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, 2008
____ 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, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer", "accelerated filer" and
smaller reporting company" in Rule 12b-2 of the Exchange Act: Large accelerated filer
___ Accelerated filer
X
Non-accelerated filer (do not check if a
smaller reporting company) ___ Smaller reporting company ___
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act): YES: ___ NO:
X
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date:
Class of Common Stock
|
Number of Shares Outstanding November 4, 2008
|
$2.00 Par Value
|
2,900,908
|
TABLE OF CONTENTS
|
|
Page
No.
|
PART I
|
FINANCIAL INFORMATION
|
|
|
|
|
Item
1.
|
Financial
Statements (
unaudited)
:
|
|
|
|
|
|
Consolidated
Balance Sheets at September 30, 2008, and December 31, 2007
|
3
|
|
|
|
|
Consolidated
Statements of Income for the three and nine months ended
September 30, 2008 and 2007
|
4
|
|
|
|
|
Consolidated
Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2008
and 2007
|
5
|
|
|
|
|
Consolidated
Statements of Cash Flows for the nine months ended
September 30, 2008 and 2007
|
6
|
|
|
|
|
Consolidated
Statements of Comprehensive Income for the three and nine months ended September 30, 2008
and 2007
|
7
|
|
|
|
|
Notes
to Consolidated Interim Financial Statements
|
8-18
|
|
|
|
Item
2.
|
Management's
Discussion and Analysis of Financial Condition and Results of Operations
|
18-50
|
|
|
|
Item
3.
|
Quantitative and Qualitative Disclosures About Market Risk
|
50-53
|
|
|
|
Item
4.
|
Controls and Procedures
|
54
|
|
|
|
|
|
|
PART II
|
OTHER INFORMATION
|
|
|
|
|
Item
1.
|
Legal Proceedings
|
54
|
|
|
|
Item
1A.
|
Risk Factors
|
54-55
|
|
|
|
Item
2.
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
56
|
|
|
|
Item
3.
|
Defaults Upon Senior Securities
|
56
|
|
|
|
Item
4.
|
Submission of Matters to a Vote of Security Holders
|
56
|
|
|
|
Item
5.
|
Other Information
|
56
|
|
|
|
Item
6.
|
Exhibits
|
57
|
|
|
|
Signatures
|
|
57
|
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2008 AND DECEMBER 31, 2007
(Dollars in thousands, except share data)
(
unaudited
)
|
September 30,
2008
|
|
December 31,
2007
|
Assets
|
|
|
|
Cash and due from banks
|
$ 9,287
|
|
$ 7,726
|
Overnight interest bearing money market funds
|
3
|
|
5
|
Total cash and cash equivalents
|
9,290
|
|
7,731
|
Securities available for sale, at fair value
|
269,609
|
|
264,617
|
Federal Home Loan Bank stock
|
14,031
|
|
13,156
|
Loans
|
624,205
|
|
579,711
|
Allowance for loan losses
|
(5,220)
|
|
(4,743)
|
Loans, net of allowance for loan losses
|
618,985
|
|
574,968
|
Premises and equipment, net
|
10,421
|
|
10,795
|
Goodwill
|
3,158
|
|
3,158
|
Bank owned life insurance
|
6,521
|
|
6,340
|
Other assets
|
9,989
|
|
8,707
|
TOTAL ASSETS
|
$942,004
|
|
$889,472
|
|
|
|
|
Liabilities
|
|
|
|
Deposits
|
|
|
|
Demand and other
non-interest bearing deposits
|
$ 62,568
|
|
$ 65,161
|
NOW accounts
|
71,884
|
|
67,050
|
Savings and money
market deposits
|
163,611
|
|
163,009
|
Time deposits
|
202,031
|
|
140,204
|
Brokered time deposits
|
78,069
|
|
103,692
|
Total deposits
|
578,163
|
|
539,116
|
Short-term borrowings
|
96,901
|
|
148,246
|
Long-term advances from Federal Home Loan Bank
|
193,671
|
|
130,607
|
Junior subordinated debentures
|
5,000
|
|
---
|
Other liabilities
|
5,598
|
|
5,529
|
TOTAL LIABILITIES
|
879,333
|
|
823,498
|
|
|
|
|
Shareholders' equity
|
|
|
|
Capital stock, par value $2.00; authorized
10,000,000 shares;
issued 3,643,614 shares at
September 30, 2008 and December 31, 2007
|
7,287
|
|
7,287
|
Surplus
|
4,863
|
|
4,668
|
Retained earnings
|
67,258
|
|
63,292
|
Accumulated other comprehensive (loss) income:
|
|
|
|
Unamortized net actuarial losses on employee benefit plans,
net of tax of ($60) and ($64),at
September 30, 2008 and
December 31, 2007, respectively
|
(117)
|
|
(124)
|
Net unrealized (depreciation) appreciation on securities available for sale,
net of tax of ($2,036) and $616, at
September 30, 2008 and
December 31, 2007, respectively
|
(3,953)
|
|
1,196
|
Net unrealized appreciation on derivative instruments,
net of tax of $183 and $24 at
September 30, 2008 and
December 31, 2007, respectively
|
355
|
|
46
|
Total accumulated other comprehensive (loss) income
|
(3,715)
|
|
1,118
|
|
Less: cost of 728,373 and 640,951 shares of treasury stock at
September 30, 2008 and December 31,
2007, respectively
|
(13,022)
|
|
(10,391)
|
|
|
|
|
TOTAL
SHAREHOLDERS' EQUITY
|
62,671
|
|
65,974
|
|
|
|
|
TOTAL
LIABILITIES AND SHAREHOLDERS' EQUITY
|
$942,004
|
|
$889,472
|
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, 2008 AND 2007
(Dollars in thousands, except share data)
(unaudited)
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2008
|
2007
|
|
2008
|
2007
|
Interest and dividend income:
|
|
|
|
|
|
Interest and fees on loans
|
$ 9,412
|
$ 9,681
|
|
$28,310
|
$28,281
|
Interest and dividends on securities
|
4,103
|
3,685
|
|
11,800
|
10,051
|
Total interest and dividend income
|
13,515
|
13,366
|
|
40,110
|
38,332
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
Deposits
|
3,551
|
4,207
|
|
11,465
|
12,084
|
Short-term borrowings
|
358
|
1,967
|
|
1,155
|
4,919
|
Long-term borrowings
|
2,478
|
1,279
|
|
7,538
|
4,538
|
Total interest expense
|
6,387
|
7,453
|
|
20,158
|
21,541
|
|
|
|
|
|
|
Net interest income
|
7,128
|
5,913
|
|
19,952
|
16,791
|
Provision for loan losses
|
860
|
214
|
|
1,669
|
247
|
Net interest income after provision for loan losses
|
6,268
|
5,699
|
|
18,283
|
16,544
|
|
|
|
|
|
|
Noninterest income:
|
|
|
|
|
|
Trust and other financial services
|
639
|
564
|
|
1,917
|
1,747
|
Service charges on deposit accounts
|
459
|
454
|
|
1,226
|
1,242
|
Other service charges, commissions and fees
|
64
|
57
|
|
171
|
162
|
Credit and debit card service charges and fees
|
876
|
871
|
|
1,716
|
1,579
|
Net securities gains (losses)
|
89
|
231
|
|
604
|
(671)
|
Other operating income
|
97
|
86
|
|
571
|
240
|
Total non-interest income
|
2,224
|
2,263
|
|
6,205
|
4,299
|
|
|
|
|
|
|
Noninterest expense:
|
|
|
|
|
|
Salaries and employee benefits
|
2,592
|
2,386
|
|
7,933
|
6,885
|
Postretirement plan settlement
|
---
|
---
|
|
---
|
(832)
|
Occupancy expense
|
312
|
294
|
|
1,049
|
987
|
Furniture and equipment expense
|
357
|
396
|
|
1,220
|
1,284
|
Credit and debit card expenses
|
619
|
621
|
|
1,200
|
1,079
|
Other operating expense
|
1,232
|
1,099
|
|
3,932
|
3,743
|
Total non-interest expense
|
5,112
|
4,796
|
|
15,334
|
13,146
|
|
|
|
|
|
|
Income before income taxes
|
3,380
|
3,166
|
|
9,154
|
7,697
|
Income taxes
|
1,047
|
1,019
|
|
2,840
|
2,332
|
|
|
|
|
|
|
Net income
|
$ 2,333
|
$ 2,147
|
|
$ 6,314
|
$ 5,365
|
|
|
|
|
|
|
Earnings Per Share:
|
|
|
|
|
|
Basic earnings per share
|
$ 0.80
|
$ 0.71
|
|
$ 2.13
|
$ 1.76
|
Diluted earnings per share
|
$ 0.78
|
$ 0.69
|
|
$ 2.09
|
$ 1.72
|
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, 2008 AND 2007
(Dollars in thousands, except share data)
(unaudited)
|
Capital
Stock
|
Surplus
|
Retained
Earnings
|
Accumulated
Other
Comprehensive
Income (Loss)
|
Treasury
Stock
|
Total
Shareholders'
Equity
|
|
|
|
|
|
|
|
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 ($0.710 per share)
|
---
|
---
|
(2,161)
|
---
|
---
|
(2,161)
|
Purchase
of treasury stock (36,947 shares)
|
---
|
---
|
---
|
---
|
(1,152)
|
(1,152)
|
Stock
options exercised
(18,216 shares),
including related 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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2007
|
$7,287
|
$4,668
|
$63,292
|
$1,118
|
$(10,391)
|
$65,974
|
Net
income
|
---
|
---
|
6,314
|
---
|
---
|
6,314
|
Total
other comprehensive loss
|
---
|
---
|
---
|
(4,833)
|
---
|
(4,833)
|
Cash
dividends declared ($0.760 per share)
|
---
|
---
|
(2,250)
|
---
|
---
|
(2,250)
|
Purchase
of treasury stock (95,943 shares)
|
---
|
---
|
---
|
---
|
(2,888)
|
(2,888)
|
Stock
options exercised (8,521 shares),
including related tax effects
|
---
|
27
|
(98)
|
---
|
257
|
186
|
Recognition
of stock option expense
|
---
|
168
|
---
|
---
|
---
|
168
|
Balance September 30, 2008
|
$7,287
|
$4,863
|
$67,258
|
$(3,715)
|
$(13,022)
|
$62,671
|
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, 2008 AND 2007
(Dollars in thousands)
(unaudited)
|
2008
|
2007
|
Cash
flows from operating activities:
|
|
|
Net income
|
$ 6,314
|
$ 5,365
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
Depreciation and amortization of premises and equipment
|
750
|
919
|
Amortization of core deposit intangible
|
50
|
50
|
Provision for loan losses
|
1,669
|
247
|
Net securities (gains) losses
|
(604)
|
671
|
Net (accretion) amortization of bond discounts and premiums
|
(508)
|
132
|
Recognition of stock option expense
|
168
|
157
|
Postretirement plan settlement
|
---
|
(832)
|
Net change in other assets
|
1,198
|
(93)
|
Net change in other liabilities
|
69
|
(763)
|
Net cash provided by operating activities
|
9,106
|
5,853
|
|
|
|
Cash
flows from investing activities:
|
|
|
Purchases of securities available for sale
|
(72,264)
|
(117,581)
|
Proceeds from maturities, calls and principal paydowns of mortgage-backed securities
|
39,518
|
31,559
|
Proceeds from sales of securities available for sale
|
21,065
|
54,513
|
Net increase in Federal Home Loan Bank stock
|
(875)
|
(983)
|
Net loans made to customers
|
(45,769)
|
(11,055)
|
Proceeds from sale of other real estate owned
|
340
|
---
|
Capital expenditures
|
(376)
|
(408)
|
Net cash used in investing activities
|
(58,361)
|
(43,955)
|
|
|
|
Cash
flows from financing activities:
|
|
|
Net increase in deposits
|
39,047
|
30,543
|
Proceeds from issuance of junior subordinated debentures
|
5,000
|
---
|
Net (decrease) increase in securities sold under repurchase agreements and fed funds
purchased
|
(3,705)
|
7,545
|
Proceeds from Federal Home Loan Bank advances
|
91,980
|
79,000
|
Repayments of Federal Home Loan Bank advances
|
(76,556)
|
(84,578)
|
Purchases of treasury stock
|
(2,888)
|
(1,152)
|
Proceeds from stock option exercises, including excess tax benefits
|
186
|
414
|
Payments of dividends
|
(2,250)
|
(2,161)
|
Net cash provided by financing activities
|
50,814
|
29,611
|
|
|
|
Net
increase (decrease) in cash and cash equivalents
|
1,559
|
(8,491)
|
Cash
and cash equivalents at beginning of period
|
7,731
|
19,547
|
Cash
and cash equivalents at end of period
|
$ 9,290
|
$ 11,056
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
Cash paid during the period for:
|
|
|
Interest
|
$ 20,151
|
$ 20,822
|
Income taxes
|
$ 1,555
|
$ 1,508
|
|
|
|
Schedule
of noncash investing activities
|
|
|
Transfer from loans to other real estate owned
|
$
83
|
$ ---
|
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, 2008 AND 2007
(Dollars in thousands)
(unaudited)
|
Three Months Ended
September 30,
|
|
2008
|
2007
|
|
|
|
Net
income
|
$ 2,333
|
$2,147
|
Net unrealized (depreciation) appreciation on securities available for sale,
net of tax of ($1,085) and $847,
respectively
|
(2,106)
|
1,645
|
Less reclassification adjustment for net gains related to securities
available for sale included in net
income, net of tax of $30 and $78, respectively
|
(59)
|
(153)
|
Net unrealized appreciation and other amounts for interest rate derivatives,
net of tax of $81 and $84,
respectively
|
159
|
163
|
Amortization of actuarial gain for supplemental executive retirement plan,
net of related tax of $1 and $4,
respectively
|
2
|
6
|
Total other comprehensive (loss) income
|
(2,004)
|
1,661
|
Total
comprehensive income
|
$ 329
|
$3,808
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September30,
|
|
2008
|
2007
|
|
|
|
Net
income
|
$ 6,314
|
$5,365
|
Net unrealized depreciation on securities available for sale,
net of tax of $2,447 and $59,
respectively
|
(4,750)
|
(113)
|
Less reclassification adjustment for net (gains)
losses related to securities
available for sale included in net
income, net of tax of ($205) and
$229, respectively
|
(399)
|
442
|
Net unrealized appreciation and other amounts for interest rate derivatives,
net of tax of $159 and $134,
respectively
|
309
|
259
|
Reversal of actuarial gain upon postretirement plan settlement, net of tax of $151
|
---
|
(291)
|
Amortization of actuarial gain for supplemental executive retirement plan,
net of related tax of $4 and $6,
respectively
|
7
|
9
|
Total other comprehensive (loss) income
|
(4,833)
|
306
|
Total
comprehensive income
|
$ 1,481
|
$5,671
|
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, 2008
(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, 2008 is not necessarily indicative of the results that
may be expected for the year ending December 31, 2008, or any other interim periods.
The consolidated balance sheet at December 31, 2007 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 210).
Accordingly, they do not include all of the information and footnotes required by U.S.
generally accepted accounting principles for complete financial statements. For further
information, refer to the consolidated financial statements included in the Companys
Annual Report on Form 10-K for the year ended December 31, 2007, 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 probable 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 allowances established for
specific loans including impaired loans, a pool of allowances based on historical
charge-offs by loan types, and supplemental allowances that adjust historical loss
experience to reflect current economic conditions, industry specific risks, and other
observable data.
While management uses available information to recognize losses on
loans, changing economic conditions and the economic prospects of the borrowers may
necessitate future additions or reductions to the allowance. In addition, various
regulatory agencies, as an integral part of their examination process, periodically review
the 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:
The Company uses the asset and liability method
of accounting for income taxes. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their
respective tax bases. If current available information indicates that it is
more-likely-than-not that deferred tax assets will not be realized, a valuation allowance
is established. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the enactment
date. Significant management judgment is required in determining income tax expense and
deferred tax assets and liabilities. As of September 30, 2008 and December 31, 2007, 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, 2008 and 2007:
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2008
|
2007
|
|
2008
|
2007
|
|
|
|
|
|
|
Net income
|
$
2,333
|
$ 2,147
|
|
$
6,314
|
$ 5,365
|
|
|
|
|
|
|
Computation of Earnings Per Share:
|
|
|
|
|
|
Weighted average number of capital stock shares outstanding
|
|
|
|
|
|
Basic
|
2,922,067
|
3,039,585
|
|
2,959,120
|
3,043,442
|
Effect of dilutive employee stock options
|
59,933
|
70,369
|
|
66,406
|
76,349
|
Diluted
|
2,982,000
|
3,109,954
|
|
3,025,526
|
3,119,791
|
|
|
|
|
|
|
EARNINGS PER SHARE:
|
|
|
|
|
|
Basic
|
$ 0.80
|
$ 0.71
|
|
$ 2.13
|
$ 1.76
|
Diluted
|
$
0.78
|
$
0.69
|
|
$
2.09
|
$
1.72
|
|
|
|
|
|
|
Anti-dilutive options excluded from earnings
per share calculation
|
153,067
|
103,286
|
|
131,071
|
72,434
|
Note 4: Retirement Benefit Plans
Prior to the first quarter of 2007, the Company sponsored a 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.
In the first quarter of 2007, the Company settled its limited
postretirement benefit program. The Company voluntarily paid out $699 to plan
participants, representing 64% of the accrued postretirement 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.
The Company also has non-qualified supplemental executive retirement
agreements with certain retired officers. The agreements provide supplemental retirement
benefits payable in installments over a period of years upon retirement or death. The
Company recognized the net present value of payments associated with the agreements over
the service periods of the participating officers. Interest costs continue to be
recognized on the benefit obligations.
The Company also has supplemental executive retirement agreements with
certain current executive officers. These agreements provide a stream of future payments
in accordance with individually defined vesting schedules upon retirement, termination, or
upon a change of control.
The following table summarizes the net periodic benefit costs for the
three and nine months ended September 30, 2008 and 2007:
|
Supplemental Executive Retirement Plans
|
|
2008
|
2007
|
Three Months Ended September 30,
|
|
|
Service
Cost
|
$ 47
|
$ 50
|
Interest
Cost
|
39
|
40
|
Amortization
of actuarial loss
|
4
|
2
|
Net Periodic Benefit Cost
|
$ 90
|
$ 92
|
|
|
|
|
|
|
|
2008
|
2007
|
Nine Months Ended September 30,
|
|
|
Service
Cost
|
$152
|
$148
|
Interest
Cost
|
124
|
121
|
Amortization
of actuarial loss
|
11
|
7
|
Net Periodic Benefit Cost
|
$287
|
$276
|
The Company is expected to recognize $379 of expense for the foregoing
plans for the year ended December 31, 2008. The Company is expected to contribute $222 to
the foregoing plans in 2008. As of September 30, 2008, the Company had contributed $193.
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, 2008 and December 31, 2007:
|
September 30,
|
December 31,
|
|
2008
|
2007
|
|
|
|
Commitments
to originate loans
|
$22,168
|
$15,075
|
Unused
lines of credit
|
$81,853
|
$85,530
|
Unadvanced
portions of construction loans
|
$10,758
|
$19,752
|
Standby
letters of credit
|
$ 462
|
$ 506
|
As of September 30, 2008 and December 31, 2007, the fair value of the
standby letters of credit was 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 repricing
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, 2008, the Bank had three outstanding derivative
instruments with notional amounts totaling $40,000. These derivative instruments were an
interest rate swap agreement 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
at 9/30/08
|
Fair Value at 9/30/08
|
|
|
|
|
|
|
Receive fixed rate, pay variable rate
|
01/24/09
|
$10,000
|
6.25%
|
Prime (5.00%)
|
$37
|
During 2003, the interest rate swap agreement was purchased to limit
the Banks exposure to falling interest rates on a pool of loans indexed to the Prime
interest rate. The Bank is required to pay to 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 interest rate swap agreement was 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, 2008, the fair value of the interest rate swap
agreement was an unrealized gain of $37, compared with an unrealized loss of $34 at
December 31, 2007. The fair value of the interest rate swap agreement was included in
other assets on the consolidated balance sheets.
During the three and nine months ended September 30, 2008, the total
net cash flows received from (paid to) counter-parties amounted to $31 and $63, compared
with ($107) and ($316) during the same periods in 2007. The net cash flows received from
(paid to) counter-parties were recorded in interest income.
At September 30, 2008, the net unrealized gain on the interest rate
swap agreement included in accumulated other comprehensive income, net of tax, amounted to
$24 compared with an unrealized loss, net of tax, of $22 at December 31, 2007.
Interest Rate Floor Agreements
Notional Amount
|
Termination Date
|
Prime
Strike Rate
|
Premium Paid
|
Unamortized Premium at 9/30/08
|
Fair
Value at 9/30/08
|
Cumulative Cash Flows Received
|
|
|
|
|
|
|
|
$20,000
|
08/01/10
|
6.00%
|
$186
|
$105
|
$353
|
$104
|
$10,000
|
11/01/10
|
6.50%
|
$ 69
|
$ 44
|
$297
|
$ 85
|
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 No. 133, "Accounting for Derivative Instruments and Hedging Activities."
For the three and nine months ended September 30, 2008, total cash
flows received from counterparties amounted to $90 and $189, compared with none during the
same periods in 2007. The cash flows received from counterparties were recorded in
interest income.
At September 30, 2008, the total fair value of the interest rate floor
agreements was $650 compared with $299 at December 31, 2007. The fair values of the
interest rate floor agreements are included in other assets on the Companys
consolidated balance sheets. Pursuant to SFAS 133, changes in the fair value, representing
unrealized gains or losses, are recorded in accumulated other comprehensive income.
The premiums paid on the interest rate floor agreements 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, 2008, $16 and $44 of the premium was recognized as a reduction of interest
income. At September 30, 2008, the remaining unamortized premiums, net of tax, totaled
$98, compared with $128 at December 31, 2007. During the next twelve months, $72 of the
premiums will be recognized as reductions of interest income, decreasing the interest
income related to the hedged pool of Prime-based loans.
A summary of the hedging related balances follows:
|
September 30, 2008
|
|
December 31, 2007
|
|
Gross
|
Net of Tax
|
|
Gross
|
Net of Tax
|
Unrealized gain on interest rate floors
|
$ 650
|
$429
|
|
$ 299
|
$ 197
|
Unrealized gain (loss) on interest rate swaps
|
37
|
24
|
|
(34)
|
(22)
|
Unamortized premium on interest rate floors
|
(149)
|
(98)
|
|
(193)
|
(128)
|
Net deferred loss on de-designation of
interest rate swaps
|
---
|
---
|
|
(2)
|
(1)
|
Total
|
$ 538
|
$355
|
|
$ 70
|
$
46
|
Note 7: Fair Value Measurements
Effective January 1, 2008, the Company adopted the provisions of
SFAS No. 157, "Fair Value Measurements," for financial assets and
financial liabilities. In accordance with Financial Accounting Standards Board Staff
Position (FSP) No. 157-2, "Effective Date of FASB Statement No. 157,"
the Company has delayed application of SFAS No. 157 for non-financial assets and
non-financial liabilities, until January 1, 2009. SFAS No. 157 defines fair
value, establishes a framework for measuring fair value in generally accepted accounting
principles and expands disclosures about fair value measurements.
SFAS No. 157 defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. A fair value measurement assumes that the transaction to sell
the asset or transfer the liability occurs in the principal market for the asset or
liability or, in the absence of a principal market, the most advantageous market for the
asset or liability. The price in the principal (or most advantageous) market used to
measure the fair value of the asset or liability shall not be adjusted for transaction
costs. An orderly transaction is a transaction that assumes exposure to the market for a
period prior to the measurement date to allow for marketing activities that are usual and
customary for transactions involving such assets and liabilities; it is not a forced
transaction. Market participants are buyers and sellers in the principal market that are
(i) independent, (ii) knowledgeable, (iii) able to transact and
(iv) willing to transact.
SFAS No. 157 requires the use of valuation techniques that are
consistent with the market approach, the income approach and/or the cost approach. The
market approach uses prices and other relevant information generated by market
transactions involving identical or comparable assets and liabilities. The income approach
uses valuation techniques to convert future amounts, such as cash flows or earnings, to a
single present amount on a discounted basis. The cost approach is based on the amount that
currently would be required to replace the service capacity of an asset (replacement
cost). Valuation techniques should be consistently applied. Inputs to valuation techniques
refer to the assumptions that market participants would use in pricing the asset or
liability. Inputs may be observable, meaning those that reflect the assumptions market
participants would use in pricing the asset or liability developed based on market data
obtained from independent sources, or unobservable, meaning those that reflect the
reporting entity's own assumptions about the assumptions market participants would use in
pricing the asset or liability developed based on the best information available in the
circumstances. In that regard, SFAS No. 157 establishes a fair value hierarchy for
valuation inputs that gives the highest priority to quoted prices in active markets (level
1 measurements) for identical assets or liabilities and the lowest priority to
unobservable inputs (Level 3 measurements). The fair value hierarchy is as follows:
-
Level 1
Valuation is based on unadjusted quoted prices in active markets
for identical assets or liabilities that the reporting entity has the ability to access at
the measurement date.
-
Level 2
Valuation is based on quoted prices for similar instruments in
active markets, quoted prices for identical or similar assets or liabilities in markets
that are not active, and model-based techniques for which all significant assumptions are
observable in the market.
-
Level 3
Valuation is principally generated from model-based techniques
that use at least one significant assumption not observable in the market. These
unobservable assumptions reflect estimates that market participants would use in pricing
the asset or liability. Valuation techniques include use of discounted cash flow models
and similar techniques.
SFAS 157 indicates that the level in the fair value hierarchy within
which the fair value measurement in its entirety falls is determined based on the lowest
level input that is significant to the fair value measurement in its entirety.
The most significant instruments that the Company values are securities,
all of which fall into Level 2 in the fair value hierarchy. The securities in the
available for sale portfolio are priced by independent providers. In obtaining such
valuation information from third parties, the Company has evaluated their valuation
methodologies used to develop the fair values in order to determine whether valuations are
appropriately placed within the fair value hierarchy and whether the valuations are
representative of an exit price in the Companys principal markets. The
Companys principal markets for its securities portfolios are the secondary
institutional markets, with an exit price that is predominantly reflective of bid level
pricing in those markets. Additionally, the Company periodically tests the reasonableness
of the prices provided by these third parties by obtaining desk bids from a variety of
institutional brokers.
A description of the valuation methodologies used for instruments
measured at fair value, as well as the general classification of such instruments pursuant
to the valuation hierarchy, is set forth below. These valuation methodologies were applied
to all of the Companys financial assets and financial liabilities carried at fair
value effective January 1, 2008.
-
Securities Available for Sale:
Securities classified as available for sale are
reported at fair value utilizing Level 2 inputs. For these securities, the Company
obtains fair value measurements from independent pricing providers. The fair value
measurements used by the pricing providers consider observable data that may include
dealer quotes, market maker quotes and live trading systems. If quoted prices are not
readily available, fair values are determined using matrix pricing models, or other
model-based valuation techniques requiring observable inputs other than quoted prices such
as market pricing spreads, credit information, callable features, cash flows, the U.S.
Treasury yield curve, trade execution data, market consensus prepayment speeds, default
rates, and the securities terms and conditions, among other things.
-
Derivative Instruments:
Derivative instruments are reported at fair value
utilizing Level 2 inputs. The Company obtains independent dealer market price estimates to
value its Prime interest rate swaps and floors. Derivative instruments are priced by
independent providers using observable market data and assumptions with adjustments based
on widely accepted valuation techniques. A discounted cash flow analysis on the expected
cash flows of each derivative reflects the contractual terms of the derivatives, including
the period to maturity, and uses observable market-based inputs, including interest rate
curves, implied volatilities, transaction size, custom tailored features, counterparty
credit quality, and the estimated current replacement cost of the derivative instrument.
The foregoing valuation methodologies may produce fair value
calculations that may not be fully indicative of net realizable value or reflective of
future fair values. While Company management believes these valuation methodologies are
appropriate and consistent with other market participants, the use of different
methodologies or assumptions to determine the fair value of certain financial instruments
could result in a different estimate of fair value at the reporting date.
The following table summarizes financial assets and financial
liabilities measured at fair value on a recurring basis as of September 30, 2008,
segregated by the level of the valuation inputs within the fair value hierarchy utilized
to measure fair value:
|
Level 1 Inputs
|
Level 2 Inputs
|
Level 3 Inputs
|
Total Fair Value
|
|
|
|
|
|
Securities
available for sale
|
$ ---
|
$269,609
|
$ ---
|
$269,609
|
Derivative assets
|
$ ---
|
$ 687
|
$ ---
|
$ 687
|
SFAS No. 157 also requires disclosure of assets and liabilities
measured and recorded at fair value on a non-recurring basis; that is, the instruments are
not measured at fair value on an ongoing basis but are subject to fair value adjustments
in certain circumstances (for example, when there is evidence of impairment).
The following table summarizes financial assets and financial
liabilities measured at fair value on a non-recurring basis as of September 30, 2008,
segregated by the level of the valuation inputs within the fair value hierarchy utilized
to measure fair value.
|
Principal Balance as of 9/30/08
|
Level 1
Inputs
|
Level 2 Inputs
|
Level 3 I
nputs
|
Fair Value
as of
9/30/08
|
Collateral
dependent impaired loans
|
$712
|
$ ---
|
$---
|
$632
|
$632
|
Specific allowances for impaired loans are determined in accordance
with SFAS No. 114 "Accounting by Creditors For Impairment of a Loan," as amended
by SFAS 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and
Disclosures." During the nine months ended September 30, 2008 specific loan loss
allowances totaling $460 were established for three collateral dependent impaired
commercial loans with principal balances totaling $2,531. These specific loan loss
allowances were included in the provision for loan losses during the period in which the
allowances were established. In the third quarter of 2008, one of these impaired loans was
charged down to $200, requiring a $564 adjustment to the corresponding loan loss
allowance. Company management determined the impairment charges based on the fair
values of collateral. Based on this technique, these impaired loans were classified as
Level 3 for valuation purposes.
In the second quarter of 2008, one of these impaired loans was
satisfied with no adjustment necessary to the corresponding loan loss allowance. In the
third quarter the Company recorded the aforementioned adjustment of $564 and established a
reserve of $80 for one of the loans included in the table above.
Note 8: Recently Adopted Accounting Standards
The Company recently adopted the following accounting standards:
Fair Value Measurements for Financial Assets and Liabilities:
Effective
January 1, 2008, the Company adopted the provisions of SFAS No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115." SFAS No. 159 permits the Company to choose to measure eligible
items at fair value at specified election dates. Unrealized gains and losses on items for
which the fair value measurement option has been elected are reported in earnings at each
subsequent reporting date. The fair value option (i) may be applied instrument by
instrument, with certain exceptions, thus the Company may record identical financial
assets and liabilities at fair value or by another measurement basis permitted under
generally accepted accounting principles, (ii) is irrevocable (unless a new election date
occurs) and (iii) is applied only to entire instruments and not to portions of
instruments. Adoption of SFAS 159 on January 1, 2008 did not have a significant impact on
the Companys financial statements. The fair value option was not elected for any
financial instrument as of or since January 1, 2008.
Written Loan Commitments Recorded at Fair Value Through Earnings:
In
November 2007, the United States Securities and Exchange Commission ("SEC")
staff issued Staff Accounting Bulletin ("SAB") No. 109, "Written Loan
Commitments Recorded at Fair Value Through Earnings." SAB No. 109 provides
views on the accounting for written loan commitments recorded at fair value
under GAAP. SAB No. 109 supersedes SAB No. 105, "Application of Accounting Principles
to Loan Commitments." Specifically, SAB No. 109 states that the expected net
future cash flows related to the associated servicing of a loan should be included in the
measurement of all written loan commitments that are accounted for at fair value through
earnings. The provisions of SAB No. 109 are applicable on a prospective basis to written
loan commitments recorded at fair value under GAAP that are issued or modified in fiscal
quarters beginning after December 15, 2007 (January 1, 2008 for the Company). SAB No. 109
did not have an impact on the Companys consolidated financial condition or results
of operations.
Accounting for Income Tax Benefits of Dividends on Share-Based Payment
Awards:
In June 2007, the FASB ratified a consensus reached by the Emerging Issues
Task Force (the "EITF") on Issue No. 06-01, "Accounting for Income Tax
Benefits of Dividends on Share-Based Payment Awards," which clarifies the accounting
for income tax benefits related to the payment of dividends on equity-classified employee
share-based payment awards that are charged to retained earnings under SFAS No. 123(R).
The EITF concluded that a realized income tax benefit from dividends
or dividend equivalents that are charged to
retained earnings and are paid to employees for equity classified
non-vested equity shares, non-vested equity share units and outstanding equity share
options should be recognized as an increase to additional paid-in capital. EITF Issue No.
06-11 should be applied prospectively to the income tax benefits that result from
dividends on equity-classified employee share-based payment awards that are declared
in fiscal years beginning after
December 15, 2007, and interim periods within those
fiscal years. Retrospective application to previously issued financial statements is
prohibited. The Companys adoption of EITF Issue No. 06-11 did not have an impact on
its consolidated financial condition or results of operations.
Note 9: Recent Accounting Developments
The following information addresses new or proposed accounting
pronouncements that could have an impact on the Companys financial condition or
results of operations.
Business Combinations:
In December 2007, the Financial
Accounting Standards Board ("FASB") issued revised Statement of Financial
Accounting Standards ("SFAS") No. 141, "Business Combinations," or
SFAS No. 141(R). SFAS No. 141(R) retains the fundamental requirements of SFAS 141 that the
acquisition method of accounting (formally the purchase method) be used for all business
combinations; that an acquirer be identified for each business combination; and that
intangible assets be identified and recognized separately from goodwill.
SFAS No. 141(R)
requires the acquiring entity in a business combination to
recognize the assets acquired, the liabilities assumed and any non-controlling
interest in the acquired entity at the acquisition date, measured at their fair values as
of that date, with limited exceptions. Additionally, SFAS No. 141(R) changes the
requirements for recognizing assets acquired and liabilities assumed arising from
contingencies and recognizing and measuring contingent consideration. SFAS No. 141(R) also
enhances the disclosure requirements for business combinations. SFAS No. 141(R) applies
prospectively to business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December 15, 2008
(January 1, 2009 for the Company) and may not be applied before that date.
Non-controlling interests in Consolidated Financial Statements:
In
December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in
Consolidated Financial Statements, an amendment of Accounting Research Bulletin
("ARB") No. 51", "Consolidated Financial Statements". SFAS No.
160 amends ARB No. 51 to establish accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary.
Among other things, SFAS No. 160 clarifies that a non-controlling interest in a subsidiary
is an ownership interest in the consolidated entity that should be reported as equity in
the consolidated financial statements and requires net income to be reported at amounts
that include the amounts attributable to both the parent and the non-controlling interest.
SFAS No. 160 also amends SFAS No. 128, "Earnings per Share," so that earnings
per share calculations in consolidated financial statements will continue to be based on
amounts attributable to the parent. SFAS No. 160 is effective for fiscal years, and
interim periods within those years, beginning on or after December 15, 2008 (January 1,
2009 for the Company) and is applied prospectively as of the beginning of the fiscal year
in which it is initially applied, except for the presentation and disclosure requirements
which are to be applied retrospectively for all periods presented. SFAS No. 160 is not
expected to have an impact on the Companys consolidated financial condition or
results of operations.
Disclosures About Derivative Instruments and Hedging Activities:
In
March 2008, the FASB issued SFAS No. 161
, "
Disclosures About Derivative
Instruments and Hedging Activities, an Amendment of FASB Statement No. 133." SFAS No.
161 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," to amend and expand the disclosure requirements of SFAS No. 133 to
provide greater transparency about (i) how and why an entity uses derivative instruments,
(ii) how derivative instruments and related hedge items are accounted for under SFAS No.
133 and its related interpretations, and (iii) how derivative instruments and related
hedged items affect an entity's financial position, results of operations and cash flows.
To meet those objectives, SFAS No. 161 requires qualitative disclosures about objectives
and strategies for using derivatives, quantitative disclosures about fair value amounts of
gains and losses on derivative instruments and disclosures about credit-risk related
features in derivative agreements. SFAS No. 161 must be applied prospectively for interim
periods and fiscal years beginning after November 15, 2008 (January 1, 2009 for the
Company). SFAS No.161 is not expected to have a significant impact on the Company's
consolidated results of operation or financial condition.
The Hierarchy of Generally Accepted Accounting Principals:
In
May 2008, the FASB issued SFAS No. 162,
"
The
Hierarchy of
Generally Accepted Accounting Principles
"
. SFAS No. 162 identifies the
sources of accounting principles and the framework for selecting the principles used in
the preparation of financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles (the "GAAP hierarchy").
SFAS No. 162 will become effective 60 days following the SEC's approval of the
Public Company Accounting Oversight Board amendments to AU Section 411, "The
Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles." SFAS No.162 is not expected to have a significant impact on the
Company's consolidated results of operation or financial condition.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS
OF OPERATIONS
Managements discussion and analysis, which follows, focuses on
the factors affecting the Companys consolidated results of operations for the three
and nine months ended September 30, 2008 and 2007, and financial condition at September
30, 2008, and December 31, 2007, and where appropriate, factors that may affect future
financial performance. The following discussion and analysis of financial condition and
results of operations of the Company and its subsidiaries should be read in conjunction
with the consolidated financial statements and notes thereto, and selected financial and
statistical information appearing elsewhere in this report on Form 10-Q.
Amounts in the prior period financial statements are reclassified
whenever necessary to conform to current period presentation.
Unless otherwise noted, all dollars are expressed in thousands except
share data.
Use of Non-GAAP Financial Measures:
Certain information
discussed below is presented on a fully taxable equivalent basis. Specifically, included
in third quarter 2008 and 2007 interest income was $486 and $341, respectively, of
tax-exempt interest income from certain investment securities and loans. For the nine
months ended September 30, 2008 and 2007, the amount of tax-exempt income included in
interest income was $1,473 and $1,132.
An amount equal to the tax benefit derived from this tax exempt income
has been added back to the interest income totals discussed in certain sections of this
Managements Discussion and Analysis, representing tax equivalent adjustments of $221
and $149, in the third quarter of 2008 and 2007, respectively, and $662 and $495 for the
nine months ended September 30, 2008 and 2007, respectively, which increased net interest
income accordingly. The analysis of net interest income tables included in this report on
Form 10-Q provide a reconciliation of tax equivalent financial information to the
Company's consolidated financial statements, which have been prepared in accordance with
U.S. generally accepted accounting principles.
Management believes the disclosure of tax equivalent net interest
income information improves the clarity of financial analysis, and is particularly useful
to investors in understanding and evaluating the changes and trends in the Company's
results of operations. Other financial institutions commonly present net interest income
on a tax equivalent basis. This adjustment is considered helpful in the comparison of one
financial institution's net interest income to that of another institution, as each will
have a different proportion of tax-exempt interest from their earning asset portfolios.
Moreover, net interest income is a component of a second financial measure commonly used
by financial institutions, net interest margin, which is the ratio of net interest income
to average earning assets. For purposes of this measure as well, other financial
institutions generally use tax equivalent net interest income to provide a better basis of
comparison from institution to institution. The Company follows these practices.
FORWARD LOOKING STATEMENTS DISCLAIMER
Certain statements, as well as certain other discussions contained in
this 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;
|
|
|
|
(x)
|
|
Changes in
general, national, international, regional or local economic conditions and credit markets
which are less favorable than those anticipated by Company management, including fears of
global economic recession and continued sub-prime loan and credit issues, impacting the
Company's investment portfolio, quality of credits, or the overall demand for the
Company's products or services; and
|
|
|
|
(xi)
|
|
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 and results of operations are based on the Consolidated Financial
Statements, which are prepared in accordance with U.S. generally accepted accounting
principles. The preparation of such financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosure of contingent assets and liabilities.
Management evaluates its estimates, including those related to the allowance for loan
losses, on an ongoing basis. Management bases its estimates on historical experience and
various other assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis in making judgments about the carrying values of assets
that are not readily apparent from other sources. Actual results could differ from the
amount derived from 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, 2007 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:
The allowance for loan losses (the
"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 probable 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, 2008 and December 31, 2007, 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 effect on the Company's results of
operations. The Companys annual impairment test was performed as of December 31,
2007. 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 $2,333 or fully diluted
earnings per share of $0.78 for the three months ended September 30, 2008, compared with
$2,147 or fully diluted earnings per share of $0.69 for the same quarter in 2007,
representing increases of $186 and $0.09, or 8.7% and 13.0%, respectively. The annualized
return on average shareholders equity ("ROE") and average assets
("ROA") amounted to 14.46% and 0.99%, respectively, compared with 13.68% and
1.00% for the same quarter in 2007.
As more fully discussed below, the increase in third quarter 2008
earnings compared with the third quarter of 2007 was principally attributed to a $1,215 or
20.5% increase in net interest income, partially offset by a $646 increase in the
provision for loan losses and a $142 decline in securities gains.
For the nine months ended September 30, 2008, consolidated net income
amounted to $6,314 or fully diluted earnings per share of $2.09, compared with $5,365 or
fully diluted earnings per share of $1.72 for the same period in 2007, representing
increases of $949 and $0.37, or 17.7% and 21.5%, respectively. The annualized ROE and ROA
amounted to 12.78% and 0.92%, compared with 11.52% and 0.86% for the same period in 2007,
respectively.
As more fully discussed below, the increased level of earnings was
attributed to a variety of factors including: a $3,161 or 18.8% increase in net interest
income; a $1,275 increase in net securities gains (losses); a $313 gain representing the
proceeds from shares redeemed in connection with the Visa Inc. initial public offering;
and a $170 or 9.7% increase in trust and financial services fees. Partially offsetting the
foregoing revenue increases was a $1,422 increase in the provision for loan losses and a
$2,188 or 16.6% increase in non-interest expenses, which largely reflected a $1,048 or
15.2% increase in salaries and employee benefit expenses and the recording of a
non-recurring $832 expense reduction recorded in the first quarter of 2007 related to the
Companys settlement of its limited postretirement benefit program.
Net Interest Income:
For the three and nine months ended September 30, 2008, net
interest income on a fully tax equivalent basis amounted to $7,349 and $20,614,
representing increases of $1,287 and $3,328, or 21.2% and 19.3%, compared with the same
periods in 2007, respectively. The increases in net interest income were principally
attributed to an improved net interest margin and average earning asset growth. The
decline in short-term interest rates over the past twelve months favorably impacted the
Banks net interest margin, as the cost of interest bearing liabilities declined
faster and to a greater degree than the decline in earning asset yields. For the three and
nine months ended September 30, 2008, the fully tax equivalent net interest margin
amounted to 3.22% and 3.11%, representing improvements of 29 and 22 basis points compared
with the same periods in 2007, respectively.
Non-interest Income:
For the quarter ended September 30, 2008, total
non-interest income amounted to $2,224, representing a decline of $39, or 1.7%, compared
with the same quarter in 2007. The decline in non-interest income was principally
attributed to a $142 decline in securities gains, largely offset by a $75 or 13.3%
increase in trust and other financial services fees. All other categories of non-interest
income posted increases compared with the third quarter of 2007.
For the nine months ended September 30, 2008, total
non-interest income amounted to $6,205, representing an increase of $1,906, or 44.3%,
compared with the same period in 2007. During the first nine months of 2007 the Bank
restructured a portion of its securities portfolio, recording net securities losses of
$671, whereas during the same period in 2008 the Bank recorded securities gains of $604.
Also included in non-interest income was a $313 gain recorded in the first quarter of 2008
representing the proceeds from shares redeemed in connection with the Visa, Inc. initial
public offering.
For the nine months ended September 30, 2008, trust and other financial
services fees and credit and debit card fees were up $170 and $137, or 9.7% and 8.7%,
respectively, compared with the same period last year.
-
Non-Interest Expense:
For the quarter ended September 30, 2008, total
non-interest expense amounted to $5,112 representing an increase of $316 or 6.6%, compared
with the same quarter in 2007. The increase in non-interest expense was principally
attributed to a $206, or 8.6%, increase in salaries and employee benefits, due to a
variety of factors enumerated below. In connection with the previously reported Visa
Reorganization, in the third quarter of 2008 the Bank increased its Visa indemnification
and covered litigation liability by $68, based upon the terms of Visas recent
settlement in principle with Discover Financial Services. The Bank anticipates recovery of
this amount in the fourth quarter of 2008 using Loss Shares that will be issued by VISA.
For the nine months ended September 30, 2008, total non-interest
expense amounted to $15,334, representing an increase of $2,188, or 16.6%, compared with
the same period in 2007. The increase in non-interest expense was largely attributed to
the settlement of the Companys limited postretirement program in the first quarter
of 2007, which reduced that reporting periods non-interest expense by $832. The
increase in non-interest expense was also attributed to higher levels of salaries and
employee benefits, which were up $1,048 or 15.2% compared with the first nine months of
2007. The increase in salaries and employee benefits was attributed to a variety of
factors including: strategic additions to staff; normal increases in base salaries; higher
levels of accrued incentive compensation; certain employee severance payments; and a
non-recurring employee health insurance expense credit attained in the second quarter of
2007 based on favorable claims experience.
Summary Financial Condition
Total assets ended the third quarter at $942,004, representing an
increase of $52,532, or 5.9%, compared with December 31, 2007. This increase was
principally attributed to the growth of the Banks loan portfolio.
-
Loans:
Total loans ended the third quarter at $624,205, representing an increase
of $44,494, or 7.7%, compared with December 31, 2007. Business lending activity led the
overall growth of the loan portfolio, as residential mortgage loan originations slowed.
The Banks
non-performing loans ended the third quarter at relatively low levels, representing $3,339
or 0.53% of total loans, compared with $2,062, or 0.36% at December 31, 2007. For the nine
months ended September 30, 2008, net loan charge-offs amounted to $1,192, compared with
$142 during the same period in 2007. For the three and nine months ended September 30,
2008, the Bank recorded provisions for loan losses of $860 and $1,669, representing
increases of $646 and $1,422 compared with the same periods in 2007, respectively. The
increases in the provision were largely attributed to the increase in net loan
charge-offs, growth in the loan portfolio, generally declining real estate values in the
markets served by the Bank, and other qualitative and environmental considerations.
-
Securities:
total securities ended the third quarter at $269,609, representing
an increase of $4,992, or 1.9%, compared with December 31, 2007. The Companys solid
earnings and strong loan growth lessened the need for further securities leverage.
-
Deposits:
Total deposits ended the third quarter at $578,163, representing an
increase of $39,047 or 7.2% compared with December 31, 2007. Deposit growth was led by
meaningful increases in retail time deposits and NOW accounts, offset in part by a $25,623
million or 24.7% decline in brokered time deposits.
-
Borrowings:
Total borrowings ended the third quarter at $295,572, representing
an increase of $16,719, or 6.0%, compared with December 31, 2007. The increase in
borrowings was principally used to support earning asset growth, as well as reducing the
Banks dependence on higher cost and more volatile brokered deposits.
-
Capital:
The Bank continued to exceed regulatory requirements for
"well-capitalized"
institutions. At September 30, 2008, the Banks
Tier I Leverage, Tier I Risk-based, and Total Risk-based Capital ratios were 7.05%, 10.55%
and 11.78%, respectively. Under the capital adequacy guidelines administered by the
Banks principal regulators, "well-capitalized" institutions are those with
Tier I leverage, Tier I Risk-based, and Total Risk-based ratios of at least 5%, 6% and
10%, respectively.
-
Cash Dividends:
The Company paid cash dividends of 26.0 cents per share of
common stock in the third quarter of 2008, representing an increase of 2.0 cents, or 8.3%,
compared with the same quarter in 2007. The Companys Board of Directors recently
declared a fourth quarter dividend of 26.0 cents per share, unchanged from the prior
quarter, but representing an increase of 1.5 cents, or 6.1%, compared with the dividend
declared for the same quarter in 2007.
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, 2008, net interest income on a
fully tax equivalent basis amounted to $7,349, compared with $6,062 in the third quarter
of 2007, representing an increase of $1,287, or 21.2%. As more fully discussed below, the
increase in the Banks third quarter 2008 net interest income compared with the same
quarter in 2007 was principally attributed to a 29 basis point improvement in the tax
equivalent net interest margin, combined with average earning growth of $86,755, or 10.6%.
For the nine months ended September 30, 2008, net interest income on a
fully tax equivalent basis amounted to $20,614, compared with $17,286 for the same period
in 2007, representing an increase of $3,328, or 19.3%. As more fully discussed below, the
increase in net interest income was principally attributed to earning asset growth of
$87,121 or 10.9%, combined with a 22 basis point improvement in the tax equivalent net
interest margin, compared with the nine months ended September 30, 2007.
Factors contributing to the changes in net interest income and the net
interest margin are more fully enumerated in the following discussion and analysis.
Net Interest Income Analysis:
The following tables summarize
the 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, 2008 and 2007, respectively:
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
SEPTEMBER 30, 2008 AND 2007
|
2008
|
|
2007
|
|
Average
Balance
|
Interest
|
Average
Rate
|
|
Average
Balance
|
Interest
|
Average
Rate
|
Interest Earning Assets:
|
|
|
|
|
|
|
|
Loans
(1,3)
|
$616,413
|
$ 9,439
|
6.09%
|
|
$559,499
|
$ 9,707
|
6.88%
|
Taxable
securities (2)
|
240,673
|
3,564
|
5.89%
|
|
222,083
|
3,163
|
5.65%
|
Non-taxable
securities (2,3)
|
35,842
|
620
|
6.88%
|
|
24,139
|
405
|
6.66%
|
Total securities
|
276,515
|
4,184
|
6.02%
|
|
246,222
|
3,568
|
5.75%
|
Federal
Home Loan Bank stock
|
13,928
|
105
|
3.00%
|
|
12,569
|
203
|
6.41%
|
Fed funds sold, money market funds,
and time deposits with other banks
|
1,018
|
8
|
3.13%
|
|
2,829
|
37
|
5.19%
|
|
|
|
|
|
|
|
|
Total Earning Assets
|
907,874
|
13,736
|
6.02%
|
|
821,119
|
13,515
|
6.53%
|
|
|
|
|
|
|
|
|
Non-Interest Earning Assets:
|
|
|
|
|
|
|
|
Cash
and due from banks
|
6,442
|
|
|
|
8,213
|
|
|
Allowance
for loan losses
|
(5,411)
|
|
|
|
(4,547)
|
|
|
Other
assets (2)
|
28,844
|
|
|
|
29,184
|
|
|
Total Assets
|
$937,749
|
|
|
|
$853,969
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Deposits
|
$520,297
|
$ 3,551
|
2.72%
|
|
$463,273
|
$ 4,207
|
3.60%
|
Borrowings
|
287,681
|
2,836
|
3.92%
|
|
261,981
|
3,246
|
4.92%
|
Total Interest Bearing Liabilities
|
807,978
|
6,387
|
3.14%
|
|
725,254
|
7,453
|
4.08%
|
Rate
Spread
|
|
|
2.88%
|
|
|
|
2.45%
|
|
|
|
|
|
|
|
|
Non-Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Demand
and other non-interest
bearing deposits
|
60,469
|
|
|
|
61,517
|
|
|
Other
liabilities
|
5,112
|
|
|
|
4,953
|
|
|
Total Liabilities
|
873,559
|
|
|
|
791,724
|
|
|
Shareholders'
equity
|
64,190
|
|
|
|
62,245
|
|
|
Total Liabilities and Shareholders' Equity
|
$937,749
|
|
|
|
$853,969
|
|
|
Net
interest income and net
interest margin (3)
|
|
7,349
|
3.22%
|
|
|
6,062
|
2.93%
|
Less:
Tax Equivalent adjustment
|
|
(221)
|
|
|
|
(149)
|
|
Net Interest Income
|
|
$ 7,128
|
3.12%
|
|
|
$ 5,913
|
2.86%
|
-
For purposes of these computations, non-accrual loans are included in
average loans.
-
For purposes of these computations, unrealized gains (losses) on
available-for-sale securities are recorded in other assets.
-
For purposes of these computations, net interest income and net
interest margin are reported on a tax equivalent basis.
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
NINE MONTHS ENDED
SEPTEMBER 30, 2008 AND 2007
|
|
2008
|
|
|
|
2007
|
|
|
Average
Balance
|
Interest
|
Average
Rate
|
|
Average
Balance
|
Interest
|
Average
Rate
|
Interest Earning Assets:
|
|
|
|
|
|
|
|
Loans (1,3)
|
$605,505
|
$28,390
|
6.26%
|
|
$554,522
|
$28,358
|
6.84%
|
Taxable securities (2)
|
226,842
|
9,993
|
5.88%
|
|
202,438
|
8,406
|
5.55%
|
Non-taxable securities (2,3)
|
36,773
|
1,874
|
6.81%
|
|
27,110
|
1,370
|
6.76%
|
Total securities
|
263,615
|
11,867
|
6.01%
|
|
229,548
|
9,776
|
5.69%
|
Federal Home Loan Bank stock
|
13,848
|
438
|
4.22%
|
|
12,483
|
607
|
6.50%
|
Fed funds sold, money market funds, and time
|
|
|
|
|
|
|
|
deposits with other banks
|
2,884
|
77
|
3.57%
|
|
2,178
|
86
|
5.28%
|
|
|
|
|
|
|
|
|
Total Earning Assets
|
885,852
|
40,772
|
6.15%
|
|
798,731
|
38,827
|
6.50%
|
|
|
|
|
|
|
|
|
Non-Interest Earning Assets:
|
|
|
|
|
|
|
|
Cash and due from banks
|
5,391
|
|
|
|
6,983
|
|
|
Allowance for loan losses
|
(5,106)
|
|
|
|
(4,549)
|
|
|
Other assets (2)
|
31,390
|
|
|
|
30,340
|
|
|
Total Assets
|
$917,527
|
|
|
|
$831,505
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Deposits
|
$514,040
|
$11,465
|
2.98%
|
|
$454,191
|
$12,084
|
3.56%
|
Borrowings
|
278,431
|
8,693
|
4.17%
|
|
256,460
|
9,457
|
4.93%
|
Total Interest Bearing Liabilities
|
792,471
|
20,158
|
3.40%
|
|
710,651
|
21,541
|
4.05%
|
Rate Spread
|
|
|
2.75%
|
|
|
|
2.45%
|
|
|
|
|
|
|
|
|
Non-Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
Demand and other non-interest bearing deposits
|
54,238
|
|
|
|
53,761
|
|
|
Other liabilities
|
4,815
|
|
|
|
4,828
|
|
|
Total Liabilities
|
851,524
|
|
|
|
769,240
|
|
|
Shareholders' equity
|
66,003
|
|
|
|
62,265
|
|
|
Total Liabilities and Shareholders' Equity
|
$917,527
|
|
|
|
$831,505
|
|
|
Net interest income and net interest margin (3)
|
|
20,614
|
3.11%
|
|
|
17,286
|
2.89%
|
Less: Tax Equivalent adjustment
|
|
(662)
|
|
|
|
(495)
|
|
Net Interest Income
|
|
$19,952
|
3.01%
|
|
|
$16,791
|
2.81%
|
-
For purposes of these computations, non-accrual loans are included in average loans.
-
For purposes of these computations, unrealized gains (losses) on available-for-sale
securities are recorded in other assets.
-
For purposes of these computations, net interest income and net interest margin are
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 and nine months ended September 30, 2008, the fully tax
equivalent net interest margin amounted to 3.22% and 3.11%, compared with 2.93% and 2.89%
during the same periods in 2007, representing improvements of 29 and 22 basis points,
respectively.
The following table summarizes the net interest margin components, on a
quarterly basis, over the past two years. Factors contributing to the changes in the net
interest margin are enumerated in the following discussion and analysis.
NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED
|
2008
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Quarter:
|
3
|
2
|
1
|
|
4
|
3
|
2
|
1
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
Interest Earning Assets:
|
|
|
|
|
|
|
|
|
|
|
Loans (1,3)
|
6.09%
|
6.19%
|
6.52%
|
|
6.71%
|
6.88%
|
6.88%
|
6.74%
|
|
6.68%
|
Taxable securities (2)
|
5.89%
|
5.88%
|
5.88%
|
|
5.78%
|
5.65%
|
5.62%
|
5.38%
|
|
5.03%
|
Non-taxable securities (2,3)
|
6.88%
|
6.77%
|
6.78%
|
|
6.71%
|
6.66%
|
6.80%
|
6.80%
|
|
6.80%
|
Total securities
|
6.02%
|
6.00%
|
6.02%
|
|
5.87%
|
5.75%
|
5.77%
|
5.56%
|
|
5.30%
|
Federal Home Loan Bank stock
|
3.00%
|
3.98%
|
5.73%
|
|
6.31%
|
6.41%
|
6.56%
|
6.54%
|
|
6.13%
|
Fed Funds sold, money market funds,
and time deposits with other banks
|
3.13%
|
3.00%
|
4.37%
|
|
5.01%
|
5.19%
|
5.67%
|
4.88%
|
|
5.20%
|
Total Earning Assets
|
6.02%
|
6.08%
|
6.35%
|
|
6.45%
|
6.53%
|
6.57%
|
6.40%
|
|
6.29%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Demand and other non-interest
bearing deposits
|
2.72%
|
2.92%
|
3.33%
|
|
3.51%
|
3.60%
|
3.56%
|
3.51%
|
|
3.37%
|
Borrowings
|
3.92%
|
4.21%
|
4.39%
|
|
4.69%
|
4.92%
|
4.93%
|
4.95%
|
|
4.87%
|
Total Interest Bearing Liabilities
|
3.14%
|
3.36%
|
3.71%
|
|
3.95%
|
4.08%
|
4.04%
|
4.04%
|
|
3.89%
|
|
|
|
|
|
|
|
|
|
|
|
Rate Spread
|
2.88%
|
2.72%
|
2.64%
|
|
2.50%
|
2.45%
|
2.53%
|
2.36%
|
|
2.40%
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Margin (2)
|
3.22%
|
3.07%
|
3.03%
|
|
2.97%
|
2.93%
|
2.96%
|
2.79%
|
|
2.87%
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Margin without
Tax Equivalent Adjustments
|
3.12%
|
2.97%
|
2.92%
|
|
2.89%
|
2.86%
|
2.88%
|
2.70%
|
|
2.77%
|
-
For purposes of these computations, non-accrual loans are included in
average loans.
-
For purposes of these computations, unrealized gains (losses) on
available-for-sale securities are recorded in other assets.
-
For purposes of these computations, net interest income and net
interest margin are reported on a tax equivalent basis.
Beginning in September 2007, the Board of Governors of the Federal
Reserve System (the "Federal Reserve") decreased short-term interest rates seven
times for a total of 325 basis points. These actions have favorably impacted the
Banks net interest income, given its liability sensitive balance sheet.
Specifically, the Banks total weighted average cost of funds declined at a faster
pace and to a greater extent than the decline in the weighted average yield on its earning
asset portfolios.
The weighted average yield on average earning assets amounted to 6.02%
in the third quarter of 2008, compared with 6.53% in the third quarter of 2007,
representing a decline of 51 basis points. However, the weighted average cost of interest
bearing liabilities amounted to 3.14% in the third quarter of 2008, compared with 4.08% in
the third quarter of 2007, representing a decline of 94 basis points. In short, since the
third quarter of 2007, the decline in the Banks weighted average cost of interest
bearing liabilities exceeded the decline in the weighted average yield on its earning
asset portfolios by 43 basis points.
For the nine months ended September 30, 2008, the weighted average
yield on average earning assets amounted to 6.15%, compared with 6.50% for the same period
in 2007, representing a decline of 35 basis points. However, the weighted average cost of
interest bearing liabilities amounted to 3.40% during the nine months ended September 30,
2008, compared with 4.05% for the same period in 2007, representing a decline of 65 basis
points. In short, comparing the first nine months of 2008 with the same period in 2007,
the decline in the Banks weighted average cost of interest bearing liabilities
exceeded the decline in the weighted average yield on its earning asset portfolios by 30
basis points.
In October 2008, the Board of Governors of the Federal Reserve System
reduced short-term interest rates by an additional 100 basis points. Should interest rates
continue at current levels, Company management anticipates the Banks improving net
interest margin trend will continue into the fourth quarter of 2008, generating higher
levels of net interest income. Management anticipates the continued improvement in the net
interest margin will be driven by a continued downward re-pricing of interest bearing
liabilities, as time deposits and borrowed funds maturities are replaced at lower
prevailing costs, while the yields on its average earning asset portfolios continue to
stabilize. Management also anticipates that the net interest margin and net interest
income will be favorably impacted by the current positively sloped U.S. Treasury yield
curve, as compared with the yield flat-to-inverted curve environment experienced in 2007.
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.
Interest Income:
For the three and nine months ended September
30, 2008, total interest income, on a fully tax equivalent basis, amounted to $13,736 and
$40,772 compared with $13,515 and $38,827 during the same periods in 2007, representing
increases of $221 and $1,945, or 1.6% and 5.0%, respectively.
The increases in interest income were principally attributed to average
earning asset growth of $86,755 and $87,121, or 10.6% and 10.9%, largely offset by 51 and
35 basis point declines in the weighted average earning asset yields, when comparing the
three and nine months ended September 30, 2008 with the same periods in 2007,
respectively. The declines in the weighted average earning asset yields were principally
attributed to the reduction of short-term interest rates by the Federal Reserve, the
impact of which reduced the weighted average yield on the Banks variable rate loan
portfolios. To a lesser extent, the weighted average loan yields were also impacted by the
renegotiation of certain fixed rate loans to variable rate loans with lower prevailing
interest rates. For the three and nine months ended September 30, 2008, the weighted
average yield on the Banks loan portfolio amounted to 6.09% and 6.26%, representing
declines of 79 and 58 basis points compared with the same periods in 2007.
For the three and nine months ended September 30, 2008, the weighted
average yield on the Banks securities portfolio amounted to 6.02% and 6.01%,
representing improvements of 27 and 32 basis points, compared with the same periods in
2007. The improved yield on the securities portfolio reflects, in part, the restructuring
of a portion of the portfolio in 2007. In addition, because the majority of the securities
portfolio is comprised of fixed rate securities, the decline in short-term interest rates
has had minimal impact on the portfolios weighted average yield.
As depicted on the rate/volume analysis tables below, comparing the
three and nine months ended September 30, 2008 with the same periods in 2007, the
increased volume of average earning assets on the balance sheet contributed $1,454 and
$4,176 to the increases in interest income, but were largely offset by declines of $1,233
and $2,231 attributed to the impact of the lower weighted average earning asset yields.
Interest Expense:
For the three and nine months ended September
30, 2008, total interest expense amounted to $6,387 and $20,158, compared with $7,453 and
$21,541 during the same periods in 2007, representing declines of $1,066 and $1,383, or
14.3% and 6.4%, respectively.
The declines in interest expense were principally attributed to 94 and
65 basis point declines in the weighted average cost of interest bearing liabilities,
offset in part by increases in average interest bearing liabilities totaling $82,724 and
$81,820, or 11.4% and 11.5%, when comparing the three and nine months ended September 30,
2008 with the same periods in 2007, respectively. The declines in the average cost of
interest bearing funds were principally attributed to declines in short-term market
interest rates between periods and, to a lesser extent, a proportionately lower
utilization of wholesale funding.
For the three and nine months ended September 30, 2008, the total
weighted average cost of interest bearing liabilities amounted to 3.14% and 3.40%,
compared with 4.08% and 4.05% during the same periods in 2007, representing declines of 94
and 65 basis points, respectively. For the three and nine months ended September 30, 2008,
the weighted average cost of borrowed funds declined 100 and 76 basis points to 3.92% and
4.17%, while the weighted average cost of interest bearing deposits declined 88 and 58
basis points to 2.72% and 2.98%, compared with the same periods in 2007, respectively. The
decline in the weighted average cost of borrowed funds outpaced the decline in the
weighted average cost of interest bearing deposits, reflecting the shorter maturities of
the Banks borrowing base as rates began declining, combined with highly competitive
market pricing pressures for deposits in the markets served by the Bank.
As depicted on the rate/volume analysis tables below, comparing the
three and nine months ended September 30, 2008 with the same periods in 2007, the impact
of the lower weighted average rate paid on interest bearing liabilities contributed $1,904
and $3,799 to the declines in interest expense, but were largely offset by increases of
$838 and $2,416 attributed to the impact of the increased volume of average interest
bearing liabilities.
Rate/Volume Analysis:
The following table sets 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, 2008 VERSUS SEPTEMBER 30, 2007
INCREASES (DECREASES) DUE TO:
|
Average
Volume
|
Average
Rate
|
Total
Change
|
|
|
|
|
Loans
(1,3)
|
$ 995
|
$(1,263)
|
$ (268)
|
Taxable
securities (2)
|
265
|
136
|
401
|
Non-taxable
securities (2,3)
|
196
|
19
|
215
|
Investment
in Federal Home Loan Bank stock
|
22
|
(120)
|
(98)
|
Fed
funds sold, money market funds, and time
deposits with other banks
|
(24)
|
(5)
|
(29)
|
|
|
|
|
TOTAL
EARNING ASSETS
|
$1,454
|
$(1,233)
|
$ 221
|
|
|
|
|
Interest
bearing deposits
|
519
|
(1,175)
|
(656)
|
Borrowings
|
319
|
(729)
|
(410)
|
TOTAL
INTEREST BEARING LIABILITIES
|
$
838
|
$(1,904)
|
$(1,066)
|
|
|
|
|
NET
CHANGE IN NET INTEREST INCOME
|
$
616
|
$
671
|
$ 1,287
|
-
For purposes of these computations, non-accrual loans are included in average loans.
-
For purposes of these computations, unrealized gains (losses) on available-for-sale
securities are recorded in other assets.
-
For purposes of these computations, net interest income and net interest margin are
reported on a tax equivalent basis.
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2008 VERSUS SEPTEMBER 30, 2007
INCREASES (DECREASES) DUE TO:
|
Average
Volume
|
Average
Rate
|
Total
Change
|
|
|
|
|
Loans (1,3)
|
$2,585
|
$(2,553)
|
$
32
|
Taxable securities (2)
|
1,014
|
573
|
1,587
|
Non-taxable securities (2,3)
|
488
|
16
|
504
|
Investment in Federal Home Loan Bank stock
|
66
|
(235)
|
(169)
|
Fed funds sold, money market funds, and time
deposits with other banks
|
23
|
(32)
|
(9)
|
|
|
|
|
TOTAL EARNING ASSETS
|
$4,176
|
$(2,231)
|
$ 1,945
|
|
|
|
|
Interest bearing deposits
|
1,604
|
(2,223)
|
(619)
|
Borrowings
|
812
|
(1,576)
|
(764)
|
TOTAL INTEREST BEARING LIABILITIES
|
$2,416
|
$(3,799)
|
$(1,383)
|
|
|
|
|
NET CHANGE IN NET INTEREST INCOME
|
$1,760
|
$ 1,568
|
$ 3,328
|
-
For purposes of these computations, non-accrual loans are included in
average loans.
-
For purposes of these computations, unrealized gains (losses) on
available-for-sale securities are recorded in other assets.
-
For purposes of these computations, net interest income and net
interest margin are 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 probable
loss in the Banks current loan portfolio.
The Banks non-performing loans remained at relatively low levels
at quarter end, representing $3,399 or 0.53% of total loans, compared with $2,062 or 0.36%
of total loans at December 31, 2007.
Net charge-offs amounted to $1,192 during the first nine months of
2008, or annualized net charge-offs to average loans outstanding of 0.26%, compared with
$142 or annualized net charge-offs to average loans outstanding of 0.03% for the same
period in 2007. Two problem loans were accountable for $1,094, or 91.8%, of the
charge-offs during the nine months ended September 30, 2008.
The allowance expressed as a percentage of non-performing loans stood
at 156% at September 30, 2008, compared with 230% at December 31, 2007.
For the three and nine months ended September 30, 2008, the provision
for loan losses (the "provision") amounted to $860 and $1,669 compared with $214
and $247 during the same periods in 2007. The increases in the provision were largely
attributed to increases in net loan charge-offs, growth in the loan portfolio, generally
declining real estate values in much of the Banks market area, and other qualitative
and environmental considerations.
Refer below to Item 2 of this Part I, Financial Condition, Loans,
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, 2008, total
non-interest income amounted to $2,224 and $6,205, compared with $2,263 and $4,299 during
the same periods in 2007, representing a decline of $39 or 1.7% and an increase of $1,906
or 44.3%, 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 other
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, 2008, income from
trust and other financial services amounted to $639 and $1,917, compared with $564 and
$1,747 during the same periods in 2007, representing increases $75 and $170, or 13.3% and
9.7%, respectively. Revenue generated from third party brokerage activities posted
meaningful increases, which were principally attributed to staff additions and new client
relationships. Revenue from trust and investment management activities was relatively flat
compared with the three and nine months ended September 30, 2007, principally reflecting
declining market values of assets under management and held in custody.
At September 30, 2008, total assets under management at Bar Harbor
Trust Services ("Trust Services"), a Maine chartered non-depository trust
company and second tier subsidiary of the Company, stood at $253,021 compared with
$278,227 at December 31, 2007, representing a decline of $25,206 or 9.1%. The decline in
assets under management was principally reflective of the broad declines experienced by
the equity markets in general during the nine months ended September 30, 2008, offset in
part by growth in managed assets.
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, 2008, income from
service charges on deposit accounts amounted to $459 and $1,226, compared with $454 and
$1,242 for the same periods in 2007, representing an increase of $5 or 1.1% and a decline
of $16 or 1.3%, respectively.
The declines in service charges on deposit accounts were principally
attributed to relatively small declines in deposit account overdraft activity, compared
with the three and nine months ended September 30, 2007, and the fact that the Bank has
not increased its deposit account fee amounts charged to customers since early 2007.
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, 2008, credit and
debit card service charges and fees amounted to $876 and $1,716, compared with $871 and
$1,579 during the same periods in 2007, representing increases of $5 and $137, or 0.6% and
8.7%, respectively.
The increases in credit and debit card fees were largely attributed to
increases in debit card fees, principally reflecting the ongoing growth in the Banks
demand deposits accounts base, combined with a new program introduced in 2007 that offers
rewards for certain debit card transactions.
Merchant credit card processing fees posted increases for the nine
months ended September 30, 2008, reflecting higher merchant credit card processing volumes
compared with the nine months ended September 30, 2007. For the quarter ended September
30, 2008, merchant credit card processing fees were unchanged compared with the same
quarter in 2007, reflecting essentially flat transaction volumes compared with the same
quarter in 2007.
As previously reported by the Company on October 3, 2008, the Bank
entered into a definitive Merchant Portfolio Purchase Agreement (the "Purchase
Agreement") with TransFirst, LLC, a Delaware limited liability company
("TransFirst") and Columbus Bank and Trust Company, a Georgia state banking
corporation ("Columbus Bank"). On the same date, September 30, 2008, the Bank
also entered into a definitive Referral and Sales Agreement with TransFirst. Pursuant to
the Purchase Agreement, the Bank has agreed to sell and assign and Columbus as
"Transferee" has agreed to purchase and assume a mutually agreed list of assets
comprised of certain Bank merchant processing agreements and theBanks rights under
those agreements, including BHBTs books and records reasonably required to manage
and monitor the Banks card processing services and other obligations under the
transferred merchant agreements (collectively the "Purchased Assets"). The
Purchased Assets include those merchant agreements between BHBT and merchants that govern
the merchants participation in BHBTs merchant program for credit or debit card
processing services. The legal transfer of the Purchased Assets occurred on November 1,
2008 (the "Transfer Date"), at which time TransFirst began the conversion of the
transferred merchants and related accounts to the purchasers processing systems,
which conversion is anticipated to be completed by February 28, 2008. The Bank will
continue to provide card processing services to the merchants in the portfolio of sold
accounts until such time as TransFirst has completed its conversion of an assigned
merchant account. In consideration of the sale of the Purchased Assets, TransFirst has
paid to the bank on the Transfer date $250,000 (the "Purchase Price").
The RSA is effective as of November 1, 2008. Under the RSA, the Bank
has agreed to refer its current and prospective merchant customers exclusively to
TransFirst for all payment processing services. The RSA has an initial ten (10) year term
with recurring one (1) year renewals thereafter, unless terminated by either party or
notice of nonrenewal is provided by either party. In consideration for performance of its
obligations under the RSA, TransFirst has agreed to pay to BHBT: (i) a monthly cash
installment payment of $15,833.00, payable in arrears, for sixty (60) consecutive months
beginning November 1, 2008, with the first monthly payment for November 2008 payable on
December 1, 2008; (ii) ten percent (10%) of net revenues paid for Payment Processing
Services by merchants who were part of the merchant portfolio purchased by TransFirst
under the Purchase Agreement; (iii) twenty percent (20%) of net revenues paid for Payment
Processing Services by merchants referred to TransFirst by BHBT under the RSA; and (iv) 5%
of net revenues paid for Payment Processing Services by merchants otherwise solicited by
TransFirst under the RSA. In addition, TransFirst will pay the Bank a nominal referral fee
for each merchant referred to TransFirst by the Bank that commences Payment Processing
Services through TransFirst (not including those merchants that are part of the merchant
portfolio purchased by TransFirst pursuant to the Purchase Agreement), and a fee of One
Dollar ($1.00) for each cash advance transaction processed by TransFirst for the Bank.
The principal objectives underlying the Banks decision to
terminate its direct participation in the payments industry as a processor of merchant
credit card and debit card transactions were the mitigation of risks such as fraud and
identity theft, along with the additional costs and resources required to monitor the
Banks merchants and demonstrate compliance with the standards set forth by the
Payment Card Industry (PCI DSS). The Bank will continue to offer and support these
services to existing and future merchant processing clients through a third party
processor. Bank management believes this new approach will improve the overall
profitability of this business, while offering enhanced levels of service and technology
resources to its customers.
Net Securities Gains (Losses):
For the three months ended
September 30, 2008, total securities gains amounted to $89, compared with $231 for the
same quarter in 2007, representing a decline of $142, or 61.5%. For the nine months ended
September 30, 2008, total securities gains amounted to $604, compared with net securities
losses of $671 during the same period in 2007, representing an increase of $1,275, or
190.0%. The amount recorded during the nine months ended September 30, 2008 represented
realized gains on the sale of securities, while the amount recorded during the same period
in 2007 represented a securities impairment loss of $1,162, offset in part by realized
gains from the sale of securities of $491.
In April 2007, Companys Board of Directors approved the
restructuring of a portion of the Companys consolidated balance sheet through the
sale of $43,337 of its aggregate $227,473 available for sale securities portfolio, 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, the Company recorded an adjustment to write down these securities to fair
value at March 31, 2007, resulting in an impairment loss of $1,162.
Other Operating Income:
For the three months ended September
30, 2008, total other operating income amounted to $97, compared with $86 during the same
quarter in 2007, representing an increase of $11, or 12.8%. For the nine months ended
September 30, 2008, total other operating income amounted to $571, compared with $240
during the same period in 2007, representing an increase of $331, or 137.9%. The increase
was attributed to a gain recorded in the first quarter of 2008 representing the proceeds
from shares redeemed in connection with the Visa, Inc. initial public offering.
As previously reported, in Part II, Item 7 of the Companys Annual
Report on Form 10-K, and in connection with the Banks merchant services and Visa
credit card business, prior to September 2007 the Bank was a member of Visa U.S.A. Inc.
Card Association. As a part of the Visa Inc. reorganization in 2007, (the "Visa
Reorganization"), the Bank received its proportionate number of Class U.S.A. shares
of Visa Inc. common stock, or 20,187 shares.
In connection with the Visa Inc. initial public offering that occurred
in March of 2008, the Banks Class U.S.A. shares were converted to 18,949 shares of
Visa Inc. Class B Common Stock, of which 7,326 shares were immediately redeemed. The
proceeds from this redemption amounted to $313 and were recorded in other operating income
in the Companys consolidated statement of income. The 11,623 post redemption
non-marketable shares owned by the Bank are convertible to Class A Visa Inc. shares three
years after the initial public offering, or upon settlement of certain litigation between
Visa Inc. and other third parties, whichever is later.
Non-interest Expense
For the three and nine months ended September 30, 2008, total
non-interest expense amounted to $5,112 and $15,334, representing increases of $316 and
$2,188, or 6.6% and 16.6%, compared with the same periods in 2007, 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, 2008, salaries and employee benefit expenses amounted to $2,592
and $7,933, compared with $2,386 and $6,885 during the same periods in 2007, representing
increases of $206 and $1,048, or 8.6% and 15.2%, respectively.
The increases in salaries and employee benefits were attributed to a
variety of factors including strategic additions to staff, normal increases in base
salaries, higher levels of accrued incentive compensation, certain employee severance
payments, and a non-recurring employee health insurance credit attained in the second
quarter of 2007 based on favorable claims experience.
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 $699 to plan
participants. 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 2007 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, 2008, total occupancy expenses amounted to $312 and $1,049, compared with
$294 and $987 during the same periods in 2007, representing increases of $18 and $62, or
6.1% and 6.3%, respectively.
The increases in occupancy expense were principally attributed higher
fuel and utilities prices during the three and nine months ended September 30, 2008,
compared with the same periods last year. Grounds keeping and snow removal expenses at the
Banks twelve branch office locations also posted moderate increases during the first
nine months of 2008 compared with the same period in 2007.
Furniture and Equipment Expenses:
For the three and nine months
ended September, 30 2008, furniture and equipment expenses amounted to $357 and $1,220,
compared with $396 and $1,284 during the same periods in 2007, representing declines of
$39 and $64, or 9.8% and 5.0%, respectively.
The declines in furniture and equipment expenses were principally
attributed to lower maintenance fees on certain equipment and a decline in depreciation
expense, compared with the three and nine months ended September 30, 2007.
Credit and Debit Card Expenses:
Credit and debit card expenses principally relate to the Banks merchant
credit 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.
For the three and nine months ended September 30, 2008, credit and
debit card expenses amounted to $619 and $1,200, compared with $621 and $1,079 during the
same periods in 2007, representing a decline of $2 or 0.3% and an increase of $121 or
11.2%, respectively.
The increase in credit and debit card expenses for the nine months
ended September 30, 2008 compared with the same period in 2007 were principally attributed
to increases in debit card transactions, reflecting the growth of the Banks retail
checking account base and the 2007 introduction of a new program that provides customer
rewards for certain debit card activity. Merchant credit card processing expenses were
also moderately higher, principally reflecting higher merchant credit card transaction
processing volumes compared with the nine months ended September 30, 2007. Credit and
debit card expenses also included the costs incurred during the first half of 2008
associated with the voluntary re-issuance of a large number of credit and debit cards that
were compromised in the widely-publicized Hannaford Bros. Supermarket data breach. The
increased credit and debit card expenses were more than offset by a $137 increase in
credit and debit card income, which is included in non-interest income in the
Companys consolidated statements of income.
The small decline in credit and debit card expenses for the quarter
ended September 30, 2008 compared with the same quarter in 2007 reflects relatively flat
merchant transaction processing volumes.
Other Operating Expenses:
For the three months ended September
30, 2008, total other operating expenses amounted to $1,232, compared with $1,099 during
the same quarter in 2007, representing an increase of $133, or 12.1%. In connection with
the previously reported Visa Reorganization discussed below, in the third quarter of 2008
the Bank increased its Visa indemnification and covered litigation liability by $68, based
on the terms of Visas recent settlement in principle with Discover Financial
Services. The Bank anticipates recovery of this amount in the fourth quarter of 2008 using
loss shares that will be issued by Visa.
For the nine months ended September 30, 2008, total other operating
expenses amounted to $3,932, compared with $3,743 during the same period in 2007,
representing an increase of $189, or 5.0%. The increase in other operating expenses was
attributed to a variety of factors including increases in professional services, marketing
expenses, charitable contributions and staff development costs. These increases were
partially offset by declines in courier services, and telecommunications costs. The
decline in courier services was principally attributed to the mid 2007 implementation of
remote image item capture technology in all of the Banks branch office locations.
Also included in other operating expenses for the nine months ended
September 30, 2008 was $128 reduction in the Companys liability related to the Visa
Reorganization and the Visa Inc. initial public offering recorded in the first quarter of
2008. As previously reported in Part II, Item 7 of the Companys Annual Report on
Form 10-K, as a former member of Visa, the Bank has an obligation to indemnify Visa U.S.A.
under its bylaws and Visa Inc. under a retrospective responsibility plan, approved as part
of the Visa Reorganization, for contingent losses in connection with covered litigation
(the "Visa Indemnification") disclosed in Visa Inc.s public filings with
the SEC, based on its membership proportion. The Bank is not a party to the lawsuits
brought against Visa U.S.A. In 2007 the Bank recorded a $243 liability in connection with
the Visa Indemnification. In connection with the March 2008 Visa Inc. public offering the
Bank reduced this liability by $128. As discussed above, in the third quarter of 2008 the
Bank increased this liability by $68 to $183, reflecting Visas recent settlement in
principle with Discover Financial Services. The Company recognizes its portion of the Visa
Indemnification at the estimated fair value of such obligation in accordance with FASB
Interpretation No. 45, "
Guarantors Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others"
.
Income Taxes
For the three and nine months ended September 30, 2008, total income
taxes amounted to $1,047 and $2,840, compared with $1,019 and $2,332 during the same
periods in 2007, representing increases of $28 and $508, or 2.7% and 21.8%, respectively.
The Company's effective tax rates for the three and nine months ended
September 30, 2008 amounted to 31.0% and 31.0%, compared with 32.2% and 30.3% for the same
periods in 2007. The income tax provisions for these periods were 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, 2008 represented 66.3% and 28.6% of total assets, compared with
65.2% and 29.7% at December 31, 2007, respectively.
At September 30, 2008, total assets amounted to $942,004, compared with
$889,472 at December 31, 2007, representing an increase of $52,532, or 5.9%.
Securities
The securities portfolio is primarily comprised of mortgage-backed
securities issued by U.S. government agencies, U.S. government sponsored enterprises, and
other private label issuers. The portfolio also includes tax-exempt obligations of state
and political subdivisions, and obligations of other U.S. government sponsored
enterprises. As of September 30, 2008, the securities portfolio did not contain any pools
of sub-prime mortgage-backed securities, collateralized debt obligations, or commercial
mortgage-backed securities. Additionally, the Bank did not have any equity securities or
corporate debt exposure in its securities portfolio, nor did it own any perpetual
preferred stock in Federal Home Loan Mortgage ("FHLMC") or Federal National
Mortgage Association ("FNMA"), or any interests in pooled trust preferred
securities or auction rate securities.
During the nine months ended September 30, 2008, the securities
portfolio represented 29.8% of the Companys average earning assets and generated
29.1% of total tax equivalent interest and dividend income, compared with 28.7% and 25.2%
during the same period in 2007.
The overall objectives of the Banks strategy for the 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 securities at
September 30, 2008 and December 31, 2007. 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. Gains and losses on the sale
of securities available for sale are determined using the specific-identification method
and are shown separately in the consolidated statements of income.
Total Securities:
At September 30, 2008, total securities
amounted to $269,609, compared with $264,617 at December 31, 2007, representing an
increase of $4,992 or 1.9%. The Companys solid earnings and strong loan growth
lessened the need for further securities leverage.
Impaired Securities:
The securities portfolio contains certain
investments where amortized cost exceeds fair value, which at September 30, 2008 amounted
to unrealized losses of $8,366, compared with $723 at December 31, 2007. The increase in
unrealized losses from December 31, 2007 levels was principally attributed to changes in
prevailing market conditions, interest rates and market yields at quarter end, including
historically wide pricing spreads to the U.S. Treasury yield curve (the "yield
curve").
At September 30, 2008, unrealized losses on securities in an unrealized
loss position more than twelve months amounted to $967, or 1.1% of their amortized cost,
compared with $348 or 1.4% at December 30, 2007, respectively.
Unrealized losses that are considered other-than-temporary are recorded
as a loss on the Companys consolidated statements 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 these
securities until a recovery of their amortized cost, which may be at 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, 2008 were attributed to prevailing market conditions, interest rates and
market yields, combined with historically wide pricing spreads to the yield curve. Because
the decline in market value was attributable to changes in prevailing market yields and
interest rates, and because the Bank has the ability and intent to hold these investment
securities until a recovery of their amortized cost, which may be at maturity, the Company
does not consider these investment securities to be other-than-temporarily impaired at
September 30, 2008.
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,
|
December 31,
|
|
2008
|
2007
|
|
|
|
Commercial
real estate mortgages
|
$219,142
|
$183,663
|
Commercial
and industrial loans
|
68,807
|
65,238
|
Agricultural
and other loans to farmers
|
19,802
|
15,989
|
Total commercial loans
|
307,751
|
264,890
|
|
|
|
Residential
real estate mortgages
|
249,819
|
251,625
|
Consumer
loans
|
8,206
|
10,267
|
Home
equity loans
|
49,720
|
45,783
|
Total consumer loans
|
307,745
|
307,675
|
|
|
|
Tax
exempt loans
|
7,621
|
6,001
|
|
|
|
Deferred
origination costs, net
|
1,088
|
1,145
|
Total
loans
|
624,205
|
579,711
|
Allowance
for loan losses
|
(5,220)
|
(4,743)
|
Total
loans net of allowance for loan losses
|
$618,985
|
$574,968
|
Total Loans:
At September 30, 2008, total loans amounted to
$624,205, compared with $579,711 at December 31, 2007, representing an increase of
$44,494, or 7.7%. Business lending activity led the overall growth of the loan portfolio
during the nine months ended September 30, 2008, as residential mortgage originations
slowed.
Commercial Loans:
At September 30, 2008, total commercial loans
amounted to $307,751, compared with $264,890 at December 31, 2007, representing an
increase of $42,861, or 16.2%.
Commercial loans represented 96.2% of total loan growth when comparing
September 30, 2008 with December 31, 2007. Commercial loan growth was principally driven
by commercial real estate mortgage loans, which posted an increase of $35,479, or 19.3%
compared with December 31, 2007. Agricultural loans and commercial and industrial loans
also posted increases, up $3,813 and $3,569, or 23.8% and 5.5%, respectively, compared
with December 31, 2007
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.
Consumer Loans:
At September 30, 2008, total consumer loans,
which principally consisted of consumer real estate (residential mortgage) loans, amounted
to $307,745, compared with $307,675 at December 31, 2007, representing an increase of $70.
Consumer loan growth was primarily impacted by $1,806 or 0.7% decline
in residential real estate loans, reflecting a continued softening of the real estate
markets in the communities served by the Bank. While the Bank originated and closed
$26,290 in residential real estate loans during the first nine months of 2008, this amount
was more than offset by $28,096 in cash flows (principal paydowns) from the existing
residential real estate loan portfolio. Consumer loans also posted a decline from year-end
2007 levels, down $2,061 or 20.1%. Offsetting the declines in residential real estate
loans and consumer loans was a $3,937 or 8.6% increase in home equity loans, when
comparing September 30, 2008 with December 31, 2007.
Tax Exempt Loans:
At September 30, 2008, tax exempt loans,
which principally consisted of loans to local government municipalities, amounted to
$7,621, compared with $6,001 at December 31, 2007, representing an increase of $1,620, or
27.0%.
Subprime Mortgage Lending:
Subprime mortgage lending, which has
been the riskiest sector of the residential housing market, is not a market that Bank
management has ever actively pursued. In general, the industry does not apply a uniform
definition of what actually constitutes "subprime" lending. In referencing
subprime lending activities, Bank management relies upon several sources, including
Maines Predatory Lending Law enacted January 1, 2008, and the "Statement of
Subprime Mortgage Lending" issued by the federal bank regulatory agencies (the
"Agencies") on June 29, 2007, which further references the Expanded Guidance for
Subprime Lending Programs (the "Expanded Guidance"), issued by the Agencies by
press release dated January 31, 2001.
In the Expanded Guidance, the Agencies indicated that subprime lending
does not refer to individual subprime loans originated and managed, in the ordinary course
of business, as exceptions to prime risk selection standards. The Agencies recognize that
many Prime loan portfolios will contain such accounts. The Agencies also excluded Prime
loans that develop credit problems after origination and community development loans from
the subprime arena. According to the Expanded Guidance, subprime loans are other loans to
borrowers that display one or more characteristics of reduced payment capacity. Five
specific criteria, which are not intended to be exhaustive and are not meant to define
specific parameters for all subprime borrowers and may not match all markets or
institutions specific subprime definitions, are set forth, including having a FICO
(credit) score of 660 or lower. Based on the definitions and exclusions described above,
Bank management considers the Bank as a Prime lender. Within the Banks residential
mortgage loan portfolio there are loans that, at the time of origination, had FICO scores
of 660 or below. However, as a portfolio lender, the Bank reviews all credit underwriting
data including all data included in borrower credit reports and does not base its
underwriting decisions solely on FICO scores. Bank management believes the aforementioned
loans, when made, were amply collateralized and documented, and otherwise conformed to the
Banks lending standards.
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 consulting firm, 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 2007 and this continued to be the case during
the nine months ended September 30, 2008. The following table sets forth the details of
non-performing loans as of the dates indicated:
TOTAL NON-PERFORMING LOANS
|
September 30,
|
December 31,
|
|
2008
|
2007
|
Loans accounted for on a non-accrual basis:
|
|
|
Real Estate:
|
|
|
Construction
|
$ 210
|
$ ---
|
Residential mortgage
|
821
|
450
|
Commercial and industrial, and agricultural
|
2,049
|
1,598
|
Consumer
|
19
|
5
|
Total non-accrual loans
|
3,099
|
2,053
|
Accruing loans contractually past due 90 days or
|
|
|
or more
|
240
|
9
|
Total non-performing loans
|
$3,339
|
$2,062
|
|
|
|
Allowance for loan losses to non-performing loans
|
156%
|
230%
|
Non-performing loans to total loans
|
0.53%
|
0.36%
|
Allowance to total loans
|
0.84%
|
0.82%
|
At September 30, 2008, total non-performing loans stood at $3,339, or
0.53% of total loans, compared with $2,062 or 0.36% of total loans at December 31, 2007.
As of September 30, 2008, total non-performing loans were up $1,277 compared with year-end
2007, but remained at relatively low levels. A large portion of the increase was
attributed to one commercial credit for $646 that became non-performing during the third
quarter.
The Bank attributes the stability of the loan portfolio to mature
credit administration processes and disciplined underwriting standards, aided by a
relatively stable local economy. The Bank maintains a centralized loan collection and
managed asset department, providing timely and effective collection efforts for problem
loans.
While the level of non-performing loans ratios continued to reflect the
overall favorable quality of the loan portfolio at September 30, 2008, Bank management is
cognizant of the continued softening of the real estate market and softening economic
conditions overall, and believes it is managing credit risk accordingly. Future levels of
non-performing loans may be influenced by economic conditions, including the impact of
those conditions on the Bank's customers, including debt service levels, declining
collateral values, historically high 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:
Real estate acquired in satisfaction
of a loan is reported in other assets. Properties acquired by foreclosure or deed in lieu
of foreclosure are transferred to other real estate owned ("OREO") and recorded
at the lower of cost or fair market value less estimated costs to sell based on appraised
value at the date actually or constructively received. Loan losses arising from the
acquisition of such property are charged against the allowance for loan losses. Subsequent
reductions in fair value below the carrying value are charged to other operating expenses.
At September 30, 2008 total OREO amounted to $83, compared with $340 at
December 31, 2007. One residential mortgage loan property comprised the September 30, 2008
balance of OREO.
Allowance for Loan Losses
:
At September 30, 2008 the allowance
for loan losses (the "allowance") stood at $5,220, representing an increase of
$477, or 10.1%, compared with December 31, 2007. At September 30, 2008, the allowance
expressed as a percentage of total loans stood at 84 basis points, up from 82 basis points
at December 31, 2007.
The allowance is available to absorb probable losses on loans. The
determination of the adequacy of the allowance and provisioning for estimated losses is
evaluated quarterly based on review of loans, with particular emphasis on non-performing
and other loans that management believes warrant special consideration.
The allowance is maintained at a level that, in managements
judgment, is appropriate for the amount of risk inherent in the current loan portfolio,
and adequate to provide for estimated, probable losses. Allowances are established for
specific impaired loans, a pool of reserves based on historical net loan charge-offs by
loan types, and supplemental reserves that adjust historical net loss experience to
reflect current economic conditions, industry specific risks, and other qualitative and
environmental considerations impacting the inherent risk of loss in the current loan
portfolio.
Specific allowances for impaired loans are determined in accordance
with SFAS No. 114 "Accounting by Creditors For Impairment of a Loan," as amended
by SFAS 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and
Disclosures." The amount of loans considered to be impaired totaled $2,049 as of
September 30, 2008, compared with $1,598 as of December 31, 2007. The related allowance
for loan losses on these impaired loans amounted to $201 as of September 30, 2008,
compared with $280 as of December 31, 2007.
Management recognizes that early and accurate recognition of risk is
the best means to reduce credit losses. The Bank employs a comprehensive risk management
structure to identify and manage the risk of loss. For consumer loans, the Bank identifies
loan delinquency beginning at 10-day delinquency and provides appropriate follow-up by
written correspondence or personal contact. Non-residential mortgage consumer loan losses
are recognized no later than the point at which a loan is 120 days past due. Residential
mortgage losses are recognized during the foreclosure process, or sooner, when that loss
is quantifiable and reasonably assured. For commercial loans, the Bank applies a risk
grading system, which stratifies the portfolio and allows management to focus appropriate
efforts on the highest risk components of the portfolio. The risk grades include ratings
that correlate with regulatory definitions of "Pass," "Other Assets
Especially Mentioned," "Substandard," "Doubtful," and
"Loss."
While management uses available information to recognize losses on
loans, changing economic conditions and the economic prospects of the borrowers may
necessitate future additions or reductions to the allowance. In addition, various
regulatory agencies, as an integral part of their examination process, periodically review
the 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 increased during nine months ended
September 30, 2008, with net loan charge-offs amounting to $1,192, or annualized net
charge-offs to average loans outstanding of 0.26%, compared with $142, or annualized net
charge-offs to average loans outstanding of 0.03%, during the first nine months of 2007.
Two problem loans accounted for $1,094, or 91.8%, of total net charge-offs during the nine
months ended September 30, 2008.
There were no material changes in loan concentrations during the nine
months ended September 30, 2008.
The following table details changes in the allowance and summarizes
loan loss experience by loan type for the nine-month periods ended September 30, 2008 and
2007.
ALLOWANCE FOR LOAN LOSSES
NINE MONTHS ENDED
SEPTEMBER 30, 2008 AND 2007
|
2008
|
|
2007
|
|
|
|
|
Balance
at beginning of period
|
$ 4,743
|
|
$ 4,525
|
Charge
offs:
|
|
|
|
Commercial, financial, agricultural, and
other loans to farmers
|
821
|
|
80
|
Real estate:
|
|
|
|
Mortgage
|
315
|
|
41
|
Installments and other loans to individuals
|
79
|
|
73
|
Total
charge-offs
|
1,215
|
|
194
|
|
|
|
|
Recoveries:
|
|
|
|
Commercial, financial, agricultural, and
other loans to farmers
|
1
|
|
24
|
Real estate:
|
|
|
|
Mortgage
|
3
|
|
---
|
Installments and other loans to individuals
|
19
|
|
28
|
Total
recoveries
|
23
|
|
52
|
|
|
|
|
Net
charge-offs
|
1,192
|
|
142
|
Provision
charged to operations
|
1,669
|
|
247
|
|
|
|
|
Balance
at end of period
|
$ 5,220
|
|
$ 4,630
|
|
|
|
|
Average
loans outstanding during period
|
$605,505
|
|
$554,522
|
|
|
|
|
Annualized
net charge-offs to average loans outstanding
|
0.26%
|
|
0.03%
|
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, 2008, is appropriate for the risks inherent in the loan portfolio.
Deposits
During the nine months ended September 30, 2008, 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, 2008, total deposits amounted to $578,163, compared
with $539,116 at December 31, 2007, representing an increase $39,047, or 7.2%. Retail
deposits led the overall growth in total deposits, posting an increase of $64,670, or
14.9%, compared with December 31, 2007. The increase in retail deposits was largely offset
by a decrease in deposits obtained from the national market ("brokered
deposits"), which posted a decline of $25,623, or 24.7%, compared with December 31,
2007.
Retail deposit growth was principally attributed to time deposits and
NOW accounts, which posted increases of $61,827 and $4,834, or 44.1% and 7.2%, compared
with December 31, 2007, respectively. The increase in retail time deposits was largely
attributed to the successful gathering of out of market certificates of deposit, all of
which were within the FDIC insurance limitations. The increase in retail time deposits was
also attributed to approximately $10,000 received from the State of Maine and
approximately $8,000 received from clients of Trust Services.
At September 30, 2007 total demand deposits stood at $62,568,
representing a decline of $2,593 or 4.0%, compared with December 31, 2007. As discussed
above, the Banks demand deposits are highly seasonal in nature and the timing and extent
of seasonal swings vary from year to year. For the nine months ended September 30, 2008,
average demand deposits amounted to $54,238, compared with $53,761 during the same period
in 2007, representing an increase of $477, or 0.9%
As discussed above, total deposits included brokered time deposits. At
September 30, 2008, total brokered deposits amounted to $78,069 or 13.5% of total
deposits, compared with $103,692 or 19.2% of total deposits at December 31, 2007. The
decline in brokered deposits was principally attributed to strong retail deposit growth.
In addition, over the past nine months prevailing market conditions have kept the cost of
brokered deposits at historically wide spreads compared with other wholesale sources of
funding, prompting management to re-balance a portion of the Banks wholesale funding
base.
Bank management believes it has exercised restraint with respect to
overly aggressive deposit pricing strategies, and has sought to achieve an appropriate
balance between retail deposit growth and wholesale funding levels, while considering the
associated impacts on the Banks net interest margin and liquidity position. In
offering retail time deposits, the Bank generally prices these deposits on a relationship
basis. At September 30, 2008, the weighted average cost of retail time deposits was 3.52%
compared with 4.15% at December 31, 2007. At September 30, 2008 the weighted average cost
of brokered time deposits was 4.09%, compared with 5.01% at December 31, 2007. Given the
current interest rate environment and continuing time deposit maturities, management
anticipates that the weighted average cost of time deposits will continue to show declines
for the balance of 2008.
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 secured by stock in the FHLB,
investment 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 investment securities portfolio and, to a lesser
extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet
interest rate risk, given the Banks ability to select desired amounts, terms and
maturities on a daily basis.
At September 30, 2008, total borrowings amounted to $295,572, compared
with $278,853 at December 31, 2007, representing an increase of $16,719, or 6.0%, compared
with December 31, 2007. The increase in total borrowings was principally used to reduce
the Banks reliance on higher cost and more volatile brokered time deposits.
Comparing September 30, 2008 with December 31, 2007, short-term
borrowings declined $51,345 or 34.6%, while long-term borrowings increased $63,064, or
48.2%. During the nine months ended September 30, 2008, the Bank extended the maturities
on a portion of its FHLB borrowings. These actions were taken during periods of favorable
market interest rates, and were consistent with the Banks strategy of lessening its
exposure to rising interest rates over a five year horizon.
In the second quarter of 2008, the Companys wholly owned
subsidiary, Bar Harbor Bank & Trust (the "Bank"), issued $5,000 aggregate
principal amount of subordinated debt securities. This action was taken to bolster the
Banks Tier 2 capital level and help support future earning asset growth without
jeopardizing the Banks historically strong capital position. The subordinated debt
securities are due in 2023, but are callable by the Bank after five years without penalty.
The rate of interest on these securities is three month Libor plus 345 basis points. The
subordinated debt securities are classified as borrowings on the Companys
consolidated balance sheet.
At September 30, 2008, total borrowings expressed as a percent of total
assets amounted to 31.4 %, unchanged compared with December 31, 2007.
Capital Resources
Consistent with its long-term goal of operating a sound and profitable
organization, during the third quarter of 2008 the Company maintained its strong capital
position and continued to be a ""well-capitalized"" financial
institution according to applicable regulatory standards. Management believes this to be
vital in promoting depositor and investor confidence and providing a solid foundation for
future growth.
Capital Ratios:
The Company and the Bank are subject to the
risk based capital guidelines administered by the 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, 2008, the Company and the Bank were considered
"well-capitalized" under the regulatory guidelines. 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 and the Banks
regulatory capital at September 30, 2008 and December 31, 2007, under the rules applicable
at that date.
|
|
For capital
adequacy purposes
|
To be well
capitalized under
prompt corrective
action provisions
|
|
Actual
|
Required
|
Required
|
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|
|
|
|
|
|
|
As of September 30, 2008
|
|
|
|
|
|
|
Total Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
Consolidated
|
$73,366
|
11.74%
|
$50,004
|
8.0%
|
N/A
|
|
Bank
|
$73,526
|
11.78%
|
$49,928
|
8.0%
|
$62,410
|
10.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
Consolidated
|
$63,146
|
10.10%
|
$25,002
|
4.0%
|
N/A
|
|
Bank
|
$65,813
|
10.55%
|
$24,964
|
4.0%
|
$37,446
|
6.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Average Assets)
|
|
|
|
|
|
|
Consolidated
|
$63,146
|
6.76%
|
$37,380
|
4.0%
|
N/A
|
|
Bank
|
$65,813
|
7.05%
|
$37,345
|
4.0%
|
$46,682
|
5.0%
|
|
|
For capital
adequacy purposes
|
To be well
capitalized under
prompt corrective
action provisions
|
|
Actual
|
Required
|
Required
|
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|
|
|
|
|
|
|
As of
December 31, 2007
|
|
|
|
|
|
|
Total Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
Consolidated
|
$
66,307
|
11.
59%
|
$
45,774
|
8.0%
|
N/A
|
|
Bank
|
$
66,495
|
11.
64%
|
$
45,706
|
8.0%
|
$
57,132
|
10.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
C
onsolidated
|
$
61,564
|
10.
76%
|
$
22,887
|
4.0%
|
N/A
|
|
Bank
|
$
64,259
|
11.25%
|
$
22,853
|
4.0%
|
$
34,279
|
6.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Average Assets)
|
|
|
|
|
|
|
Consolidated
|
$
61,564
|
7.10%
|
$
34,674
|
4.0%
|
N/A
|
|
Bank
|
$64,
259
|
7.
44%
|
$
34,541
|
4.0%
|
$
43,177
|
5.0%
|
Cash Dividends:
The Company's principal source of funds to pay
cash dividends and support its commitments is derived from Bank operations. The Company
paid dividends in the aggregate amount of $2,250 and $2,161 during the nine months ended
September 30, 2008 and 2007, at a rate of $0.76 and $0.71 per share, respectively.
The Company paid cash dividends of 26.0 cents per share of common stock
in the third quarter of 2008, representing an increase of 2.0 cents, or 8.3%, compared
with the same quarter in 2007. The Companys Board of Directors recently declared a
fourth quarter dividend of 26.0 cents per share, unchanged from the prior quarter, but
representing an increase of 1.5 cents, or 6.1%, compared with the dividend declared for
the same quarter in 2007.
Stock Repurchase Plan:
In August 2008, the Companys Board of Directors approved a
program to repurchase of up to 300,000 shares of the Companys common stock, or
approximately 10.2% of the shares currently outstanding. The new stock repurchase program
became effective as of August 21, 2008 and will continue for a period of up to twenty-four
consecutive months. Depending on market conditions and other factors, these purchases may
be commenced or suspended at any time, or from time to time, without prior notice and may
be made in the open market or through privately negotiated transactions. As of September
30, 2008, the Company had repurchased 18,745 shares of stock under this plan, at a total
cost of $548 and an average price of $29.26 per share. The Company recorded the
repurchased shares as treasury stock.
The new stock repurchase program replaced the Companys stock
repurchase program that had been in place since February 2004, which had authorized the
repurchase of up to 310,000 or approximately 10% of the Companys outstanding shares
of common stock. As of August 19, 2008, the date this program was terminated, the Company
had repurchased 288,799 shares at a total cost of $8,441,454 and an average price of
$29.23 per share.
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.
Recent Market Developments
The financial services industry as a whole is facing unprecedented
challenges in the face of the current national and global economic crisis. The global and
U.S. economies are experiencing significantly reduced business activity as a result of,
among other factors, disruptions in the financial system during the past year. Dramatic
declines in the nationwide housing market during the past year, with falling home prices
and increasing foreclosures and unemployment, have resulted in significant write-downs of
asset values by many financial institutions, including government-sponsored entities and
major commercial and investment banks. These write-downs, initially of mortgage-backed
securities but spreading to credit default swaps and other derivative securities, have
caused many financial institutions to seek additional capital; to merge with larger and
stronger institutions; and, in some cases, to fail. The Company is fortunate that the
markets it serves have been impacted to a lesser extent than many other areas around the
Country.
In response to the financial crises affecting the banking system and
financial markets, there have been several recent announcements of Federal programs
designed to purchase assets from, provide equity capital to, and guarantee the liquidity
of the industry.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008
(the "EESA") was signed into law. The EESA authorizes the U.S. Treasury to,
among other things, purchase up to $700 billion of mortgages, mortgage-backed securities,
and certain other financial instruments from financial institutions for the purpose of
stabilizing and providing liquidity to the U.S. financial markets. The Company did not
originate or invest in sub-prime assets and, therefore, does not expect to participate in
the sale of any of our assets into these programs. The EESA also immediately increased the
FDIC deposit insurance limit from $100,000 to $250,000 through December 31, 2009.
On October 14, 2008, the U.S. Treasury announced that it will purchase
equity stakes in a wide variety of banks and thrifts. Under this program, known as the
Troubled Asset Relief Program Capital Purchase Program (the "TARP Capital Purchase
Program"), the U.S. Treasury will make $250 billion of capital available (from the
$700 billion authorized by the EESA) to U.S. financial institutions in the form of
preferred stock. In conjunction with the purchase of preferred stock, the U.S. Treasury
will receive warrants to purchase common stock with an aggregate market price equal to 15%
of the preferred investment. Participating financial institutions will be required to
adopt the U.S. Treasurys standards for executive compensation and corporate
governance for the period during which the Treasury holds equity issued under the TARP
Capital Purchase Program. The U.S. Treasury initially announced that nine large financial
institutions agreed to participate in the TARP Capital Purchase Program and other
financial institutions have since agreed to participate. The Company is currently well
capitalized, and continues to lend in its markets. To date, the Company has not made an
application for the additional equity capital and will continue to review clarifications
of these plans, or others if announced, to determine if the Company should participate in
these programs.
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, 2008. 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
|
|
|
|
|
|
|
Borrowings
from Federal Home
Loan Bank
|
$271,731
|
$78,060
|
$83,700
|
$78,971
|
$31,000
|
Securities
sold under agreements
to repurchase
|
18,841
|
18,841
|
---
|
---
|
---
|
Junior
Subordinated Debenture
|
5,000
|
---
|
---
|
---
|
5,000
|
Operating
Leases
|
222
|
94
|
128
|
---
|
---
|
Total
|
$295,794
|
$96,995
|
$83,828
|
$78,971
|
$36,000
|
All FHLB advances are fixed-rate instruments. Advances are payable at
their call dates or final maturity dates. Advances are stated in the above table at their
contractual final maturity dates. At September 30, 2008, the Bank had $88,000 in callable
advances.
In the normal course of its banking and financial services business,
and in connection with providing products and services to its customers, the Company has
entered into a variety of traditional third party contracts for support services. Examples
of such contractual agreements would include services providing 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.
Standby Letters of Credit:
The Bank guarantees the obligations
or performance of certain customers by issuing standby letters of credit to third parties.
These letters of credit are sometimes issued in support of third party debt. The risk
involved in issuing standby letters of credit is essentially the same as the credit risk
involved in extending loan facilities to customers, and they are subject to the same
origination, portfolio maintenance and management procedures in effect to monitor other
credit products. The amount of collateral obtained, if deemed necessary by the Bank upon
issuance of a standby letter of credit, is based upon management's credit evaluation of
the customer.
At September 30, 2008, commitments under existing standby letters of
credit totaled $462, compared with $506 at December 31, 2007. The fair value of the
standby letters of credit was not significant as of the foregoing dates.
Off-Balance Sheet Risk
The Bank is party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financial needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial instruments
include commitments to extend credit and 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:
|
September 30,
|
|
December 31,
|
(Dollars in thousands)
|
2008
|
|
2007
|
|
|
|
|
Commitments
to originate loans
|
$ 22,168
|
|
$ 15,075
|
Unused
lines of credit
|
81,853
|
|
85,530
|
Unadvanced
portions of construction loans
|
10,758
|
|
19,752
|
Total
|
$114,779
|
|
$120,357
|
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
repricing 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, 2008, 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, 2008 are summarized below. Also refer to Note 7 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
|
Fixed Interest
Rate
|
Variable
Interest Rate
at 9/30/08
|
Fair Value
at 9/30/08
|
|
|
|
|
|
|
Receive fixed rate, pay variable rate
|
01/24/09
|
$10,000
|
6.25%
|
Prime (5.00%)
|
$37
|
The interest rate swap agreement was 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."
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, 2008, based upon the then
current Prime interest rate of 5.00%.
|
Payments Due by Period
|
|
|
|
|
Total
|
Less Than 1 Year
|
|
|
|
Fixed payments due from counter-party
|
$199
|
$199
|
Variable payments due to counter-party based on Prime rate
|
159
|
159
|
Net cash flow
|
$ 40
|
$ 40
|
INTEREST RATE FLOOR AGREEMENTS
Notional Amount
|
Termination
Date
|
Prime Strike Rate
|
Premium Paid
|
Unamortized Premium at 9/30/08
|
Fair Value at 9/30/08
|
Cumulative Cash Flows Received
|
|
|
|
|
|
|
|
$20,000
|
08/01/10
|
6.00%
|
$186
|
$105
|
$353
|
$104
|
$10,000
|
11/01/10
|
6.50%
|
$ 69
|
$ 44
|
$297
|
$ 85
|
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 a liquidity position of at least 5.0% of total assets.
At September 30, 2008, liquidity, as measured by the basic surplus/deficit model, was 7.9%
over the 30-day horizon and 7.7% over the 90-day horizon.
At September 30, 2008, the Bank had unused lines of credit and net
unencumbered qualifying collateral availability to support its credit line with the FHLB
approximating $50 million. The Bank also had capacity to borrow funds on a secured basis
utilizing certain un-pledged securities in its investment 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. The Company believes that the level of liquidity is sufficient to meet current
and future funding requirements. However, changes in economic conditions, including
consumer savings habits and availability or access to the brokered deposit market could
potentially have a significant impact on the 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 repricing 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 repricing dates for variable products, contractual maturities for fixed rate
products, and product specific assumptions for deposit accounts, such as money market
accounts, that are subject to repricing based on current market conditions. Repricing
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 repricing volumes consistent with this flat rate assumption.
-
A 200 basis point rise or decline in interest rates applied against a parallel shift in
the yield curve over a twelve-month period together with a dynamic balance sheet
anticipated to be consistent with such interest rate changes.
-
Various non-parallel shifts in the yield curve, including changes in either short-term
or long-term rates over a twelve-month horizon, together with a dynamic balance sheet
anticipated to be consistent with such interest rate changes.
-
An extension of the foregoing simulations to each of two, three, four and five year
horizons to determine the interest rate risk with the level of interest rates stabilizing
in years two through five. Even though rates remain stable during this two to five year
time period, repricing 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, 2008, over one and two-year horizons and under
different interest rate scenarios. In light of the Federal Funds rate of 1.00% and the
two-year Treasury of 1.96% on the date presented, the analysis incorporates a declining
interest rate scenario of 100 basis points, rather than the 200 basis points, as would
normally be the case. The table also summarizes net interest income sensitivity under a
non-parallel shift in the yield curve, whereby short-term interest rates decline 100 basis
points.
INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
SEPTEMBER
|
-100 Basis Points Parallel Yield Curve Shift
|
+200 Basis Points Parallel Yield Curve Shift
|
-100 Basis Points Short-term Rates
|
Year 1
|
|
|
|
Net interest income change ($)
|
$ 137
|
$ (891)
|
$ 541
|
Net interest income change (%)
|
0.45%
|
-2.92%
|
1.77%
|
|
|
|
|
Year 2
|
|
|
|
Net interest income change ($)
|
$ 575
|
$ 460
|
$ 2,716
|
Net interest income change (%)
|
1.89%
|
1.51%
|
8.91%
|
During the first nine months of 2008, the interest rate risk profile of
the Banks balance sheet became less liability sensitive than exhibited over the past
few years. This was principally attributed to the extension of FHLB borrowings into
longer-term maturities out to five years, as well as adding longer-term certificates of
deposit to the Banks balance sheet. These actions were taken to protect the
Banks net interest margin and net interest income in a rising rate environment, at
times when borrowing costs were at cyclical lows.
As more fully discussed below, the September 30, 2008 interest rate
sensitivity modeling results indicate that the Banks balance sheet is about evenly
matched over the one-year horizon and is favorably positioned for increases or declines in
short-term and or long-term interest rates over the two-year horizon. While changes to net
interest income are favorable in both an increasing and declining rate environment, these
changes are less positive than the base case scenario (i.e., interest rates unchanged),
particularly in year two of the simulation.
Assuming interest rates remain at or near 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 and beyond. The upward trend principally results from funding
costs rolling over at current lower interest rates while earning asset yields remaining
relatively stable.
Assuming short-term and long-term interest rates decline 100 basis
points from current levels (i.e., a parallel yield curve shift) and the Banks
balance sheet structure and size remain at current levels, management believes net
interest income will increase slightly over the one year horizon, and will show a moderate
increase over the two year horizon. The simulation model suggests that in a falling rate
environment net interest income will initial trend in line with the base case scenario, as
reductions in funding costs essentially offset lower earning asset yields. Over the two
year horizon, the interest rate sensitivity simulation model suggests the net interest
margin will be pressured by accelerated cash flows on earning assets and the repricing of
the Banks earning asset base. However, despite these factors, the model indicates
that net interest income will continue its upward trend over the two year horizon as
funding costs continue a downward trend. Should the yield curve steepen as rates fall, the
model suggests that accelerated earning asset prepayments will slow, resulting in a
stronger improvement in net interest income. Management anticipates that continued earning
asset growth will be needed to meaningfully increase the Banks current level of net
interest income should both long-term and short-term interest rates decline in parallel.
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 a moderate decline over the twelve month
horizon, then begin a steady recovery over the two year horizon and beyond. 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
moderate decline in net interest income. As funding costs begin to stabilize early in the
second year of the simulation, the earning asset portfolios will 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 over the two year horizon and beyond. Management
believes strong earning asset growth will be necessary to meaningfully increase the
current level of net interest income over the one year horizon should short-term and
long-term interest rates rise in parallel. Over the two year horizon and beyond,
management believes moderate earning asset growth will be necessary to meaningfully
increase the current level of net interest income.
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. Given the overall state of the
economy and the historic trauma in the financial markets at September 30, 2008, management
modeled an alternative future interest rate scenario 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 100 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
moderately improve over the twelve-month horizon and significantly strengthen over the
twenty-four month horizon and beyond. The model indicates that funding costs will show
significant declines while earning asset yields will only decline moderately. In year one
of this scenario management believes that earning asset growth will be required to
meaningfully increase net interest income. Over the two year horizon and beyond,
management believes net interest income will show meaningfully increases without the
benefit of earning asset growth.
The preceding sensitivity analysis does not represent a Company
forecast and should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the nature and
timing of interest rate levels and yield curve shape, prepayment speeds on loans and
securities, deposit rates, pricing decisions on loans and deposits, reinvestment or
replacement of asset and liability cash flows, and renegotiated loan terms with borrowers.
While assumptions are developed based upon current economic and local market conditions,
the Company cannot make any assurances as to the predictive nature of these assumptions
including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity
analysis, actual results may also differ due to: prepayment and refinancing levels
deviating from those assumed; the impact of interest rate change caps or floors on
adjustable rate assets; the potential effect of changing debt service levels on customers
with adjustable rate loans; depositor early withdrawals and product preference changes;
and other such variables. The sensitivity analysis also does not reflect additional
actions that the 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
The following Risk Factors should be read in conjunction with, and
supplements and amends, those factors that may affect the Company's business or operations
described under the heading "Risk Factors" previously disclosed in Part I, Item
1A of the Companys Annual Report on Form 10-K for the year ended December 31, 2007.
There can be no assurance that recent actions by governmental agencies
and regulators, as well as recently enacted legislation authorizing the U.S. government to
invest in, and purchase large amounts of illiquid assets from, financial institutions will
help stabilize the U.S. financial system.
In recent periods, various Federal agencies and bank regulators have
taken steps to stabilize and stimulate the financial services industry. Changes also have
been made in tax policy for financial institutions. In addition, on October 3, 2008,
President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the
"EESA"). The legislation reflects an initial legislative response to the
financial crises affecting the banking system and financial markets and going concern
threats to financial institutions. Pursuant to the EESA, the U.S. Treasury will have the
authority to, among other things, purchase up to $700 billion of mortgages,
mortgage-backed securities and certain other financial instruments from financial
institutions for the purpose of stabilizing and providing liquidity to the U.S. financial
markets. As an initial program, the U.S. Treasury is exercising its authority to purchase
an aggregate of $250 billion of capital instruments from financial entities throughout the
United States. There can be no assurance, however, as to the actual impact that the EESA
will have on the financial markets, including the extreme levels of volatility and limited
credit availability currently being experienced. The failure of the EESA to help stabilize
the financial markets and a continuation or worsening of current financial market
conditions could materially and adversely affect our business, financial condition,
results of operations, access to credit or the trading price of our common stock.
Difficult market conditions have adversely affected our industry.
Dramatic declines in the national housing market over the past year,
with falling home prices and increasing foreclosures, unemployment and under-employment,
have negatively impacted the credit performance of mortgage loans and resulted in
significant write-downs of asset values by financial institutions, including
government-sponsored entities as well as major commercial and investment banks. These
write-downs, initially of mortgage-backed securities but spreading to credit default swaps
and other derivative and cash securities, in turn, have caused many financial institutions
to seek additional capital, to merge with larger and stronger institutions and, in some
cases, to fail. Reflecting concern about the stability of the financial markets generally
and the strength of counterparties, many lenders and institutional investors have reduced
or ceased providing funding to borrowers, including to other financial institutions. This
market turmoil and tightening of credit have led to an increased level of commercial and
consumer delinquencies, lack of consumer confidence, increased market volatility and
widespread reduction of business activity generally. The resulting economic pressure on
consumers and lack of confidence in the financial markets could adversely affect our
business, financial condition and results of operations. In particular, the Company may
face the following risks in connection with these events:
-
The Company expects to face increased regulation of our industry. Compliance with such
regulation may increase our costs and limit our ability to pursue business opportunities.
-
Market developments may affect customer confidence levels and may cause increases in
delinquencies and default rates, which the Company expects could impact our charge-offs
and provision for loan losses.
-
Our ability to borrow from other financial institutions or to access the debt or equity
capital markets on favorable terms or at all could be adversely affected by further
disruptions in the capital markets or other events, including actions by rating agencies
and deteriorating investor expectations.
-
Competition in our industry could intensify as a result of the increasing consolidation
of financial services companies in connection with current market conditions.
-
We may be required to pay significantly higher Federal Deposit Insurance Corporation
premiums because market developments have significantly depleted the insurance fund of the
FDIC and reduced the ratio of reserves to insured deposits.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and
disruption for more than 12 consecutive months. In the third quarter of 2008, the
volatility and disruption reached unprecedented levels. In some cases, the markets have
produced downward pressure on stock prices and credit availability for certain issuers
without regard to those issuers underlying financial strength. If current levels of
market disruption and volatility continue or worsen, there can be no assurance that the
Company will not experience an adverse effect, which may be material, on our ability to
access capital and on our business, financial condition and results of operations.
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.
|
(a)
|
(b)
|
(c )
|
(d)
|
Period
|
Total Number
of Shares Purchased
|
Average
Price Paid
per Share
|
Total Number of Shares Purchased
as Part of
Publicly
Announced Plans
or Programs
|
Maximum
Number of
Shares that May
Yet Be Purchased
Under the Plans
or Programs
|
|
|
|
|
|
2004 Share Repurchase Plan
|
|
|
|
|
July
1-31, 2008
|
8,932
|
$26.45
|
8,932
|
23,022
|
August
1-19, 2008
|
1,821
|
$29.32
|
1,821
|
21,201
|
|
|
|
|
|
|
|
|
|
|
2008 Share Repurchase Plan
|
|
|
|
|
August
21-31, 2008
|
930
|
$29.04
|
930
|
299,070
|
September
1-30, 2008
|
17,815
|
$29.27
|
17,815
|
281,255
|
In August 2008, the Companys Board of Directors approved a
program to repurchase of up to 300,000 shares of the Companys common stock, or
approximately 10.2% of the shares currently outstanding. The new stock repurchase program
became effective as of August 21, 2008 and will continue for a period of up to twenty-four
consecutive months. Depending on market conditions and other factors, these purchases may
be commenced or suspended at any time, or from time to time, without prior notice and may
be made in the open market or through privately negotiated transactions.
The new stock repurchase program replaced the Companys stock
repurchase program that had been in place since February 2004, which had authorized the
repurchase of up to 310,000 or approximately 10% of the Companys outstanding shares
of common stock. As of August 19, 2008, the date this program was terminated, the Company
had repurchased 288,799 shares.
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 15 (a)(3.2) filed with
the Commission March 17, 2008.
|
|
|
|
|
10.1
|
Merchant
Portfolio Purchase Agreement with TransFirst, LLC and Columbus Bank and Trust Company,
dated
September 30, 2008
|
|
Filed
herewith
|
|
|
|
|
10.2
|
Schedule 1 to
Merchant Portfolio Purchase Agreement
|
|
Filed herewith
|
|
|
|
|
10.3
|
Referral
and Sales Agreement with TransFirst dated September 30, 2008
|
|
Filed
herewith
|
|
|
|
|
11.1
|
Statement
re computation of per share earnings
|
|
Data
required by SFAS No. 128, Earnings Per Share, is provided in Note 3 to the consolidated
financial statements in this report on Form 10-Q.
|
|
|
|
|
31.1
|
Certification
of the Chief Executive Officer under
Rule 13a-14(a)/15d-14(a)
|
|
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)
|
|
|
|
/s/Joseph
M. Murphy
|
|
|
Date:
November 10, 2008
|
Joseph
M. Murphy
|
|
President
& Chief Executive Officer
|
|
|
|
/s/Gerald
Shencavitz
|
|
|
Date:
November 10, 2008
|
Gerald
Shencavitz
|
|
Executive
Vice President & Chief Financial Officer
|
Bar Harbor Bankshares (AMEX:BHB)
Historical Stock Chart
Von Jun 2024 bis Jul 2024
Bar Harbor Bankshares (AMEX:BHB)
Historical Stock Chart
Von Jul 2023 bis Jul 2024