
relationships, over the past twelve months the Bank more closely followed the market with
respect to the upward pricing and re-pricing of maturity and non-maturity deposits.
For the three and nine months ended September 30, 2007, the weighted
average cost of funds amounted to 4.08% and 4.05%, compared with 3.81% and 3.56% during
the same periods in 2006, respectively. For the three and nine months ended September 30,
2007, the weighted average cost of borrowed funds increased 3 and 26 basis points to 4.92%
and 4.93%, respectively, while the weighted average cost of interest bearing deposits
increased 38 and 63 basis points to 3.60% and 3.56%, respectively. The increase in the
weighted average cost of interest bearing deposits outpaced the weighted average cost of
borrowed funds, reflecting the re-pricing of certain maturity deposits, highly competitive
market pricing pressures for deposits, combined with a higher utilization of brokered time
deposits.
As depicted on the rate/volume analysis tables below, comparing the
three and nine months ended September 30, 2007 with the same periods in 2006, the
increased volume of average interest bearing liabilities on the balance sheet contributed
$457 and $1,156 to the increases in interest expense, while the increases attributed to
the impact of higher weighted average rates paid on interest bearing liabilities amounted
to $464 and $2,590, respectively.
Rate/Volume Analysis:
The following tables set forth a summary
analysis of the relative impact on net interest income of changes in the average volume of
interest earning assets and interest bearing liabilities, and changes in average rates on
such assets and liabilities. The income from tax-exempt assets has been adjusted to a
fully tax equivalent basis, thereby allowing uniform comparisons to be made. Because of
the numerous simultaneous volume and rate changes during the periods analyzed, it is not
possible to precisely allocate changes to volume or rate. For presentation purposes,
changes which are not solely due to volume changes or rate changes have been allocated to
these categories in proportion to the relationships of the absolute dollar amounts of the
change in each.
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2007 VERSUS SEPTEMBER 30, 2006
INCREASES (DECREASES) DUE TO:
|
Average
Volume
|
Average
Rate
|
Net
Interest Income
|
|
|
|
|
Loans (1,2)
|
$ 246
|
$ 296
|
$
542
|
Taxable securities
|
672
|
356
|
1,028
|
Non-taxable securities (2)
|
(179)
|
(7)
|
(186)
|
Federal Home Loan Bank stock
|
(2)
|
(147)
|
(149)
|
Fed funds sold, money market funds, and time
|
|
|
|
deposits with other banks
|
(8)
|
(1)
|
(9)
|
|
|
|
|
TOTAL EARNING ASSETS
|
$ 729
|
$ 497
|
$ 1,226
|
|
|
|
|
Interest bearing deposits
|
204
|
442
|
646
|
Securities sold under repurchase agreements and
fed funds purchased
|
14
|
19
|
33
|
Borrowings from Federal Home Loan Bank
|
239
|
3
|
242
|
TOTAL INTEREST BEARING LIABILITIES
|
$ 457
|
$ 464
|
$
921
|
|
|
|
|
NET CHANGE IN NET INTEREST INCOME
|
$ 272
|
$ 33
|
$
305
|
(1) For purposes of these computations, non-accrual loans are
included in average loans.
(2) For the purposes of these computations, interest income is reported on a
tax-equivalent basis.
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2007 VERSUS SEPTEMBER 30, 2006
INCREASES (DECREASES) DUE TO:
|
Average
Volume
|
Average
Rate
|
Net
Interest Income
|
|
|
|
|
Loans (1,2)
|
$1,030
|
$1,111
|
$2,141
|
Taxable securities
|
1,397
|
892
|
2,289
|
Non-taxable securities (2)
|
(409)
|
(40)
|
(449)
|
Federal Home Loan Bank stock
|
7
|
99
|
106
|
Fed funds sold, money market funds, and time
deposits with other banks
|
---
|
4
|
4
|
|
|
|
|
TOTAL EARNING ASSETS
|
$2,025
|
$2,066
|
$4,091
|
|
|
|
|
Interest bearing deposits
|
708
|
2,105
|
2,813
|
Securities sold under repurchase agreements
and fed funds purchased
|
8
|
63
|
71
|
Borrowings from Federal Home Loan Bank
|
440
|
422
|
862
|
TOTAL INTEREST BEARING LIABILITIES
|
$1,156
|
$2,590
|
$3,746
|
|
|
|
|
NET CHANGE IN NET INTEREST INCOME
|
$ 869
|
$ (524)
|
$
345
|
(1) For purposes of these computations, non-accrual loans are
included in average loans.
(2) For purposes of these computations, interest income is reported on a
tax-equivalent basis.
Provision for Loan Losses
The provision for loan losses reflects the amount necessary to maintain
the allowance for loan losses (the "allowance") at a level that, in
managements judgment, is appropriate for the amount of inherent risk of loss in the
Banks current loan portfolio.
The Banks non-performing loans remained at low levels at
quarter-end, representing $872 or 0.15% of total loans, compared with $628 and $745, or
0.11% and 0.14% of total loans at December 31 and September 30, 2006, respectively. The
allowance expressed as a percentage of non-performing loans stood at 531% at September 30,
2007, compared with 721% and 617% at December 31 and September 30, 2006, respectively.
The Banks loan loss experience continued at low levels during the
first nine months of 2007, with net charge-offs amounting to $142, or annualized net
charge-offs to average loans outstanding of 0.03%, compared with $178 and 0.04% during the
same period in 2006.
For the three and nine months ended September 30, 2007, the Bank
recorded provisions for loan losses of $214 and $247, compared with $81 and $124 during
the same periods in 2006. The incr
eases in the provision for loan
losses principally reflected growth in the Banks commercial loan portfolio.
Refer below to Item 2 of this Part I,
Allowance for Loan Losses,
in
this report on Form 10-Q
for further discussion and analysis regarding the
allowance.
Non-interest Income
In addition to net interest income, non-interest income is a
significant source of revenue for the Company and an important factor in its results of
operations.
For the three and nine months ended September 30, 2007, total
non-interest income amounted to $2,263 and $4,299, compared with $2,199 and $5,328 during
the same periods in 2006, representing an increase of $64 or 2.9% and a decline of $1,029
or 19.3%, respectively.
Factors contributing to the changes in non-interest income are
enumerated in the following discussion and analysis:
Trust and Other Financial Services:
Income from trust and
financial services is principally derived from fee income based on a percentage of the
market value of client assets under management and held in custody and, to a lesser
extent, revenue from brokerage services conducted through Bar Harbor Financial Services,
an independent third-party broker.
For the three and nine months ended September 30, 2007, income from
trust and other financial services amounted to $564 and $1,747 compared with $486 and
$1,558 during the same periods in 2006, representing increases of $78 and $189, or 16.0%
and 12.1%, respectively. The increases in fee income were driven by trust and investment
management services, principally reflecting growth in assets under management.
At September 30, 2007, total managed assets at Bar Harbor Trust
Services, a Maine chartered non-depository trust company and second tier subsidiary of the
Company, stood at $278,112 compared with $252,057 and $237,657 at December 31 and
September 30, 2006, representing increases of $26,055 and $40,455, or 10.3% and 17.0%,
respectively.
Service Charges on Deposits
: This income is principally derived
from monthly deposit account maintenance and activity fees, overdraft fees, and a variety
of other deposit account related fees.
For the three and nine months ended September 30, 2007, income
generated from service charges on deposit accounts totaled $454 and $1,242, compared with
$440 and $1,188 during the same periods in 2006, representing increases of $14 and $54, or
3.2% and 4.5%, respectively. The increases in service charges on deposit accounts were
principally attributed to the continued growth of the Banks retail, non-maturity
deposit account base.
Credit and Debit Card Service Charges and Fees:
This income is
principally derived from the Banks merchant credit card processing services, its
Visa debit card product and, to a lesser extent, fees associated with its Visa credit card
portfolio. Historically, the Banks merchant credit card processing activities have
been highly seasonal in nature with transaction and fee income volumes peaking in the
summer and autumn, while declining in the winter and spring.
For the three and nine months ended September 30, 2007, credit and
debit card service charges and fees amounted to $871 and $1,579 compared with $776 and
$1,399 during the same periods in 2006, representing increases of $95 and $180, or 12.2%
and 12.9%, respectively.
The increases in credit and debit card service charges and fees were
principally attributed to an increase in debit card fees, reflecting the ongoing growth in
the Banks deposit accounts base, combined with the introduction of a new deposit
product that offers rewards for debit card transactions. Merchant credit card processing
fees also posted an increase, reflecting higher merchant credit card processing volumes,
compared with the three and nine months ended September 30, 2006. The increase in credit
and debit card processing revenue was greater than the increase in credit and debit card
processing expense, which is included in non-interest expense in the Companys
consolidated statements of income.
Net Securities Gains (Losses):
For the three months ended
September 30, 2007, net realized gains on the sale of securities amounted to $231 compared
with $357 during the same quarter in 2006, representing a decline of $126, or 35.3%. For
the nine months ended September 30, 2007, net securities losses amounted to $671, compared
with securities gains of $667 during the same period in 2006, representing a decline of
$1,338, or 200.6%.
In April 2007, the Companys Board of Directors approved the
restructuring of a portion of the Banks securities portfolio through the sale of
$43,337 of its aggregate $227,473 available for sale securities, the proceeds from which
were initially used to pay down short-term borrowings. Since the Company no longer had the
intent to hold these securities until a recovery of their amortized cost, which may be at
maturity, the Company recorded an adjustment to write down these securities to fair value
at March 31, 2007, resulting in a pre-tax impairment loss of $1,162 included in first
quarter 2007 earnings as a reduction of non-interest income. The Companys primary
objectives were to improve future period earnings and provide a means to more effectively
respond to current and future yield curve environments.
The $671 in net securities losses recorded during the nine months ended
September 30, 2007 were comprised of securities impairment losses of $1,162 and realized
losses of $150 on the sale of securities, offset in part by realized gains of on the sale
of securities amounting to $641.
Other Operating Income:
For the three and nine months ended
September 30, 2007, total other operating income amounted to $86 and $240, compared with
$79 and $345 for the same periods in 2006, representing an increase of $7 or 8.9% and a
decline of $105 or 30.4%, respectively.
The decline in other operating income for the nine months ended
September 30, 2007 compared with the same period in 2006 was attributed to a $150 gain on
the sale of a parcel of Bank-owned real estate adjacent to the Banks Southwest
Harbor, Maine branch office, recorded during the first quarter of 2006.
Non-interest Expense
For the three and nine months ended September 30, 2007, total
non-interest expenses amounted to $4,796 and $13,146, compared with $4,857 and $14,192 for
the same periods in 2006, representing declines of $61 and $1,046, or 1.3% and 7.4%,
respectively.
Factors contributing to the changes in non-interest expense are
enumerated in the following discussion and analysis.
Salaries and Employee Benefit Expenses:
For the three and nine
months ended September 30, 2007, salaries and employee benefit expenses amounted to $2,386
and $6,885, compared with $2,360 and $7,077 during the same periods in 2006, representing
an increase of $26 or 1.1% and a decline of $192 or 2.7%, respectively.
The decline in salaries and employee benefit expenses for the nine
months ended September 30, 2007 compared with the same period in 2006 was attributed to a
variety of factors including: changes in overall staffing levels and mix, changes to
certain employee benefit programs; and lower levels of incentive compensation.
Postretirement Plan Settlement:
In the first quarter of 2007,
the Company settled its limited postretirement benefit program, which funded medical
coverage and life insurance benefits to a closed group of active and retired employees who
met minimum age and service requirements. The Company voluntarily paid out $700 to plan
participants, representing 64% of the total benefit obligation. This payment fully settled
all Company obligations related to this program. In connection with the settlement of the
postretirement program, the Company recorded a first quarter reduction in non-interest
expense of $832, representing the remaining accrued benefit obligation and the actuarial
gain related to the program.
Occupancy Expenses:
For the three and nine months ended
September 30, 2007, total occupancy expenses amounted to $294 and $987, compared with $329
and $978 for the same periods in 2006, representing a decline of $35 or 10.6% and an
increase of $9 or 0.9%, respectively.
The decline in occupancy expenses for the three months ended September
30, 2007 compared with the same quarter last year was principally attributed to small
declines in a variety of expense categories including utilities, grounds keeping and real
estate taxes.
Furniture and Equipment Expenses:
For the three and nine months
ended September 30, 2007, furniture and equipment expenses amounted to $396 and $1,284,
compared with $456 and $1,378 for the same periods in 2006, representing declines of $60
and $94, or 13.2% and 6.8%, respectively. The declines in furniture and equipment expenses
were attributed to declines in a variety of expense categories including depreciation
expense, maintenance contracts, miscellaneous equipment purchases and personal property
taxes. The declines also reflect certain expenses associated with the Banks major
renovation and opening of a new branch office in the community of Somesville, Maine during
2006.
Credit and Debit Card Expenses:
For the three and nine months
ended September 30, 2007, credit and debit card expenses amounted to $621 and $1,079,
compared with $577 and $993 for the same periods in 2006, representing increases of $44
and $86, or 7.6% and 8.7%, respectively.
Credit and debit card expenses principally relate to the Banks
merchant credit and debit card processing activities, Visa debit card processing expenses
and, to a lesser extent, its Visa credit card portfolio. Historically, the Banks
merchant credit card processing activities have been highly seasonal in nature with
transaction volumes peaking in the summer and autumn, while declining in the winter and
spring.
The increases in credit and debit card expenses were principally
attributed to increases in the volume of debit card transactions, reflecting the growth of
the Banks retail checking account base and the introduction of a new deposit product
that provides customer rewards for debit card activity. Merchant credit card processing
fees were also moderately higher, principally reflecting higher merchant credit card
processing volumes compared with the same periods in 2006. The increases in credit and
debit card expenses were less than the increases in credit and debit card income, which is
included in non-interest income in the Companys consolidated statements of income.
Other Operating Expenses:
For the three and nine months ended
September 30, 2007, other operating expenses amounted to $1,099 and $3,743, compared with
$1,135 and $3,766 for the same periods in 2006, representing declines of $36 and $23, or
3.2% and 0.6%, respectively.
The declines in other operating expenses were principally attributed to
declines in marketing, training and software depreciation expenses, offset in part by
moderate increases in a variety of other expense categories including charitable
contributions, telecommunications and insurance.
Income Taxes
For the three and nine months ended September 30, 2007, total income
taxes amounted to $1,019 and $2,332, compared with $845 and $2,142 for the same periods in
2006, representing increases of $174 and $190, or 20.2% and 8.9%, respectively.
The Company's effective tax rates for the three and nine months ended
September 30, 2007 amounted to 32.2% and 30.3%, compared with 30.1% and 29.3% for the same
periods in 2006, respectively. The income tax provisions for these periods are less than
the expense that would result from applying the federal statutory rate of 34% to income
before income taxes, principally because of the impact of tax exempt interest income on
certain investment securities, loans and bank owned life insurance.
Fluctuations in the Companys effective tax rate are generally
attributed to changes in the relationship between non-taxable income and non-deductible
expense, and income before income taxes, during any given reporting period.
FINANCIAL CONDITION
Total Assets
The Companys assets principally consist of loans and securities,
which at September 30, 2007, represented 65.9% and 28.5% of total assets, compared with
67.3% and 25.9% at December 31, 2006, respectively.
At September 30, 2007, total assets amounted to $858,755 compared with
$824,877 and $795,379 at December 31 and September 30, 2006, representing increases of
$33,878 and $63,376, or 4.1% and 8.0%, respectively.
Securities
The securities portfolio is primarily comprised of mortgage-backed
securities issued by U.S. government agencies, U.S. government sponsored enterprises, and
other corporate issuers. The portfolio also includes tax-exempt obligations of state and
political subdivisions, and obligations of other U.S. government sponsored enterprises.
The overall objectives of the Banks strategy for the investment
securities portfolio include maintaining appropriate liquidity reserves, diversifying
earning assets, managing interest rate risk, leveraging the Banks strong capital
position, and generating acceptable levels of net interest income.
Securities available for sale represented 100% of total investment
securities at September 30, 2007 and 2006. Securities available for sale are reported at
their fair value with unrealized gains or losses, net of taxes, excluded from earnings but
shown separately as a component of shareholders equity.
For the nine months ended September 30, 2007, the securities portfolio
represented 28.7% of the Companys average earning assets and generated 25.2% of
total tax-equivalent interest and dividend income, compared with 27.0% and 22.8% for the
same period in 2006, respectively.
At September 30, 2007, total securities amounted to $244,457, compared
with $213,252 and $197,884 at December 31 and September 30, 2006, representing increases
of $31,205 and $46,573, or 14.6% and 23.5%, respectively.
In the second quarter of 2007, the Bank completed the restructuring of
a portion of its securities portfolio, selling a total of $46,170 in securities with below
market yields while paying down short-term borrowings. During the later part of the second
quarter, market yields climbed to a five-year high, with the benchmark 10-year U.S.
Treasury advancing from 4.63% in mid May to 5.30% in mid June. The strong increase in
market yields presented opportunities for replacing the securities sold, increasing the
Banks earning assets, and generating higher levels of net interest income.
Impaired Securities:
The securities portfolio contains certain
investments where amortized cost exceeds fair market value, which at September 30, 2007
amounted to an unrealized loss of $1,536 compared with $2,635 at December 31, 2006. At
September 30, 2007, unrealized losses on securities in a continuous unrealized loss
position more than twelve-months amounted to $780 or 1.5 % of their amortized cost,
compared with $2,418 or 2.4% at December 31, 2006, respectively. The decline in unrealized
losses principally reflected the favorable impact of the securities portfolio
restructuring in the second quarter of 2007, combined with lower interest rates and market
yields at September 30, 2007 compared with December 31, 2006.
Unrealized losses that are considered other-than-temporary are recorded
as a loss on the Companys consolidated statement of income. In evaluating whether
impairment is other-than-temporary, management considers a variety of factors including
the nature of the investment security, the cause of the impairment, the severity and
duration of the impairment, and the Banks ability and intent to hold the security to
maturity. Other data considered by management includes, for example, sector credit
ratings, volatility of the securitys market price, and any other information
considered relevant in determining whether other-than-temporary impairment has occurred.
Management believes the unrealized losses in the securities portfolio
at September 30, 2007 were attributed to interest rate increases, and reflected the
volatile movements in the U.S. Treasury curve over the past few years. Specifically,
certain debt securities were purchased in an interest rate environment lower than that
prevailing at September 30, 2007. Because the decline in market value was attributable to
changes in interest rates and not credit quality, and because the Bank has the ability and
intent to hold these securities until a recovery of their amortized cost, which may be at
maturity, the Company does not consider these securities to be other-than-temporarily
impaired at September 30, 2007.
Loans
The loan portfolio is primarily secured by real estate in the counties
of Hancock, Washington and Knox, Maine. The following table summarizes the components of
the Bank's loan portfolio as of the dates indicated.
LOAN PORTFOLIO SUMMARY
|
September 30,
2007
|
December 31,
2006
|
September 30,
2006
|
|
|
|
|
Commercial real estate mortgages
|
$173,326
|
$159,661
|
$154,027
|
Commercial and industrial loans
|
61,547
|
61,762
|
61,139
|
Agricultural and other loans to farmers
|
18,608
|
17,743
|
18,392
|
Total commercial loans
|
253,481
|
239,166
|
233,558
|
|
|
|
|
Residential real estate mortgages
|
250,822
|
253,640
|
250,950
|
Consumer loans
|
9,380
|
10,911
|
11,532
|
Home equity loans
|
46,472
|
45,156
|
45,484
|
Total consumer loans
|
306,674
|
309,707
|
307,966
|
|
|
|
|
Tax exempt loans
|
5,857
|
6,226
|
5,963
|
Total loans
|
566,012
|
555,099
|
547,487
|
Allowance for loan losses
|
(4,630)
|
(4,525)
|
(4,593)
|
Total loans, net of
allowance for loan losses
|
$561,382
|
$550,574
|
$542,894
|
Total Loans
:
At September 30, 2007, total loans amounted to
$566,012, compared with $555,099 and $547,487 at December 31, and September 30, 2006,
representing increases of $10,913 and $18,525, or 2.0% and 3.4%, respectively.
At September 30, 2007, total commercial loans amounted to $253,481,
compared with $239,166 and $233,558 at December 31 and September 30, 2006, representing
increases of $14,315 and $19,923, or 6.0% and 8.5%, respectively. Bank management
attributes the overall growth in commercial loans, in part, to an effective business
banking team, a variety of new business development initiatives, focused incentive
compensation plans, and a relatively stable local economy.
At September 30, 2007, total consumer loans, which principally
consisted of consumer real estate (residential mortgage) loans, amounted to $306,674,
compared with $309,707 and $307,966 at December 31 and September 30, 2006, representing a
declines of $3,033 and $1,292 or 1.0% and 0.4%, respectively. Principally reflecting a
softening real estate market, consumer real estate loan originations started slowing in
the later part of 2006 and this trend continued during the nine months ended September 30,
2007. During 2007, the Banks residential mortgage loan origination activity replaced
a significant amount of principal cash flows from the consumer real estate portfolio,
which increased the overall portfolio yield given the 2007 interest rate environment.
At September 30, 2007, consumer and commercial loans secured by real
estate comprised 86.5% of the loan portfolio, compared with 86.5% and 85.1% at December 31
and September 30, 2006, respectively. Over the past few years, the strength in the local
real estate markets, both residential and commercial, has led to historically high
property values in the Banks market area. However, in the latter part of 2006 and
continuing into the first nine months of 2007, this trend began to soften. Recognizing the
impact a softening real estate market may have on the loan portfolio and origination
pipeline, the Bank periodically reviews its underwriting standards in an effort to ensure
that the quality of the loan portfolio is not jeopardized by unrealistic loan to value
ratios or debt service levels. There was no significant deterioration in the performance
or risk characteristics of the real estate loan portfolios through the reporting period.
Credit Risk
:
Credit risk is managed through loan officer
authorities, loan policies, and oversight from the Banks Senior Credit Officer, the
Bank's Senior Loan Officers Committee, the Director's Loan Committee, and the Bank's Board
of Directors. Management follows a policy of continually identifying, analyzing and
grading credit risk inherent in the loan portfolio. An ongoing independent review,
subsequent to management's review, of individual credits is performed by an independent
loan review function, which reports to the Audit Committee of the Board of Directors.
As a result of managements ongoing review of the loan portfolio,
loans are placed on non-accrual status, either due to the delinquent status of principal
and or interest, or a judgment by management that, although payments of principal and or
interest are current, such action is prudent because collection in full of all outstanding
principal and interest is in doubt. Loans are generally placed on non-accrual status when
principal and or interest is 90 days overdue, or sooner if judged appropriate by
management. Consumer loans are generally charged-off when principal and or interest
payments are 120 days overdue, or sooner if judged appropriate by management.
Non-performing Loans:
Non-performing loans include loans on
non-accrual status, loans that have been treated as troubled debt restructurings and loans
past due 90 days or more and still accruing interest. There were no troubled debt
restructurings in the loan portfolio during 2006 and this continued to be the case during
the nine months ended September 30, 2007. The following table sets forth the details of
non-performing loans as of the dates indicated:
TOTAL NON-PERFORMING LOANS
|
September 30,
2007
|
December 31,
2006
|
September 30,
2006
|
|
|
|
|
Loans accounted for on a non-accrual basis:
|
|
|
|
Real estate loans:
|
|
|
|
Residential
mortgage
|
$ 67
|
$111
|
$242
|
Loans to finance agricultural production and
other
loans to farmers
|
59
|
41
|
43
|
Commercial and industrial loans
|
653
|
415
|
434
|
Loans to individuals for household, family, and
other
personal expenditures
|
6
|
3
|
6
|
Total non-accrual loans
|
785
|
570
|
725
|
Accruing loans contractually past due 90 days or more
|
87
|
58
|
20
|
Total non-performing loans
|
$872
|
$628
|
$745
|
|
|
|
|
Allowance for loan losses to non-performing loans
|
531%
|
721%
|
617%
|
Non-performing loans to total loans
|
0.15%
|
0.11%
|
0.14%
|
Allowance to total loans
|
0.82%
|
0.82%
|
0.84%
|
During the quarter ended September 30, 2007, the Banks
non-performing loans remained at low levels. The Bank attributes this to mature credit
administration processes and underwriting standards, aided by a relatively stable local
economy. The Bank maintains a centralized loan collection and managed assets department,
providing timely and effective collection efforts for problem loans.
At September 30, 2007, total non-performing loans amounted to $872, or
0.15% of total loans, compared with $628 or 0.11% at December 31, 2006, and $745 or 0.14%
at September 30, 2006.
While the level of non-performing loan ratios continued to reflect the
favorable quality of the loan portfolio at September 30, 2007, Bank management is
cognizant of relatively softening economic conditions overall, and believes it is managing
credit risk accordingly. Future levels of non-performing loans may be influenced by
changing economic conditions, such as the impact of those conditions on the Bank's
customers, including higher interest rates and debt service levels, oil and gas prices,
tourism activity, and other factors existing at the time. Management believes the economic
activity and conditions in the local real estate markets will continue to be significant
determinants of the quality of the loan portfolio in future periods and, thus, the
Companys results of operations and financial condition.
Other Real Estate Owned:
When the Bank takes ownership of
collateral property upon foreclosure of a real estate secured loan, the property is
transferred from the loan portfolio to Other Real Estate Owned ("OREO") at its
fair value. If the loan balance is higher than the fair value of the property, the
difference is charged to the allowance for loan losses at the time of the transfer. OREO
is classified on the consolidated balance sheet with other assets. At September 30, 2007,
there was no OREO, unchanged from December 31 and September 30, 2006.
Allowance for Loan Losses
:
The allowance for loan losses
("allowance") is available to absorb losses on loans. The determination of the
adequacy of the allowance and provisioning for estimated losses is evaluated quarterly
based on review of loans, with particular emphasis on non-performing and other loans that
management believes warrant special consideration.
The allowance is maintained at a level that, in managements
judgment, is appropriate for the amount of risk inherent in the current loan portfolio,
and adequate to provide for estimated losses.
Specific reserves for impaired loans are determined in accordance with
SFAS No. 114, "Accounting by Creditors For Impairment of a Loan," as amended by
SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition
and Disclosures." The amount of loans considered to be impaired totaled $712 as of
September 30, 2007, compared with $456 and $477 as of December 31 and September 30, 2006,
respectively. The related allowance for loan losses on these impaired loans amounted to
$159 as of September 30, 2007, compared with $130 and $156 at December 31 and September
30, 2006, respectively.
Management recognizes that early and accurate recognition of risk is
the best means to reduce credit losses and maximize earnings. The Bank employs a
comprehensive risk management structure to identify and manage the risk of loss. For
consumer loans, the Bank identifies loan delinquency beginning at 10-day delinquency and
provides appropriate follow-up by written correspondence or personal contact.
Non-residential mortgage consumer loan losses are recognized no later than the point at
which a loan is 120 days past due. Residential mortgage losses are recognized during the
foreclosure process, or sooner, when that loss is quantifiable and reasonably assured. For
commercial loans, the Bank applies a risk grading system, which stratifies the portfolio
and allows management to focus appropriate efforts on the highest risk components of the
portfolio. The risk grades include ratings that correlate with regulatory definitions of
"Pass," "Other Assets Especially Mentioned," "Substandard,"
"Doubtful," and "Loss."
Loan loss provisions are recorded based upon overall aggregate data,
and the allowance is increased when, on an aggregate basis, additional estimated losses
are identified and deemed by management as being likely. No portion of the allowance is
restricted to any loan or group of loans, and the entire allowance is available to absorb
realized losses. The amount and timing of realized losses and future allowance allocations
could vary from current estimates.
While management uses available information to recognize losses on
loans, changing economic conditions and the economic prospects of the borrowers may
necessitate future additions or reductions to the allowance. In addition, various
regulatory agencies, as an integral part of their examination process, periodically review
the Banks allowance, which also may necessitate future additions or reductions to
the allowance, based on information available to them at the time of their examination.
The Banks loan loss experience remained at low levels during the
nine months ended September 30, 2007, with net loan charge-offs amounting to $142, or
annualized net charge-offs to average loans outstanding of 0.03%, compared with $178 or
annualized net charge-offs to average loans outstanding of 0.04% during the same period in
2006.
There were no material changes in loan concentrations during the nine
months ended September 30, 2007.
The following table details changes in the allowance and summarizes
loan loss experience by loan type for the nine-month periods ended September 30, 2007 and
2006.
ALLOWANCE FOR LOAN LOSSES
NINE MONTHS ENDED
SEPTEMBER 30, 2007 AND 2006
|
2007
|
|
2006
|
|
|
|
|
Balance at beginning of period
|
$ 4,525
|
|
$ 4,647
|
Charge-offs:
|
|
|
|
Commercial, financial, agricultural, other loans
to farmers
|
80
|
|
12
|
Real estate:
|
|
|
|
Mortgage
|
41
|
|
193
|
Installments and other loans to individuals
|
73
|
|
61
|
Total charge-offs
|
194
|
|
266
|
|
|
|
|
Recoveries:
|
|
|
|
Commercial, finance agricultural, other loans to
farmers
|
24
|
|
3
|
Real estate:
|
|
|
|
Mortgage
|
---
|
|
40
|
Installments and other loans to individuals
|
28
|
|
45
|
Total recoveries
|
52
|
|
88
|
|
|
|
|
Net charge-offs
|
142
|
|
178
|
Provision charged to operations
|
247
|
|
124
|
|
|
|
|
Balance at end of period
|
$ 4,630
|
|
$ 4,593
|
|
|
|
|
Average loans outstanding during period
|
$554,522
|
|
$533,954
|
|
|
|
|
|
|
|
|
Annualized net charge-offs to average loans outstanding
|
0.034%
|
|
0.044%
|
Based upon the process employed and giving recognition to all attendant
factors associated with the loan portfolio, management believes the allowance for loan
losses at September 30, 2007, to be appropriate for the risks inherent in the loan
portfolio and resident in the local and regional economy as of that date.
Deposits
During the three and nine months ended September 30, 2007, the most
significant funding source for the Banks earning assets continued to be retail
deposits, gathered through its network of twelve banking offices throughout downeast and
midcoast Maine.
Historically, the banking business in the Banks market area has
been seasonal, with lower deposits in the winter and spring and higher deposits in summer
and autumn. These seasonal swings have been fairly predictable and have not had a
materially adverse impact on the Bank. Seasonal swings in deposits have been typically
absorbed by the Banks strong liquidity position, including borrowing capacity from
the Federal Home Loan Bank of Boston, brokered certificates of deposit obtained from the
national market and cash flows from the securities portfolio.
At September 30, 2007, total deposits amounted to $526,862, compared
with $496,319 and $514,381 at December 31 and September 30, 2006, representing increases
of $30,543 and $12,481, or 6.2% and 2.4%, respectively.
Deposit growth was principally attributed to certificates of deposit
obtained from the national market ("brokered deposits"), which at September 30,
2007 totaled $123,684, compared with $82,361 and $85,926 at December 31 and September 30,
2006, representing increases of $41,323 and $37,758, or 50.2% and 43.9%, respectively. The
increases in brokered deposits were principally used to help fund the Banks earning
asset growth, as well as replacing retail deposit declines.
At September 30, 2007, retail deposits totaled $403,178, representing
declines of $10,780 and $25,277, or 2.6% and 5.9%, compared with December 31 and September
30, 2006, respectively. The declines in retail deposits were principally attributed to
declines in money market accounts offered to clients of Bar Harbor Trust Services, a Maine
chartered non-depository trust company subsidiary of the Bank, reflecting a reallocation
of cash within certain managed asset portfolios. Comparing September 30, 2007, with
December 31 and September 30, 2006, these money market deposits accounted for $30,793 and
$33,134 of the overall retail deposit declines, respectively.
Excluding the deposit accounts offered to clients of Bar Harbor Trust
Services, at September 30, 2007 total retail deposits were showing increases of $20,013
and $7,857, or 5.3% and 2.0%, compared with December 31 and September 30, 2006,
respectively.
In general, without considering the declines in money market accounts
offered to clients of Bar Harbor Trust Services, the Banks retail deposit growth has
moderately lagged historical norms. Management believes that competition from banks and
non-banks has intensified, as savers and investors seek higher returns, and that financial
institutions in particular have been aggressively pricing their deposits in order to fund
earning asset growth. Management also believes that during the three and nine months ended
September 30, 2007 investors have been reallocating a portion of their cash positions,
believing the equity markets became more attractive from a total return perspective.
Since short-term interest rates began rising, Bank management has
exercised restraint with respect to overly aggressive deposit pricing strategies, and has
sought to achieve an appropriate balance between retail deposit growth and wholesale
funding levels, while considering the associated impacts on the Banks net interest
margin and liquidity position.
Borrowed Funds
Borrowed funds principally consist of advances from the Federal Home
Loan Bank of Boston (the "FHLB") and, to a lesser extent, securities sold under
agreements to repurchase. Advances from the FHLB are principally secured by stock in the
FHLB, securities, and blanket liens on qualifying mortgage loans and home equity loans.
The Bank utilizes borrowed funds in leveraging its strong capital
position and supporting its earning asset portfolios. Borrowed funds are principally
utilized to support the Banks securities portfolio and, to a lesser extent, fund
loan growth. Borrowed funds also provide a means to help manage balance sheet interest
rate risk, given the Banks ability to select desired amounts, terms and maturities
on a daily basis.
At September 30, 2007, total borrowings amounted to $262,679, compared
with $260,712 and $215,178 at December 31 and September 30, 2006, representing increases
of $1,967 and $47,501, or 0.8% and 22.1%, respectively. The increase in borrowings
compared with September 30, 2006 was principally utilized to help support the growth of
the Banks securities portfolio. The relatively small increase compared with December
31, 2006 reflects the seasonality of the Banks retail deposit base as described
above.
While total borrowings were showing a small increase compared with
December 31, 2006, long-term borrowings increased $29,541, while short-term borrowings
declined $27,571. The moderate shift to long-term borrowings principally reflects
managements strategy for lessening the Banks risk to rising interest rates.
At September 30, 2007, total borrowings expressed as a percent of total
assets amounted to 30.6%, compared with 31.6% and 27.1% at December 31 and September 30,
2006, respectively.
Capital Resources
Consistent with its long-term goal of operating a sound and profitable
organization, during the third quarter of 2007 the Company maintained its strong capital
position and continued to be a "well capitalized" financial institution
according to applicable regulatory standards. Management believes this to be vital in
promoting depositor and investor confidence and providing a solid foundation for future
growth.
The Company and the Bank are subject to the risk based capital
guidelines administered by the Companys and the Bank's principal regulators. The
risk based capital guidelines are designed to make regulatory capital requirements more
sensitive to differences in risk profiles among banks and bank holding companies, to
account for off-balance sheet exposure and to minimize disincentives for holding liquid
assets. Under these guidelines, assets and off-balance sheet items are assigned to broad
risk categories, each with appropriate weights. The resulting capital ratios represent
capital as a percentage of risk weighted assets and off-balance sheet items. The
guidelines require all banks and bank holding companies to maintain a minimum ratio of
total risk based capital to risk weighted assets of 8%, including a minimum ratio of Tier
I capital to total risk weighted assets of 4% and a Tier I capital to average assets of 4%
("Leverage Ratio"). Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary actions by regulators that, if
undertaken, could have a material effect on the Company's financial statements.
As of September 30, 2007, the Company and the Bank were considered well
capitalized under the regulatory framework for prompt corrective action. Under the capital
adequacy guidelines, a well capitalized institution must maintain a minimum total risk
based capital to total risk weighted assets ratio of at least 10%, a minimum Tier I
capital to total risk weighted assets ratio of at least 6%, and a minimum Tier I leverage
ratio of at least 5%.
The following table sets forth the Company's regulatory capital at
September 30, 2007 and December 31, 2006, under the rules applicable at that date.
|
September 30, 2007
|
|
December 31, 2006
|
|
Amount
|
Ratio
|
|
Amount
|
Ratio
|
|
|
|
|
|
|
Total Capital to Risk Weighted Assets
|
$65,948
|
11.95%
|
|
$63,325
|
11.65%
|
Regulatory Requirement
|
44,156
|
8.00%
|
|
43,491
|
8.00%
|
Excess over "adequately capitalized"
|
$21,792
|
3.95%
|
|
$19,834
|
3.65%
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier 1 Capital to Risk Weighted Assets
|
$61,318
|
11.11%
|
|
$58,800
|
10.82%
|
Regulatory Requirement
|
22,078
|
4.00%
|
|
21,745
|
4.00%
|
Excess over "adequately capitalized"
|
$39,240
|
7.11%
|
|
$37,055
|
6.82%
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier 1 Capital to Average Assets
|
$61,318
|
7.21%
|
|
$58,800
|
7.34%
|
Regulatory Requirement
|
34,026
|
4.00%
|
|
32,040
|
4.00%
|
Excess over "adequately capitalized"
|
$27,292
|
3.21%
|
|
$26,760
|
3.34%
|
The Company's principal source of funds to pay cash dividends and
support its commitments is derived from Bank operations. The Company declared dividends in
the aggregate amount of $2,161 and $2,060 during the nine months ended September 30, 2007
and 2006, at a rate of $0.710 and $0.675 per share, respectively.
In March 2004, the Company announced a second stock repurchase plan.
The Board of Directors of the Company authorized open market and privately negotiated
purchases of up to 10% of the Companys outstanding shares of common stock, or
310,000 shares. Purchases began on March 4, 2004 and continued through December 31, 2006.
The Companys Board of Directors subsequently authorized the continuance of this
stock repurchase plan through December 31, 2007. Depending on market conditions and other
factors, these purchases may be commenced or suspended at any time, or from time-to-time,
without prior notice. As of September 30, 2007, the Company had repurchased 180,949 shares
of stock under this plan, or 58.4% of the total authorized, at a total cost of $5,155 and
an average price of $28.49 per share. The Company records the repurchased shares as
treasury stock.
The Company believes that a stock repurchase plan is a prudent use of
capital at this time. Management anticipates the stock repurchase plan will be accretive
to the return on average shareholders equity and earnings per share. Management also
believes the stock repurchase plan helps facilitate an orderly market for the disposition
of large blocks of stock, and lessens the price volatility associated with the
Companys thinly traded stock.
Contractual Obligations
The Company is a party to certain contractual obligations under which
it is obligated to make future payments. These principally include borrowings from the
FHLB, consisting of short and long-term fixed rate borrowings, and collateralized by all
stock in the FHLB, a blanket lien on qualified collateral consisting primarily of loans
with first and second mortgages secured by one-to-four family properties, and certain
pledged investment securities. The Company has an obligation to repay all borrowings from
the FHLB.
The Company is also obligated to make payments on operating leases for
its branch office in Somesville and its office in Bangor, Maine.
The following table summarizes the Companys contractual
obligations at September 30, 2007. Borrowings are stated at their contractual maturity due
dates and do not reflect call features, or principal amortization features, on certain
borrowings.
CONTRACTUAL OBLIGATIONS
(Dollars in thousands)
|
|
Payments Due By Period
|
Description
|
Total Amount of Obligations
|
< 1 Year
|
> 1-3 Years
|
> 3-5 Years
|
> 5 Years
|
|
|
|
|
|
|
Operating Leases
|
$ 287
|
$ 89
|
$ 141
|
$ 57
|
$ ---
|
Borrowings from Federal Home Loan Bank
|
240,207
|
125,200
|
50,583
|
48,424
|
16,000
|
Securities sold under agreements to repurchase
|
22,472
|
22,472
|
---
|
---
|
---
|
Total
|
$262,966
|
$147,761
|
$50,724
|
$48,481
|
$16,000
|
All FHLB advances are fixed-rate instruments. Advances are payable at
their call dates or final maturity dates. Advances are stated at their contractual final
maturity dates in the above table. At September 30, 2007, the Bank had $81,500 in callable
advances.
In the normal course of its banking and financial services business,
and in connection with providing products and services to its customers, the Company has
entered into a variety of traditional third party contracts for support services. Examples
of such contractual agreements would include services providing ATM, Visa debit and credit
card processing, trust services accounting support, check printing, statement rendering
and the leasing of T-1 telecommunication lines supporting the Companys wide area
technology network.
The majority of the Companys core operating systems and software
applications are maintained "in-house" with traditional third party maintenance
agreements of one year or less.
Off-Balance Sheet Arrangements
The Company is, from time to time, a party to certain off-balance sheet
arrangements that have or are reasonably likely to have a current or future effect on the
Company's financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources, that may be
considered material to investors.
The Bank guarantees the obligations or performance of certain customers
by issuing standby letters of credit to third parties. These letters of credit are
sometimes issued in support of third party debt. The risk involved in issuing standby
letters of credit is essentially the same as the credit risk involved in extending loan
facilities to customers, and they are subject to the same origination, portfolio
maintenance and management procedures in effect to monitor other credit products. The
amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby
letter of credit, is based upon management's credit evaluation of the customer.
At September 30, 2007, commitments under existing standby letters of
credit totaled $306, compared with $442 at both December 31 and September 30, 2006. The
fair values of the standby letters of credit were not significant as of the foregoing
dates.
Off-Balance Sheet Risk
The Bank is party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financial needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial instruments
include commitments to extend credit and certain financial derivative instruments; namely,
interest rate swap agreements and interest rate floor agreements.
Commitments to Extend Credit:
Commitments to extend credit
represent agreements by the Bank to lend to a customer provided there is no violation of
any condition established in the contract. These commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of these commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis
using the same credit policies as it does for its balance sheet instruments. The amount of
collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is
based on management's credit evaluation of the customer.
The following table summarizes the Bank's commitments to extend credit
as of the dates shown:
(Dollars in thousands)
|
September 30,
2007
|
December 31,
2006
|
September 30,
2006
|
|
|
|
|
Commitments to originate loans
|
$ 40,024
|
$ 13,340
|
$ 30,670
|
Unused lines of credit
|
81,762
|
81,800
|
80,454
|
Un-advanced portions of construction loans
|
10,893
|
7,638
|
8,363
|
Total
|
$132,679
|
$102,778
|
$119,487
|
Financial Derivative Instruments:
As part of its overall asset
and liability management strategy, the Bank periodically uses derivative instruments to
minimize significant unplanned fluctuations in earnings and cash flows caused by interest
rate volatility. The Bank's interest rate risk management strategy involves modifying the
re-pricing characteristics of certain assets and liabilities so that changes in interest
rates do not have a significant adverse effect on net interest income. Derivative
instruments that management periodically uses as part of its interest rate risk management
strategy include interest rate swap agreements and interest rate floor agreements. A
policy statement, approved by the Board of Directors of the Bank, governs use of
derivative instruments.
At September 30, 2007, the Bank had three outstanding derivative
instruments with notional amounts totaling $40,000. The notional amounts of the financial
derivative instruments do not represent exposure to credit loss. The Bank is exposed to
credit loss only to the extent the counter-party defaults in its responsibility to pay
interest under the terms of the agreements. Management does not anticipate non-performance
by the counter-parties to the agreements, and regularly reviews the credit quality of the
counter-parties from which the instruments have been purchased.
The details of the Banks financial derivative instruments as of
September 30, 2007 are summarized below. Also refer to Note 6 of the consolidated
financial statements in Part I, Item 1 of this report on Form 10-Q.
INTEREST RATE SWAP AGREEMENT
Description
|
Maturity
|
Notional Amount
(in thousands)
|
Fixed Interest Rate
|
Variable Interest Rate
|
|
|
|
|
|
Receive fixed rate, pay variable rate
|
01/24/09
|
$10,000
|
6.25%
|
Prime (7.75%)
|
The interest rate swap agreement was designated as cash flow hedges in
accordance with SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges:
Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a
Group of Non-Benchmark-Rate-Based Loans."
The Company is required to pay a counter-party monthly variable rate
payments indexed to Prime, while receiving monthly fixed rate payments based upon an
interest rate of 6.25% over the term of the agreement.
The following table summarizes the contractual cash flows of the
interest rate swap agreement outstanding at September 30, 2007, based upon the then
current Prime interest rate of 7.75%.
|
Total
|
Less Than 1
Year
|
>1-3 Years
|
|
|
|
|
Fixed payments due from counter-party
|
$ 825
|
$627
|
$198
|
Variable payments due to counter-party based on prime rate
|
1,023
|
777
|
246
|
Net cash flow
|
($ 198)
|
($150)
|
($ 48)
|
INTEREST RATE FLOOR AGREEMENTS
Notional Amount
|
Termination Date
|
Prime Strike Rate
|
Premium Paid
|
|
|
|
|
$20,000
|
08/01/10
|
6.00%
|
$186
|
$10,000
|
11/01/10
|
6.50%
|
$ 69
|
In 2005, interest rate floor agreements were purchased to limit the
Banks exposure to falling interest rates on two pools of loans indexed to the Prime
interest rate. Under the terms of the agreements, the Bank paid premiums of $186 and $69
for the right to receive cash flow payments if the Prime interest rate falls below the
floors of 6.00% and 6.50%, thus effectively ensuring interest income on the pools of
prime-based loans at minimum rates of 6.00% and 6.50% on the $20,000 and $10,000 notional
amounts for the duration of the agreements, respectively. The interest rate floor
agreements were designated as cash flow hedges in accordance with SFAS 133.
Liquidity
Liquidity is measured by the Companys ability to meet short-term
cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable
sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy
varied liquidity demands. Besides serving as a funding source for maturing obligations,
liquidity provides flexibility in responding to customer-initiated needs. Many factors
affect the Companys ability to meet liquidity needs, including variations in the
markets served by its network of offices, its mix of assets and liabilities, reputation
and credit standing in the marketplace, and general economic conditions.
The Bank actively manages its liquidity position through target ratios
established under its Asset Liability Management Policy. Continual monitoring of these
ratios, both historical and through forecasts under multiple rate scenarios, allows the
Bank to employ strategies necessary to maintain adequate liquidity.
The Bank uses a basic surplus model to measure its liquidity over 30
and 90-day time horizons. The relationship between liquid assets and short-term
liabilities that are vulnerable to non-replacement are routinely monitored. The
Banks policy is to maintain its liquidity position at approximately 5% of total
assets. At September 30, 2007, liquidity, as measured by the basic surplus/deficit model,
was 10.4% over the 30-day horizon and 9.3% over the 90-day horizon.
At September 30, 2007, the Bank had unused lines of credit and net
unencumbered qualifying collateral availability to support its credit line with the FHLB
approximating $65,000. The Bank also had capacity to borrow funds on a secured basis
utilizing certain un-pledged securities in its securities portfolio. The Banks loan
portfolio provides an additional source of contingent liquidity that could be accessed in
a reasonable time period through pledging or sales. The Bank also has access to the
national brokered deposit market, and has been using this funding source to bolster its
liquidity position.
The Bank maintains a liquidity contingency plan approved by the
Banks Board of Directors. This plan addresses the steps that would be taken in the
event of a liquidity crisis, and identifies other sources of liquidity available to the
Company. Company management believes that the level of liquidity is sufficient to meet
current and future funding requirements. However, changes in economic conditions,
including consumer savings habits and availability or access to the brokered deposit
market could potentially have a significant impact on the Companys liquidity
position.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and the accompanying Notes to the
Consolidated Financial Statements presented elsewhere in this report have been prepared in
accordance with U.S. generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historical dollars
without considering changes in the relative purchasing power of money over time due to
inflation.
Unlike many industrial companies, substantially all of the assets and
virtually all of the liabilities of the Company are monetary in nature. As a result,
interest rates have a more significant impact on the Companys performance than the
general level of inflation. Over short periods of time, interest rates and the U.S.
Treasury yield curve may not necessarily move in the same direction or in the same
magnitude as inflation.
While the financial nature of the Companys consolidated balance
sheets and statements of income is more clearly affected by changes in interest rates than
by inflation, inflation does affect the Company because as prices increase the money
supply tends to increase, the size of loans requested tends to increase, total Company
assets increase, and interest rates are affected by inflationary expectations. In
addition, operating expenses tend to increase without a corresponding increase in
productivity. There is no precise method, however, to measure the effects of inflation on
the Companys financial statements. Accordingly, any examination or analysis of the
financial statements should take into consideration the possible effects of inflation.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates/prices, such as interest rates, foreign currency exchange
rates, commodity prices and equity prices. Interest rate risk is the most significant
market risk affecting the Company. Other types of market risk do not arise in the normal
course of the Companys business activities.
Interest Rate Risk:
Interest rate risk can be defined as an
exposure to movement in interest rates that could have an adverse impact on the Bank's net
interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity
and/or cash flow characteristics of assets and liabilities. Management's objectives are to
measure, monitor and develop strategies in response to the interest rate risk profile
inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet
are to preserve the sensitivity of net interest income to actual or potential changes in
interest rates, and to enhance profitability through strategies that promote sufficient
reward for understood and controlled risk.
The Bank's interest rate risk measurement and management techniques
incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet
instruments as they relate to current and potential changes in interest rates. The level
of interest rate risk, measured in terms of the potential future effect on net interest
income, is determined through the use of modeling and other techniques under multiple
interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and
reviewed by the Asset/Liability Committee ("ALCO") and the Banks Board of
Directors.
The Bank's Asset Liability Management Policy, approved annually by the
Banks Board of Directors, establishes interest rate risk limits in terms of
variability of net interest income under rising, flat, and decreasing rate scenarios. It
is the role of ALCO to evaluate the overall risk profile and to determine actions to
maintain and achieve a posture consistent with policy guidelines.
The Bank utilizes an interest rate risk model widely recognized in the
financial industry to monitor and measure interest rate risk. The model simulates the
behavior of interest income and expense of all balance sheet and off-balance sheet
instruments, under different interest rate scenarios together with a dynamic future
balance sheet. Interest rate risk is measured in terms of potential changes in net
interest income based upon shifts in the yield curve.
The interest rate risk sensitivity model requires that assets and
liabilities be broken down into components as to fixed, variable, and adjustable interest
rates, as well as other homogeneous groupings, which are segregated as to maturity and
type of instrument. The model includes assumptions about how the balance sheet is likely
to evolve through time and in different interest rate environments. The model uses
contractual re-pricing dates for variable products, contractual maturities for fixed rate
products, and product specific assumptions for deposits accounts, such as money market
accounts, that are subject to re-pricing based on current market conditions. Re-pricing
margins are also determined for adjustable rate assets and incorporated in the model.
Investment securities and borrowings with call provisions, are examined on an individual
basis in each rate environment to estimate the likelihood of a call. Prepayment
assumptions for mortgage loans and mortgage backed securities are developed from industry
median estimates of prepayment speeds, based upon similar coupon ranges and seasoning.
Cash flows and maturities are then determined, and for certain assets, prepayment
assumptions are estimated under different interest rate scenarios. Interest income and
interest expense are then simulated under several hypothetical interest rate conditions
including:
-
A flat interest rate scenario in which current prevailing rates are locked in and the
only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes,
and re-pricing volumes consistent with this flat rate assumption.
-
A 200 basis point rise or decline in interest rates applied against a parallel shift in
the yield curve over a twelve-month horizon together with a dynamic balance sheet
anticipated to be consistent with such interest rate changes.
-
Various non-parallel shifts in the yield curve, including changes in either short-term
or long-term rates over a twelve-month horizon, together with a dynamic balance sheet
anticipated to be consistent with such interest rate changes.
-
An extension of the foregoing simulations to each of two, three, four and five year
horizons to determine the interest rate risk with the level of interest rates stabilizing
in years two through five. Even though rates remain stable during this two to five year
time period, re-pricing opportunities driven by maturities, cash flow, and adjustable rate
products will continue to change the balance sheet profile for each of the rate
conditions.
Changes in net interest income based upon the foregoing simulations are
measured against the flat interest rate scenario and actions are taken to maintain the
balance sheet interest rate risk within established policy guidelines.
The following table summarizes the Bank's net interest income
sensitivity analysis as of September 30, 2007, over one and two-year horizons and under
different interest rate scenarios.
INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
SEPTEMBER 30, 2007
(Dollars in thousands)
|
-200 Basis Points Parallel Yield Curve Shift
|
+200 Basis Points Parallel Yield Curve Shift
|
-200 Basis Points
Short Term
Rates
|
|
|
|
|
Year 1
|
|
|
|
Net interest income change ($)
|
$1,015
|
($1,862)
|
$1,700
|
Net interest income change (%)
|
4.01%
|
(7.36%)
|
6.72%
|
|
|
|
|
Year 2
|
|
|
|
Net interest income change vs. year one base ($)
|
$1,515
|
($3,244)
|
$5,017
|
Net interest income change vs. year one base (%)
|
5.99%
|
(12.83%)
|
19.84%
|
The foregoing interest rate sensitivity modeling results indicate that
the Banks balance sheet is liability sensitive and is favorably positioned for
declining interest rates over the one and two-year horizons. The interest rate sensitivity
model also suggests that the Bank is exposed to a parallel increase in short-term and
long-term rates over the one and two-year horizons but, as discussed below, management
believes that this is a scenario that is less likely to occur.
During the third quarter of 2007, the financial markets
experienced significant volatility resulting from the continued fallout of sub-prime
lending and the global liquidity crises. The Federal Reserve responded by lowering the
targeted federal funds rate by 50 basis points in late September, which was intended to
offer some relief to financial institutions and forestall a potentially weakening economy.
Despite the decline in the Fed Funds rate, at September 30, 2007, the U.S. Treasury yield
curve (the "yield curve") remained relatively flat, with the two and ten-year
U.S. Treasury notes closing at 4.97% and 5.13%, respectively. Given this atypical shape of
the yield curve, interest rate risk sensitivity modeling is more challenging than would
traditionally be the case. Traditional modeling of parallel movements in the September 30,
2007 yield curve would suggest that it would remain relatively flat in either an
increasing or declining interest rate environment, a scenario management believes is not
likely and one that has historically not occurred. These challenges are discussed in the
following discussion and analysis covering the Banks interest rate risk sensitivity.
Assuming interest rates remain at their current levels and the
Banks balance sheet structure and size remain at current levels, the interest rate
sensitivity simulation model suggests that net interest income will trend upward over the
one and two-year horizons. The upward trend principally results from the downward
re-pricing of a large portion of the Banks short term funding base in response to
the 50 basis point reduction in the Fed Funds rate. The upward trend also reflects the
re-investment of securities and loan cash flows into higher current interest rate levels,
with loans continuing to "index up" in response to past interest rate movements.
Management anticipates that only moderate earning asset growth would be needed to
meaningfully increase the Banks current level of net interest income, should
interest rates remain at current levels.
Assuming short-term and long-term interest rates decline from current
levels (i.e., a parallel yield curve shift) and the Banks balance sheet structure
and size remain at current levels, management believes net interest income will increase
over the one and two-year horizons. The interest rate sensitivity simulation model
suggests that funding cost reductions will outpace falling asset yields, favorably
impacting net interest income. Management anticipates that a parallel decline in interest
rates will meaningfully increase the Banks current level of net interest income
without the benefit of earning asset growth.
The interest rate sensitivity model is used to evaluate the impact on
net interest income given certain non-parallel shifts in the yield curve, including
changes in either short-term or long-term interest rates. In view of the relatively flat
yield curve at September 30, 2007 combined with the prospect of further interest rate
reductions by the Federal Reserve, management modeled alternative future interest rate
scenarios and the anticipated impact on net interest income. Assuming the Banks
balance sheet structure and size remain at current levels, with the short-term Federal
Funds interest rate declining 200 basis points, and with the balance of the yield curve
returning to its historical ten-year average, the interest rate sensitivity model suggests
that net interest income will significantly improve over the twelve-month horizon and
continue to strengthen over the twenty-four month horizon. The model indicates that
funding costs will show meaningful declines while loan and securities cash flows will be
reinvested into higher yielding earning assets. Management believes this scenario is more
likely than a parallel 200 basis point decline in short and long-term interest rates,
given the current shape of the yield curve. Management also believes this scenario will
significantly increase net interest income without the benefit of earning asset growth.
Assuming the Banks balance sheet structure and size remain at
current levels and the Federal Reserve increases short-term interest rates by 200 basis
points, and the balance of the yield curve shifts in parallel with these increases,
management believes net interest income will post significant declines over the twelve and
twenty four month horizons, and then begin a steady recovery. The interest rate
sensitivity simulation model suggests that as interest rates rise, the Banks funding
costs will re-price more quickly than its earning asset portfolios, causing a sharp
decline in net interest income. As funding costs begin to stabilize in the second year of
the simulation, the earning asset portfolios continue to re-price at prevailing interest
rate levels and cash flows from earning asset portfolios will be reinvested into higher
yielding earning assets, resulting in a widening of spreads and improving levels of net
interest income. Management believes that strong earning asset growth will be necessary to
maintain the current level of net interest income should short and long-term interest
rates rise in parallel. Management believes this is a scenario that is less likely to
occur, given that the yield curve would have to remain relatively flat over the one and
two-year horizons, a phenomenon that has historically not occurred. Management also
believes that, based on a variety of current economic indicators, it is not likely the
Federal Reserve will increase short-term interest rates any time in the near future.
The preceding sensitivity analysis does not represent a Company
forecast and should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the nature and
timing of interest rate levels and yield curve shape, prepayment speeds on loans and
securities, deposit rates, pricing decisions on loans and deposits, reinvestment or
replacement of asset and liability cash flows, and others. While assumptions are developed
based upon current economic and local market conditions, the Company cannot make any
assurances as to the predictive nature of these assumptions including how customer
preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity
analysis, actual results may also differ due to: prepayment and refinancing levels
deviating from those assumed; the impact of interest rate change caps or floors on
adjustable rate assets; the potential effect of changing debt service levels on customers
with adjustable rate loans; depositor early withdrawals and product preference changes;
and other such variables. The sensitivity analysis also does not reflect additional
actions that the Banks ALCO and Board of Directors might take in responding to or
anticipating changes in interest rates, and the anticipated impact on the Banks net
interest income.
ITEM 4. CONTROLS AND PROCEDURES
Company management evaluated, with the participation of the Chief
Executive Officer and Chief Financial Officer, the effectiveness of the Company's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this quarterly
report. Based on such evaluation, the Chief Executive Officer and the Chief Financial
Officer have concluded that the Company's disclosure controls and procedures are designed
to ensure that information required to be disclosed by the Company in the reports it files
or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange Commission's
rules and regulations and are operating in an effective manner.
No change in the Company's internal control over financial reporting
(as defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934)
occurred during the most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
The Company and its subsidiaries are parties to certain ordinary
routine litigation incidental to the normal conduct of their respective businesses, which
in the opinion of management based upon currently available information will have no
material effect on the Company's consolidated financial statements.
Item 1A: Risk Factors
There have been no material changes in the Companys
risk factors from those disclosed in Part I, Item 1A of the Companys Annual Report
on Form 10-K for the year ended December 31, 2006.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
(a) None
(b) None
(c) The following table sets forth information with respect to any purchase made by
or on behalf of the Company or any "affiliated purchaser," as defined in Section
240.10b-18(a)(3) under the Exchange Act, of shares of Companys common stock during
the periods indicated.
Period
|
Total Number of
Shares Purchased
|
Average Price
Paid per Share
|
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
|
Maximum Number of Shares that May Yet Be Purchased Under the
Plans or Programs
|
|
|
|
|
|
July 1-31, 2007
|
3,904
|
$31.08
|
3,904
|
146,925
|
August 1-31, 2007
|
3,442
|
$29.08
|
3,442
|
143,483
|
September 1-30, 2007
|
14,432
|
$30.70
|
14,432
|
129,051
|
In March 2004, the Companys Board of Directors approved a program
to repurchase up to 10% of the Companys outstanding shares of common stock, or
approximately 310,000 shares. Purchases began March 4, 2004 and were continued through
December 31, 2006. The Companys Board of Directors subsequently authorized the
continuance of this stock repurchase plan through December 31, 2007. Depending on market
conditions and other factors, these purchases may be commenced or suspended at any time,
or from time-to-time, without prior notice.
Item 3: Defaults Upon Senior Securities
None
Item 4: Submission of Matters to a Vote of Security Holders
None
Item 5: Other Information
(a) None
(b) None
Item 6: Exhibits
(a) Exhibits.
EXHIBIT
NUMBER
|
|
|
|
|
|
3
|
3.1 Articles of Incorporation
|
Articles as amended July 11,
1995 are incorporated by reference to Form S-14 filed with the Commission March 26, 1984
(Commission Number 2-90171).
|
|
|
|
|
3.2 Bylaws
|
Bylaws as amended to date are
incorporated by reference to Form 10-K, Item 14 (a)(3) filed with the Commission March 28,
2002. (Commission Number 001-13349)
|
|
|
|
31.1
|
Certification of the Chief
Executive Officer under
Rule 13a-14(a)/15d-14(a)
|
Filed herewith.
|
|
|
|
31.2
|
Certification of the Chief
Financial Officer under
Rule 13a-14(a)/15d-14(a)
|
Filed herewith.
|
|
|
|
32.1
|
Certification of Chief
Executive Officer under
18 U.S.C. Section 1350
|
Filed herewith.
|
|
|
|
32.2
|
Certification of Chief
Financial Officer under
18 U.S.C. Section 1350
|
Filed herewith.
|
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
|
BAR HARBOR BANKSHARES
(Registrant)
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/s/Joseph
M. Murphy
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Date:
November 9, 2007
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Joseph
M. Murphy
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Chief
Executive Officer
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/s/Gerald
Shencavitz
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Date:
November 9, 2007
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Gerald
Shencavitz
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Chief
Financial Officer
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