27
Loan concentrations:
Because of the Companys proximity to Acadia National Park, a large part of the economic activity in the Banks area is generated from the hospitality business associated with tourism. At September 30, 2013, and December 31, 2012, loans to the lodging industry amounted to approximately $109,552 and $105,699, respectively.
28
Note 7: Reclassifications Out of Accumulated Other Comprehensive Income
The following table summarizes the reclassifications out of Accumulated Other Comprehensive Income for the nine months ended September 30, 2013.
|
|
|
|
Details about Accumulated
Other Comprehensive Income
|
Amount Reclassified from Accumulated
Other Comprehensive Income
|
|
Affected Line Item in the Statement Where Net Income is Presented
|
|
|
|
|
Unrealized gains and losses on available-for-sale securities
|
|
|
|
|
$ 659
|
|
Net gain on sales of investments
|
|
(224)
|
|
Provision for income taxes
|
|
$ 435
|
|
Net income
|
|
|
|
|
Amortization of post retirement benefit plan
|
|
|
|
Net amortization prior service costs and actuarial gain/loss
for supplemental executive retirement plan
|
$(165)
|
|
Salaries and benefits
|
Amortization of actuarial gain/loss for supplemental
executive retirement plan
|
43
|
|
Salaries and benefits
|
|
(122)
|
|
|
Tax (expense) or benefit
|
(41)
|
|
Provision for income taxes
|
Net of tax
|
$ (81)
|
|
Net income
|
|
|
|
|
Total reclassification for the period
|
$ 354
|
|
Net income, net of tax
|
Note 8: Retirement Benefit Plans
The Company has non-qualified supplemental executive retirement agreements with certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations.
The Company also has a supplemental executive retirement agreement with a certain current executive officer. This agreement provides a stream of future payments in accordance with a defined vesting schedule 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, 2013, and 2012:
|
|
|
|
Supplemental Executive
Retirement Plans
|
|
|
|
Three Months Ended September 30,
|
2013
|
2012
|
|
|
|
Service cost
|
$ 14
|
$ 84
|
Interest cost
|
30
|
63
|
Net amortization of prior service cost and actuarial (gain)/loss
|
---
|
(101)
|
Actuarial loss on supplemental executive retirement plan, net of tax
|
13
|
222
|
Net periodic benefit cost
|
$ 57
|
$268
|
|
|
|
|
Supplemental Executive
Retirement Plans
|
|
|
|
Nine Months Ended September 30,
|
2013
|
2012
|
|
|
|
Service cost
|
$ 196
|
$130
|
Interest cost
|
90
|
98
|
Net amortization of prior service cost and actuarial (gain)/loss
|
(165)
|
(99)
|
Actuarial loss on supplemental executive retirement plan, net of tax
|
43
|
222
|
Net periodic benefit cost
|
$ 164
|
$351
|
The Company is expected to recognize $224 of expense for the foregoing plans for the year ended December 31, 2013. The Company is expected to contribute $206 to the foregoing plans in 2013. As of September 30, 2013, the Company had contributed
$155.
Note 9: Commitments and Contingent Liabilities
The Companys wholly owned subsidiary, Bar Harbor Bank & Trust (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.
29
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, 2013, and December 31, 2012:
|
|
|
|
|
September 30,
2013
|
|
December 31,
2012
|
|
|
|
|
Commitments to originate loans
|
$26,058
|
|
$ 20,843
|
Unused lines of credit
|
$95,946
|
|
$106,773
|
Un-advanced portions of construction loans
|
$16,818
|
|
$ 22,047
|
Standby letters of credit
|
$ 378
|
|
$ 307
|
As of September 30, 2013, and December 31, 2012, the fair value of the standby letters of credit was not significant to the Companys consolidated financial statements.
Note 10: Goodwill and Other Intangible Assets
Goodwill:
Goodwill totaled $4,935 at September 30, 2013, and December 31, 2012. In the third quarter of 2012 the Company recorded $1,777 of goodwill in connection with the Banks acquisition of substantially all of the assets and the assumption of certain liabilities including all deposits of the Border Trust Company.
Core Deposit Intangible Asset:
The Company has a finite-lived intangible asset capitalized on its consolidated balance sheet in the form of a core deposit intangible asset related to the Border Trust Company acquisition. The core deposit intangible is being amortized over an estimated useful life of eight and one-half years and is included in other assets on the Companys consolidated balance sheet. At September 30, 2013, and December 31, 2012, the balance of the core deposit intangible asset amounted to $678 and $747, respectively. Amortization of the core deposit intangible asset is expected to be $92 and $92 for 2013 and 2014, respectively.
Note 11: Fair Value Measurements
The Company measures 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.
30
The Companys fair value measurements employ 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 servicing capacity of an asset (replacement cost). Valuation techniques are 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. The Company uses 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.
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 fair values from other independent providers and 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.
Securities Available for Sale:
All securities and major categories of 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.
31
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 tables summarize financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2013, and December 31, 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
|
|
|
|
|
September 30, 2013
|
Level 1 Inputs
|
Level 2 Inputs
|
Level 3 Inputs
|
Total Fair Value
|
Securities available for sale:
|
|
|
|
|
Mortgage-backed securities:
|
|
|
|
|
US Government-sponsored enterprises
|
$ ---
|
$278,740
|
$ ---
|
$278,740
|
US Government agencies
|
$ ---
|
$ 86,810
|
$ ---
|
$ 86,810
|
Private label
|
$ ---
|
$ 6,702
|
$ ---
|
$ 6,702
|
Obligations of states and political subdivisions thereof
|
$ ---
|
$ 90,104
|
$ ---
|
$ 90,104
|
|
|
|
|
|
|
|
|
|
|
December 31, 2012
|
Level 1 Inputs
|
Level 2 Inputs
|
Level 3 Inputs
|
Total Fair Value
|
Securities available for sale:
|
|
|
|
|
Mortgage-backed securities:
|
|
|
|
|
US Government-sponsored enterprises
|
$ ---
|
$245,823
|
$ ---
|
$245,823
|
US Government agencies
|
$ ---
|
$ 84,261
|
$ ---
|
$ 84,261
|
Private label
|
$ ---
|
$ 8,113
|
$ ---
|
$ 8,113
|
Obligations of states and political subdivisions thereof
|
$ ---
|
$ 79,843
|
$ ---
|
$ 79,843
|
The following tables present the carrying value of certain financial assets and financial liabilities measured at fair value on a non-recurring basis, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.
|
|
|
|
|
|
For the Nine Months Ended 9/30/13
|
Level 1
Inputs
|
Level 2
Inputs
|
Level 3
Inputs
|
Fair Value
as of 9/30/13
|
Loss
|
|
|
|
|
|
|
Other real estate owned
|
$ ---
|
$ ---
|
$1,782
|
$1,782
|
$200
|
Collateral dependent impaired loans
|
$ ---
|
$ ---
|
$1,845
|
$1,845
|
$ ---
|
|
|
|
|
|
|
For the Year Ended 12/31/12
|
Level 1
Inputs
|
Level 2
Inputs
|
Level 3
Inputs
|
Fair Value
as of 12/31/12
|
Loss
|
|
|
|
|
|
|
Other real estate owned
|
$ ---
|
$ ---
|
$2,780
|
$2,780
|
$146
|
Collateral dependent impaired loans
|
$ ---
|
$ ---
|
$3,149
|
$3,149
|
$ ---
|
32
The Company had total collateral dependent impaired loans with carrying values of approximately $1,845 and $3,149 which had specific reserves included in the allowance of $20 and $120, at September 30, 2013 and December 31, 2012, respectively. The Company measures the value of collateral dependent impaired loans using Level 3 inputs. Specifically, the Company uses the appraised value of the collateral, which is then discounted for estimated costs to dispose and other considerations. These discounts generally range from 10% to 30% of appraised value.
In estimating the fair value of OREO, the Company generally uses market appraisals less estimated costs to dispose of the property, which generally range from 10% to 30% of appraised value. Management may also make adjustments to reflect estimated fair value declines, or may apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property or consideration of broker quotes. The appraisers use a market, income, and/or a cost approach in determining the value of the collateral. Therefore they have been categorized as a Level 3 measurement.
There were no transfers between levels during the periods presented.
Note 12: Fair Value of Financial Instruments
The Company discloses fair value information about financial instruments for which it is practicable to estimate fair value. Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and relevant market information. Where available, quoted market prices are used. In other cases, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties and are significantly affected by the assumptions used and judgments made regarding risk characteristics of various financial instruments, discount rates, estimates of future cash flows, future expected loss experience and other factors. Changes in assumptions could significantly affect these estimates. Derived fair value estimates cannot be substantiated by comparison to independent markets and, in certain cases, could not be realized in an immediate sale of the instrument.
Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Accordingly, the aggregate fair value amounts presented do not purport to represent the underlying market value of the Company.
33
The following describes the methods and significant assumptions used by the Company in estimating the fair values of significant financial instruments:
Cash and Cash Equivalents:
For cash and cash equivalents, including cash and due from banks and other short-term investments with maturities of 90 days or less, the carrying amounts reported on the consolidated balance sheet approximate fair values.
Federal Home Loan Bank stock:
For Federal Home Loan Bank stock, the carrying amounts report on the consolidated balance sheet approximate fair values.
Loans:
For variable rate loans that re-price frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of other loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposits
:
The fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is based on the discounted value of contractual cash flows, applying interest rates currently being offered on wholesale funding products of similar maturities. The fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of alternative forms of funding (deposit base intangibles).
Borrowings:
For borrowings that mature or re-price in 90 days or less, carrying value approximates fair value. The fair value of the Companys remaining borrowings is estimated by using discounted cash flows based on current rates available for similar types of borrowing arrangements taking into account any optionality.
Accrued Interest Receivable and Payable:
The carrying amounts of accrued interest receivable and payable approximate their fair values.
Off-Balance Sheet Financial Instruments:
The Companys off-balance sheet instruments consist of loan commitments and standby letters of credit. Fair values for standby letters of credit and loan commitments were insignificant.
A summary of the carrying values and estimated fair values of the Companys significant financial instruments at September 30, 2013, and December 31, 2012, follows:
|
|
|
|
|
|
|
Carrying Value
|
Level 1 Inputs
|
Level 2 Inputs
|
Level 3 Inputs
|
Total
Fair Value
|
September 30, 2013
|
|
|
|
|
|
|
|
|
|
|
|
Financial Assets:
|
|
|
|
|
|
Cash and cash equivalents
|
$ 11,806
|
$11,806
|
$ ---
|
$ ---
|
$ 11,806
|
Federal Home Loan Bank stock
|
18,331
|
---
|
18,331
|
---
|
18,331
|
Loans, net
|
837,553
|
---
|
---
|
848,428
|
848,428
|
Interest receivable
|
4,775
|
4,775
|
---
|
---
|
4,775
|
|
|
|
|
|
|
Financial liabilities:
|
|
|
|
|
|
Deposits (with no stated maturity)
|
$497,967
|
$ ---
|
$497,967
|
$ ---
|
$497,967
|
Time deposits
|
386,630
|
---
|
390,085
|
---
|
390,085
|
Borrowings
|
364,013
|
---
|
366,355
|
---
|
366,355
|
Interest payable
|
539
|
539
|
---
|
---
|
539
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying Value
|
Level 1 Inputs
|
Level 2 Inputs
|
Level 3 Inputs
|
Total Fair Value
|
December 31, 2012
|
|
|
|
|
|
|
|
|
|
|
|
Financial Assets:
|
|
|
|
|
|
Cash and cash equivalents
|
$ 14,992
|
$14,992
|
$ ---
|
$ ---
|
$ 14,992
|
Federal Home Loan Bank stock
|
18,189
|
---
|
18,189
|
---
|
18,189
|
Loans, net
|
806,907
|
---
|
---
|
822,675
|
822,675
|
Interest receivable
|
4,502
|
4,502
|
---
|
---
|
4,502
|
|
|
|
|
|
|
Financial liabilities:
|
|
|
|
|
|
Deposits (with no stated maturity)
|
$425,205
|
$ ---
|
$425,205
|
$ ---
|
$425,205
|
Time deposits
|
370,560
|
---
|
377,427
|
---
|
377,427
|
Borrowings
|
371,567
|
---
|
377,510
|
---
|
377,510
|
Interest payable
|
684
|
684
|
---
|
---
|
684
|
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, 2013, and 2012, and financial condition at September 30, 2013, and December 31, 2012, and where appropriate, factors that may affect future financial performance. The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this 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 interest income in the third quarter of 2013 and 2012 was $968 and $836, respectively, of tax-exempt interest income from certain investment securities and loans. For the nine months ended September 30, 2013 and 2012, the amount of tax-exempt income included in interest income was $2,637 and $2,364, respectively.
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 $476 and $407 in the third quarter of 2013 and 2012, respectively, and $1,294 and $1,151 for the nine months ended September 30, 2013 and 2012, 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
34
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 quarterly 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. Readers 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. Readers 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 Companys wholly-owned banking subsidiary, Bar Harbor Bank & Trust (the Bank), and thus the Companys results of operations may be adversely affected by increases or decreases in interest rates;
|
|
|
|
(iii)
|
|
The banking business is highly competitive and the profitability of the Company depends on the Bank's ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and non-traditional institutions, such as credit unions and finance companies;
|
|
|
|
(iv)
|
|
A significant portion of the Bank's loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other intangible factors which are considered in making commercial loans and, accordingly, the Company's profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions;
|
|
|
|
(v)
|
|
Adverse changes in repayment performance and fair value of underlying residential mortgage loan collateral, that differ from the Companys current estimates, could change the Companys expectations that it will recover the amortized cost of its private label mortgage backed securities portfolio and/or its conclusion that such securities were not other-than temporarily impaired as of the date of this report;
|
|
|
|
(vi)
|
|
The Companys allowance for loan losses may be adversely impacted by a variety of factors, including, but not limited to, the performance of the Companys loan portfolio, the economy, changes in interest rates, and the view of regulatory authorities toward loan classifications;
|
|
|
|
(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 that could impact the Company's securities portfolio, quality of credits, or the overall demand for the Company's products or services; and
|
|
|
|
(xi)
|
|
The Companys success in managing the risks involved in all of the foregoing matters.
|
Readers should carefully review all of these factors as well as the risk factors set forth in Item 1A- Risk Factors, contained in the Companys Annual Report on Form 10-K for the year ended December 31, 2012. There may be other risk factors that could cause differences in future periods from those anticipated by management.
The forward-looking statements contained herein represent the Company's judgment as of the date of this quarterly 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 quarterly report on Form 10-Q, except to the extent required by federal securities laws.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
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, 2012, 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.
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 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. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, other than temporary impairment on securities, income tax estimates, and the evaluation of intangible assets. The use of these estimates is more fully described in Part I, Item 1, Note 2 of the consolidated financial statements in this quarterly report on Form 10-Q.
36
SUMMARY FINANCIAL RESULTS
For the three months ended September 30, 2013, the Company reported net income of $3,533, compared with $3,368 in the third quarter of 2012, representing an increase of $165, or 4.9%. The Companys diluted earnings per share amounted to $0.89 for the quarter compared with $0.86 in the third quarter of 2012, representing an increase of $0.03, or 3.5%.
The Companys annualized return on average shareholders equity (ROE) amounted to 11.73% for the quarter, compared with 10.49% in the third quarter of 2012. The Companys third quarter return on average assets (ROA) amounted to 1.02%, compared with 1.05% in the third quarter of 2012.
For nine months ended September 30, 2013, the Companys net income amounted to $9,919, compared with $9,636 for the same period in 2012, representing an increase of $283, or 2.9%. Diluted earnings per share amounted to $2.51 for the nine months ended September 30, 2013, compared with $2.46 for the same period in 2012, representing an increase of $0.05, or 2.0%.
For the nine months ended September 30, 2013, the Companys ROE amounted to 10.57%, compared with 10.37% for the same period in 2012. The Companys ROA amounted to 0.99% for the nine months ended September 30, 2013, compared with 1.04% for the first nine months of 2012.
As more fully enumerated in the following management discussion and analysis, the Companys year-to-date operating results were highlighted by a meaningful increase in net interest income, continued improvements in credit quality, continued commercial and consumer loan growth and higher levels of fee income. While the Companys tax-equivalent net interest income was up $1,500 or 5.3% compared with the first nine months of 2012, the net interest margin posted a nine basis point decline as earning asset yields declined faster than the cost of interest bearing liabilities. The Company continued to focus on the management of its operating expenses, posting a year-to-date efficiency ratio of 55.7%.
As previously announced, on August 10, 2012, the Bank acquired substantially all assets and assumed certain liabilities including all deposits of Border Trust Company (Border Trust), a subsidiary of Border Bancshares, Inc., headquartered in Augusta, Maine. The Bank acquired $38,520 of deposits and $33,606 in loans, as well as three branch offices (two of which were leased) located in Kennebec and Sagadahoc Counties.
The Bank paid a deposit premium of 3.85%, or $1,115, and purchased the loan portfolio, excluding selected non-performing loans, at a discount of 2.16%, or $749. In connection with this transaction, the Bank recorded goodwill of $1,777 and a core deposit intangible of $783, or 2.7% of core deposits.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the principal component of the Company's income stream and represents the difference or spread between interest generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in market interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.
Total Net Interest Income:
For the three months ended September 30, 2013, net interest income on a tax equivalent basis amounted to $10,445, compared with $9,821 in the third quarter of 2012, representing an increase of $624, or 6.4%. The increase in third quarter 2013 tax-equivalent net interest income compared with the third quarter of 2012 was principally attributed to average earning asset growth of $106,406 or 8.7%, as the net interest margin declined eight basis points.
For the nine months ended September 30, 2013, net interest income on a tax-equivalent basis amounted to $30,035, compared with $28,535 for the same period in 2012, representing an increase of $1,500, or 5.3%. The increase in net interest income was principally attributed to average earning asset growth of $100,244, or 8.5%, as the tax-equivalent net interest margin declined nine basis points.
37
Factors contributing to the changes in net interest income and the net interest margin are more fully enumerated in the following discussion and analysis.
38
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, 2013, and 2012:
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
SEPTEMBER 30, 2013 AND 2012
(1)
For purposes of these computations, non-accrual loans are included in average loans.
(2)
For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3)
For purposes of these computations, interest income, net interest income and net interest margin are reported on a tax equivalent basi
39
s.
40
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
NINE MONTHS ENDED
SEPTEMBER 30, 2013 AND 2012
|
|
|
|
|
|
|
|
|
2013
|
|
|
2012
|
|
|
Average
Balance
|
Interest
|
Weighted
Average
Rate
|
Average
Balance
|
Interest
|
Weighted
Average
Rate
|
Interest Earning Assets:
|
|
|
|
|
|
|
Loans (1,3)
|
$ 834,754
|
$28,168
|
4.51%
|
$ 770,998
|
$27,267
|
4.72%
|
Securities (2,3)
|
430,112
|
10,747
|
3.34%
|
394,669
|
11,702
|
3.96%
|
Federal Home Loan Bank stock
|
18,176
|
52
|
0.38%
|
17,089
|
63
|
0.49%
|
Fed funds sold, money market funds, and time
|
|
|
|
|
|
|
deposits with other banks
|
1
|
---
|
0.00%
|
43
|
---
|
0.00%
|
|
|
|
|
|
|
|
Total Earning Assets
|
1,283,043
|
38,967
|
4.06%
|
1,182,799
|
39,032
|
4.41%
|
|
|
|
|
|
|
|
Non-Interest Earning Assets:
|
|
|
|
|
|
|
Cash and due from banks
|
3,582
|
|
|
3,169
|
|
|
Allowance for loan losses
|
(8,270)
|
|
|
(8,428)
|
|
|
Other assets (2)
|
55,510
|
|
|
59,223
|
|
|
Total Assets
|
$1,333,865
|
|
|
$1,236,763
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
Deposits
|
$ 759,709
|
$ 4,997
|
0.88%
|
$ 687,991
|
$ 5,795
|
1.13%
|
Borrowings
|
374,395
|
3,935
|
1.41%
|
354,392
|
4,702
|
1.77%
|
Total Interest Bearing Liabilities
|
1,134,104
|
8,932
|
1.05%
|
1,042,383
|
10,497
|
1.35%
|
Rate Spread
|
|
|
3.01%
|
|
|
3.06%
|
|
|
|
|
|
|
|
Non-Interest Bearing Liabilities:
|
|
|
|
|
|
|
Demand and other non-interest bearing deposits
|
67,868
|
|
|
64,294
|
|
|
Other liabilities
|
6,436
|
|
|
5,967
|
|
|
Total Liabilities
|
1,208,408
|
|
|
1,112,644
|
|
|
Shareholders' equity
|
125,457
|
|
|
124,119
|
|
|
Total Liabilities and Shareholders' Equity
|
$1,333,865
|
|
|
$1,236,763
|
|
|
Net interest income and net interest margin (3)
|
|
30,035
|
3.13%
|
|
28,535
|
3.22%
|
Less: Tax Equivalent adjustment
|
|
(1,294)
|
|
|
(1,151)
|
|
Net Interest Income
|
|
$28,741
|
2.99%
|
|
$27,384
|
3.09%
|
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3) For purposes of these computations, interest income, 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.
41
For the three months ended September 30, 2013, the tax equivalent net interest margin amounted to 3.12%, compared with 3.20% in the third quarter of 2012, representing a decline of eight basis points. The decline in the net interest margin was attributed to earning asset yields, which declined faster and to a greater extent than the Banks interest bearing liabilities. Specifically, the yield on earning assets declined 35 basis points to 3.97% while the rate paid on interest bearing liabilities declined 31 basis points to 0.97%. In addition, the interest rate spread declined four basis points to 3.00%, reflecting a higher volume of earning assets on the Companys balance sheet.
For the nine months ended September 30, 2013, the tax-equivalent net interest margin amounted to 3.13%, compared with 3.22% for the same period in 2012, representing a decline of nine basis points. The decline in the net interest margin was largely attributed to the volume of interest earning assets added to the Companys balance sheet, as the interest rate spread declined five basis points to 3.01%. The decline in the net interest margin was also attributed to earning asset yields, which declined faster and to a greater extent than the Banks interest bearing liabilities. Specifically, the yield on earning assets declined 35 basis points to 4.06% while the rate paid on interest bearing liabilities declined 30 basis points to 1.05%.
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 further enumerated in the following discussion and analysis.
NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED
|
|
|
|
|
|
|
|
|
|
|
WEIGHTED AVERAGE RATES
|
2013
|
|
2012
|
|
2011
|
Quarter:
|
3
|
2
|
1
|
|
4
|
3
|
2
|
1
|
|
4
|
Interest Earning Assets:
|
|
|
|
|
|
|
|
|
|
|
Loans (1,3)
|
4.39%
|
4.55%
|
4.59%
|
|
4.71%
|
4.72%
|
4.64%
|
4.82%
|
|
4.88%
|
Securities (2,3)
|
3.33%
|
3.25%
|
3.45%
|
|
3.72%
|
3.72%
|
3.96%
|
4.22%
|
|
4.29%
|
Federal Home Loan Bank stock
|
0.39%
|
0.27%
|
0.49%
|
|
0.50%
|
0.49%
|
0.49%
|
0.50%
|
|
0.30%
|
Fed Funds sold, money market funds,
|
|
|
|
|
|
|
|
|
|
|
and time deposits with other banks
|
0.00%
|
0.00%
|
0.00%
|
|
0.00%
|
0.00%
|
0.00%
|
0.00%
|
|
0.00%
|
Total Earning Assets
|
3.97%
|
4.06%
|
4.16%
|
|
4.32%
|
4.32%
|
4.35%
|
4.56%
|
|
4.61%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
0.82%
|
0.86%
|
0.96%
|
|
1.05%
|
1.07%
|
1.13%
|
1.18%
|
|
1.25%
|
Borrowings
|
1.27%
|
1.50%
|
1.46%
|
|
1.63%
|
1.72%
|
1.69%
|
1.91%
|
|
2.38%
|
Total Interest Bearing Liabilities
|
0.97%
|
1.06%
|
1.14%
|
|
1.24%
|
1.28%
|
1.33%
|
1.43%
|
|
1.58%
|
|
|
|
|
|
|
|
|
|
|
|
Rate Spread
|
3.00%
|
3.00%
|
3.02%
|
|
3.08%
|
3.04%
|
3.02%
|
3.13%
|
|
3.03%
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Margin (3)
|
3.12%
|
3.12%
|
3.15%
|
|
3.23%
|
3.20%
|
3.17%
|
3.30%
|
|
3.23%
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Margin without
Tax Equivalent Adjustments
|
2.98%
|
2.99%
|
3.02%
|
|
3.08%
|
3.06%
|
3.04%
|
3.17%
|
|
3.11%
|
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3) For purposes of these computations, interest income, net interest income and net interest margin are reported on a tax equivalent basis.
For the three and nine months ended September 30, 2013, the weighted average yield on average earning assets amounted to 3.97% and 4.06%, respectively, compared with 4.32% and 4.41% for the same periods in 2012, both representing declines of 35 basis points. These declines largely resulted from the replacement of accelerated cash flows from the Banks mortgage-backed securities portfolio along with the purchase of additional securities during a period of historically low interest rates. The declines were also attributed to the origination and competitive re-pricing of certain commercial loans, as well as elevated levels of residential mortgage loan refinancing activity during a period of historically low interest rates.
42
For the three and nine months ended September 30, 2013, the weighted average cost of interest bearing liabilities amounted to 0.97% and 1.05%, respectively, compared with 1.28% and 1.35% for the same periods in 2012, representing declines of 31 and 30 basis points. These declines principally reflected the ongoing re-pricing of maturing time deposits and borrowings, combined with the lowering of interest rates on certain of the Banks core deposit products.
Interest and Dividend Income:
For the three months ended September 30, 2013, total interest and dividend income on a tax-equivalent basis amounted to $13,310, compared with $13,283 in the third quarter of 2012, representing an increase of $27, or 0.2%. The increase in interest and dividend income was attributed to average earning asset growth of $106,406, or 8.7%, the impact of which was almost entirely offset by a 35 basis point decline in the weighted average earning asset yield to 3.97%.
For the three months ended September 30, 2013, total tax-equivalent interest income from the securities portfolio amounted to $3,828, representing an increase of $31, or 0.8%, compared with the third quarter of 2012. The increase in interest income from securities was attributed to a $49,684 or 12.2% increase in total average securities, the impact of which was almost entirely offset by a 39 basis point decline in the weighted average securities portfolio yield to 3.33%, compared with the third quarter of 2012. The decline in the weighted average securities yield was largely attributed to the ongoing replacement of accelerated mortgage-backed securities cash flows in a historically low interest rate environment combined with incremental securities purchases at low prevailing market yields. Accelerated cash flows were principally attributed to increased securitized loan refinancing activity driven by historically low interest rates, a variety of government stimulus programs, quantitative easing efforts by the Federal Reserve, as well as continuing credit defaults.
For the three months ended September 30, 2013, total tax-equivalent interest income from the loan portfolio amounted to $9,464, unchanged from the third quarter of 2012. While the average loan portfolio increased $56,290 or 7.1%, the impact of this increase was entirely offset by a 33 basis point decline in the weighted average loan portfolio yield to 4.39%, compared with the third quarter of 2012. The decline in the weighted average loan yield principally reflected the origination and competitive re-pricing of certain commercial loans, as well as elevated levels of residential mortgage loan refinancing activity during a period of historically low interest rates.
43
For the nine months ended September 30, 2013, total tax-equivalent interest and dividend income amounted to $38,967, compared with $39,032 for the same period in 2012, representing a decline of $65, or 0.2%. While total average earning assets increased $100,244 or 8.5%, the impact of this increase was entirely offset by a 35 basis point decline in the weighted average earning asset yield to 4.06%, compared with the same period in 2012.
For the nine months ended September 30, 2013, total tax-equivalent interest income from the securities portfolio amounted to $10,747, representing a decline of $955, or 8.2%, compared with the same period in 2012. The decline in interest income from securities was principally attributed to a 62 basis point decline in the weighted average securities portfolio yield to 3.34%, partially offset by average securities portfolio growth of $35,443, or 9.0%. As more fully discussed above, the decline in the weighted average securities yield was largely attributed to the ongoing replacement of accelerated portfolio cash flows in a historically low interest rate environment, combined with incremental securities purchases at low prevailing market yields.
For the nine months ended September 30, 2013, total tax-equivalent interest income from the loan portfolio amounted to $28,168, representing an increase of $901 or 3.3% compared with the same period in 2012. The increase in interest income from the loan portfolio was principally attributed to average loan portfolio growth of $63,756 or 8.3%, as the weighted average yield declined 21 basis points to 4.51%, compared with the same period in 2012. The decline in yield principally reflected the origination and competitive re-pricing of certain commercial loans, as well as an elevated level of residential mortgage loan refinancing activity during a period of historically low interest rates.
Interest Expense:
For the three months ended September 30, 2013, total interest expense amounted to $2,865, compared with $3,462 in the third quarter of 2012, representing a decline of $597, or 17.2%. The decline in interest expense was principally attributed to a 31 basis point decline in the weighted average cost of interest bearing liabilities, the impact of which was largely offset by an $97,673 or 9.1% increase in total average interest bearing liabilities, compared with the third quarter of 2012.
The decline in the third quarter weighted average cost of interest bearing liabilities compared with the same quarter in 2012 was principally attributed to prevailing, historically low short-term and long-term market interest rates, with maturing time deposits and borrowings being added or replaced at a lower cost and other interest bearing deposits re-pricing into the lower interest rate environment. For the three months ended September 30, 2013, the total weighted average cost of interest bearing liabilities amounted to 0.97%, compared with 1.28% for the same quarter in 2012, representing a decline of 31 basis points. The weighted average cost of interest bearing deposits declined 25 basis points to 0.82%, compared with the third quarter of 2012, while the weighted average cost of borrowed funds declined 45 basis points to 1.27%.
For the nine months ended September 30, 2013, total interest expense amounted to $8,932, compared with $10,497 for the same period in 2012, representing a decline of $1,565, or 14.9%. The decline in interest expense was principally attributed to a 30 basis point decline in the weighted average cost of interest bearing liabilities, the impact of which was partially offset by a $91,721 or 8.8% increase in total average interest bearing liabilities, compared with the nine months ended September 30, 2012.
The decline in the weighted average cost of interest bearing liabilities for the nine months ended September 30, 2013 compared with the same period in 2012 was principally attributed to prevailing, historically low short-term and long-term market interest rates, with maturing time deposits and borrowings being added or replaced at a lower cost and other interest bearing deposits re-pricing into the lower interest rate environment. For the nine months ended September 30, 2013, the total weighted average cost of interest bearing liabilities amounted to 1.05%, compared with 1.35% for the same period in 2012, representing a decline of 30 basis points. The weighted average cost of interest bearing deposits declined 25 basis points to 0.88%, while the weighted average cost of borrowed funds declined 36 basis points to 1.41%.
Rate/Volume Analysis:
The following tables set forth a summary analysis of the relative impact on net interest income of changes in the average volume of interest earning assets and interest bearing liabilities, and changes in average rates on such assets and liabilities. The income from tax-exempt assets has been adjusted to a fully tax equivalent basis, thereby allowing uniform comparisons to be made. Because of the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes to volume or rate. For presentation purposes, changes which are not solely due to volume changes or rate changes have been allocated to these categories in proportion to the relationships of the absolute dollar amounts of the change in each.
44
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2013 and 2012
INCREASES (DECREASES) DUE TO:
|
|
|
|
|
Average
Volume
|
Average
Rate
|
Total
Change
|
|
|
|
|
Loans (1,3)
|
$ 661
|
$ (661)
|
$ ---
|
Securities (2,3)
|
461
|
(430)
|
31
|
Federal Home Loan Bank stock
|
1
|
(5)
|
(4)
|
Fed funds sold, money market funds, and time
|
|
|
|
deposits with other banks
|
---
|
---
|
---
|
|
|
|
|
TOTAL EARNING ASSETS
|
$1,123
|
$(1,096)
|
$ 27
|
|
|
|
|
Interest bearing deposits
|
165
|
(480)
|
(315)
|
Borrowings
|
159
|
(441)
|
(282)
|
TOTAL INTEREST BEARING LIABILITIES
|
$ 324
|
$ (921)
|
$(597)
|
|
|
|
|
NET CHANGE IN NET INTEREST INCOME
|
$ 799
|
$ (175)
|
$ 624
|
(1)
For purposes of these computations, non-accrual loans are included in average loans.
(2)
For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3)
For purposes of these computations, interest income is reported on a tax equivalent basis.
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2013 and 2012
INCREASES (DECREASES) DUE TO:
|
|
|
|
|
Average
Volume
|
Average
Rate
|
Total
Change
|
|
|
|
|
Loans (1,3)
|
$2,253
|
$(1,352)
|
$ 901
|
Securities (2,3)
|
1,053
|
(2,008)
|
(955)
|
Federal Home Loan Bank stock
|
4
|
(15)
|
(11)
|
Fed funds sold, money market funds, and time
|
|
|
|
deposits with other banks
|
---
|
---
|
---
|
|
|
|
|
TOTAL EARNING ASSETS
|
$3,310
|
$(3,375)
|
$ (65)
|
|
|
|
|
Interest bearing deposits
|
605
|
(1,403)
|
(798)
|
Borrowings
|
266
|
(1,033)
|
(767)
|
TOTAL INTEREST BEARING LIABILITIES
|
$ 871
|
$(2,436)
|
$(1,565)
|
|
|
|
|
NET CHANGE IN NET INTEREST INCOME
|
$2,439
|
$ (939)
|
$ 1,500
|
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available for sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.
Provision for Loan Losses
The provision for loan losses (the provision) reflects the amount necessary to maintain the allowance for loan losses 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 credit quality of the Banks loan portfolio continued to improve during the three and nine months ended September 30, 2013. This improvement was highlighted by a $2,094 or 21.2% decline in non-performing loans, with the level of other delinquent and potential problem loans remaining relatively stable compared with December 31, 2012. During the nine months ended September 30, 2013, the Bank experienced a relatively low level of loan loss experience, with total net loan charge-offs amounting to $645, or annualized net charge-offs to average loans outstanding of 0.10%, compared with $1,470 and 0.25% during the first nine months of 2012, respectively.
For the three and nine months ended September 30, 2013, the Bank recorded provisions of $170 and $928, compared with $427 and $1,302 for the same periods in 2012, representing declines of $257 and $374, or 60.2% and 28.7%, respectively. The provisions recorded for the three and nine months ended September 30, 2013, were largely driven by the Banks charge-off experience and loan portfolio growth, as the overall credit quality of the loan portfolio remained relatively stable.
Refer below to Item 2 of this Part I, Financial Condition, Loans,
Non-Performing Loans, Potential Problem Loans
and
Allowance for Loan Losses,
in this report on Form 10-Q
for further discussion and analysis related to the provision for loan losses.
Non-interest Income
For the three and nine months ended September 30, 2013, total non-interest income amounted to $1,925 and $5,749, compared with $2,298 and $5,972 for the same periods in 2012, representing declines of $373 and $223, or 16.2% and 3.7%, 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 fair market value of client assets under management and held in custody with Bar Harbor Trust Services, the Companys second tier non-depository trust company subsidiary, 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, 2013, trust and other financial service fees amounted to $900 and $2,657, compared with $850 and $2,468 for the same periods in 2012, representing increases of $50 and $189, or 5.9% and 7.7%, respectively. Reflecting new client relationships and some stability in the equity markets, quarter-end assets under management stood at $380,380, up from $355,461 at year-end 2012, and representing an increase of $22,179 or 6.2% compared with September 30, 2012.
Service Charges on Deposit Accounts:
For the three months ended September 30, 2013, income from service charges on deposit accounts amounted to $346, compared with $351 for the same quarter in 2012, representing a decline of $5, or 1.4%. For the nine months ended September 30, 2013, income from service charges on deposit accounts amounted to $962, compared with $887 for the same period in 2012, representing an increase of $75, or 8.5%. The year-to-date increase in service charges on deposits were principally attributed to the addition of three new branches in the third quarter of 2012 as well as customer overdraft fee increases instituted in the third quarter of 2012.
46
Credit and Debit Card Service Charges and Fees:
For the three and nine months ended September 30, 2013, income generated from credit and debit card service charges and fees amounted to $440 and $1,172, compared with $419 and $1,075 for the same periods in 2012, representing increases of $21 and $97, or 5.0% and 9.0%, respectively. These increases were largely attributed to continued growth of the Banks retail deposit base, higher levels of merchant credit card processing volumes, and continued success with a program that offers rewards for certain debit card transactions.
Net Securities Gains:
For the three and nine months ended September 30, 2013, total net securities gains amounted to $138 and $659, compared with $597 and $1,834 for the same periods in 2012, representing declines of $459 and $1,175, or 76.9% and 64.1%, respectively. The net realized securities gains recorded during the first nine months of 2013 were comprised of realized gains of $667, offset by realized losses of $8. The net realized securities gains recorded during the same period in 2012 were comprised of realized gains of $1,857, offset by realized losses of $23.
Net Other-than-temporary Impairment Losses Recognized in Earnings:
For the three and nine months ended September 30, 2013, net OTTI losses recognized in earnings amounted to $73 and $188 , compared with $101 and $781 for the same periods in 2012, representing declines of $28 and $593, or 27.7% and 75.9%, respectively.
During the nine months ended September 30, 2013, the Company determined that three private label mortgage-backed securities were other-than-temporarily impaired (OTTI), because the Company could no longer conclude that it was probable it would recover all of the principal and interest on these securities. The credit losses principally reflected an increase in the loss severity and constant default rate estimates of the underlying residential mortgage loan collateral, resulting from depressed real estate values and still depressed economic conditions overall. The OTTI losses represented managements best estimate of additional credit losses on the residential mortgage loan collateral underlying these securities. The credit loss was previously recorded, net of taxes, in unrealized gains or losses on securities available for sale within accumulated other comprehensive income or loss, a component of total shareholders equity on the Companys consolidated balance sheet.
Further information regarding impaired securities, other-than-temporarily impaired securities, and evaluation of securities for impairment is incorporated by reference to Notes 2 and 5 of the unaudited consolidated financial statements in Part I, Item 1 of this quarterly report on Form 10-Q.
Non-interest Expense
For the three and nine months ended September 30, 2013, total non-interest expense amounted to $6,835 and $19,737, compared with $6,559 and $18,524 for the same periods in 2012, representing increases of $276 and $1,213, or 4.2% and 6.6%, respectively.
Factors contributing to the changes in non-interest expense are more fully enumerated in the following discussion and analysis.
Salaries and Employee Benefits:
For the three and nine months ended September 30, 2013, total salaries and employee benefits expense amounted to $4,025 and $11,328, compared with $3,670 and $10,161 for the same periods in 2012, representing increases of $355 and $1,167, or 9.7% and 11.5%, respectively.
The increases in salaries and employee benefits were attributed to a variety of factors including normal increases in base salaries, higher levels of employee incentive compensation, as well as changes in staffing levels and mix. The increases in salaries and employee benefits also reflected the Banks previously reported acquisition of three Border Trust branch offices in the third quarter of 2012. Year-to-date salaries and employee benefits also included expenses related to certain equity awards to members of the Companys Board of Directors and the newly-appointed President and CEO of the Company.
Occupancy Expense:
For the three and nine months ended September 30, 2013, total occupancy expense amounted to $482 and $1,459, compared with $408 and $1,183 for the same periods in 2012, representing increases of $74 and $276, or 18.1% and 23.3%, respectfully. These increases were largely attributed to the three new branch office locations acquired in connection with the Border Trust transaction (two of which are leased properties), which was consummated in the third quarter of 2012. The increases in occupancy expense were also attributed to the Banks substantial reconfiguration of its Ellsworth campus, including the replacement of its Ellsworth retail banking office, which was put in service in the third quarter of 2012.
Other Operating Expenses:
For the three and nine months ended September 30, 2013, total other operating expenses amounted to $1,549 and $4,661, compared with $1,758 and $5,003 for the same periods in 2012, representing declines of $209 and $342, or 11.9% and 6.8%, respectively.
These declines were principally attributed to lower levels of loan collection expenses, as well as certain non-recurring branch acquisition expenses in connection with the Border Trust transaction recorded in during the first nine months of 2012.
47
Efficiency Ratio
The Companys efficiency ratio measures the relationship of operating expenses to revenues. The efficiency ratio is calculated by dividing non-interest operating expenses by the sum of tax-equivalent net interest income and non-interest income other than net securities gains, other-than-temporary impairments, and other significant non-recurring expenses, including the non-recurring expenses related to the Border Trust transaction. For the three and nine months ended September 30, 2013, the Companys efficiency ratios amounted to 55.4% and 55.7%, compared with 50.7% and 52.7% for the same periods in 2012.
Income Taxes
For the three and nine months ended September 30, 2013, total income taxes amounted to $1,356 and $3,906, compared with $1,358 and $3,894 for the same periods in 2012.
The Company's effective tax rates for the three and nine months ended September 30, 2013, amounted to 27.7% and 28.3%, compared with 28.7% and 28.8% for the same periods in 2012. The income tax provisions for these periods were less than the expense that would result from applying the federal statutory rate of 35% to income before income taxes, principally because of the impact of tax exempt 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, 2013, represented 61.3% and 33.5%, respectively, of total assets, compared with 62.6% and 32.1%, respectively, at December 31, 2012.
At September 30, 2013, the Companys total assets amounted to $1,379,270, compared with $1,302,935 at December 31, 2012, representing an increase of $76,335, or 5.9%.
Securities
The securities portfolio is comprised of mortgage-backed securities (MBS) issued by U.S. Government agencies, U.S. Government sponsored enterprises, and other non-agency, private label issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions, and debt obligations of other U.S. Government sponsored enterprises.
Management considers securities as a relatively attractive means to effectively leverage the Banks strong capital position, as securities are typically assigned a significantly lower risk weighting compared with the Banks other earning assets for the purpose of calculating the Banks and the Companys risk-based capital ratios. The overall objectives of the Companys strategy for the securities portfolio include maintaining appropriate liquidity reserves, diversifying earning assets, managing interest rate risk, leveraging the Companys strong capital position, and generating acceptable levels of net interest income.
Securities available for sale represented 100% of total securities at September 30, 2013, and December 31, 2012. 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. At September 30, 2013, total net unrealized securities losses amounted to $5,228, or 1.1% of the amortized cost of the total securities portfolio, compared with net unrealized gains of $12,271 at December 31, 2012. The unrealized losses were attributed to market interest rates and wider pricing spreads, which increased significantly beginning in the second quarter of 2013. The yield on the 10-year U.S. Treasury Note reached a year-to-date low of 1.61% on May 1, 2013 and then increased steadily by over a full percentage point, ending the third quarter at 2.61%.
48
Total Securities:
At September 30, 2013, total securities amounted to $462,356, compared with $418,040 at December 31, 2012, representing an increase of $44,316, or 10.6%. The entire increase in securities occurred during the third quarter as market yields climbed to multi-year highs. The securities purchased during the nine months ended September 30, 2013 consisted of MBS issued and guaranteed by U.S. Government agencies and sponsored-enterprises, and to a lesser extent, obligations of states and political subdivisions thereof (municipal securities).
The following tables summarize the securities available for sale portfolio as of September 30, 2013, and December 31, 2012:
|
|
|
|
|
September 30, 2013
Available for Sale:
|
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Estimated
Fair Value
|
|
|
|
|
|
Mortgage-backed securities:
|
|
|
|
|
US Government-sponsored enterprises
|
$278,954
|
$ 5,424
|
$ 5,638
|
$278,740
|
US Government agency
|
86,906
|
1,227
|
1,323
|
86,810
|
Private label
|
5,918
|
854
|
70
|
6,702
|
Obligations of states and political subdivisions thereof
|
95,806
|
1,215
|
6,917
|
90,104
|
Total
|
$467,584
|
$ 8,720
|
$13,948
|
$462,356
|
|
|
|
|
|
|
|
|
|
|
December 31, 2012
Available for Sale:
|
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Estimated
Fair Value
|
|
|
|
|
|
Mortgage-backed securities:
|
|
|
|
|
US Government-sponsored enterprises
|
$238,974
|
$ 7,913
|
$ 1,064
|
$245,823
|
US Government agency
|
82,397
|
2,080
|
216
|
84,261
|
Private label
|
8,063
|
571
|
521
|
8,113
|
Obligations of states and political subdivisions thereof
|
76,335
|
4,040
|
532
|
79,843
|
Total
|
$405,769
|
$14,604
|
$ 2,333
|
$418,040
|
Impaired Securities:
The securities portfolio contains certain securities where amortized cost exceeds fair value, which at September 30, 2013, amounted to an excess of $13,948, or 3.0% of the amortized cost of the total securities portfolio. At December 31, 2012 this amount represented an excess of $2,333, or 0.6% of the total securities portfolio. As of September 30, 2013, unrealized losses on securities in a continuous unrealized loss position more than twelve-months amounted to $2,897, compared with $744 at December 31, 2012.
As a part of the Companys ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired. If a decline in the fair value of an available for sale security is judged to be other-than-temporary, a charge is recorded in pre-tax earnings equal to the estimated credit losses inherent in the security.
Further information regarding impaired securities, other-than-temporarily impaired securities and evaluation of securities for impairment is incorporated by reference to above Notes 2 and 5 of the interim unaudited consolidated financial statements in Part I, Item 1 of this report on Form 10-Q.
49
50
Loans
Total Loans:
At September 30, 2013, total loans stood at $845,933, compared with $815,004 at December 31, 2012, representing an increase of $30,929, or 3.8%.
The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington and Knox, Kennebec, and Sagadahoc, Maine. The following table summarizes the components of the Bank's loan portfolio as of the dates indicated.
LOAN PORTFOLIO SUMMARY
|
|
|
|
September 30,
2013
|
December 31,
2012
|
|
|
|
Commercial real estate mortgages
|
$329,973
|
$324,493
|
Commercial and industrial
|
75,104
|
59,373
|
Commercial construction and land development
|
16,624
|
22,120
|
Agricultural and other loans to farmers
|
27,783
|
24,922
|
Total commercial loans
|
449,484
|
430,908
|
|
|
|
Residential real estate mortgages
|
316,395
|
297,103
|
Home equity loans
|
49,588
|
53,303
|
Other consumer loans
|
15,479
|
19,001
|
Total consumer loans
|
381,462
|
369,407
|
|
|
|
Tax exempt loans
|
15,263
|
15,244
|
|
|
|
Net deferred loan costs and fees
|
(276)
|
(555)
|
Total loans
|
845,933
|
815,004
|
Allowance for loan losses
|
(8,380)
|
(8,097)
|
Total loans net of allowance for loan losses
|
$837,553
|
$806,907
|
Commercial Loans:
At September 30, 2013, total commercial loans amounted to $449,484, compared with $430,908 at December 31, 2012, representing an increase of $18,576, or 4.3%.
Commercial loan growth has generally been challenged by a still-recovering economy, continuing economic uncertainty, diminished demand, and strong competition for quality loans. Bank management attributes the continued growth in commercial loans to an effective business banking team, deep local market knowledge, sustained new business development efforts, and a local economy that has fared better than the nation as a whole.
Consumer Loans:
At September 30, 2013, total consumer loans, which principally consisted of residential real estate mortgage loans, amounted to $381,462, compared with $369,407 at December 31, 2012, representing an increase of $12,055, or 3.3%. This increase was largely attributed to the purchase of a New England based portfolio of residential loans during the second quarter. Loans originated and closed by the Bank during the first nine months of 2013 were
51
largely offset by accelerated loan re-financings and principal pay-downs from the existing residential real estate loan portfolio, as borrowers continued to take advantage of historically low interest rates.
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 Directors Loan Committee, and the Bank's Board of Directors. Management follows a policy of continually identifying, analyzing and grading credit risk inherent in the loan portfolio. An ongoing independent review, subsequent to management's review, of individual credits is performed by an independent loan review 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 and loans past due 90 days or more and still accruing interest. The following table sets forth the details of non-performing loans as of the dates indicated:
TOTAL NON-PERFORMING LOANS
|
|
|
|
September 30,
2013
|
December 31,
2012
|
|
|
|
Commercial real estate mortgages
|
$1,317
|
$1,888
|
Commercial and industrial loans
|
553
|
818
|
Commercial construction and land development
|
1,845
|
2,359
|
Agricultural and other loans to farmers
|
67
|
664
|
Total commercial loans
|
3,782
|
5,729
|
|
|
|
Residential real estate mortgages
|
3,072
|
3,017
|
Home equity loans
|
863
|
814
|
Other consumer loans
|
54
|
72
|
Total consumer loans
|
3,989
|
3,903
|
|
|
|
Total non-accrual loans
|
7,771
|
9,632
|
Accruing loans contractually past due 90 days or more
|
2
|
235
|
Total non-performing loans
|
$7,773
|
$9,867
|
|
|
|
Allowance for loan losses to non-performing loans
|
107.8%
|
82.1%
|
Non-performing loans to total loans
|
0.92%
|
1.21%
|
Allowance to total loans
|
0.99%
|
0.99%
|
52
At September 30, 2013, total non-performing loans amounted to $7,773, compared with $9,867 at December 31, 2012, representing a decline of $2,094, or 21.2%. As more fully discussed below, one commercial real estate loan to a local, non-profit affordable housing authority in support of an affordable housing project accounted for $1,845, or 23.7% of total non-performing loans.
Non-performing commercial real estate mortgages totaled to $1,317 at September 30, 2013, down from $1,888 at December 31, 2012. At September 30, 2013, non-performing commercial real estate mortgages were represented by eleven business relationships, with outstanding balances ranging from $23 to $235.
Non-performing commercial and industrial loans totaled $553 at September 30, 2013, down from $818 at December 31, 2012. At September 30, 2013, non-performing commercial and industrial loans were represented by nine business relationships, with outstanding balances ranging from $6 to $154.
Non-performing commercial construction and land development loans totaled $1,845 at September 30, 2013, down from $2,359 at December 31, 2012. At September 30, 2013, non-performing commercial construction and land development loans were entirely represented by a commercial real estate loan to a local, non-profit affordable housing authority in support of an affordable housing project. This loan is principally secured by the housing units from the project. The project is fully constructed and there is no construction risk associated with the loan. The primary source of repayment is the sale of the existing housing units. This loan is impaired and was put on non-accrual status in late 2010. To date, the Bank has charged-off $2,014 of the original outstanding balance of this collateral dependent impaired loan. These charge-offs were based on current appraisals and revised prospects for future cash flows. This loan is recorded at fair value in the Companys financial statements.
Non-performing residential real estate mortgages totaled $3,072 at September 30, 2013, up from $3,017 at December 31, 2012. At September 30, 2013, non-performing residential real estate loans were represented by thirty-three, conventional, 1-4 family mortgage loans, with outstanding balances ranging from $10 to $380.
Non-performing home equity loans totaled $863 at September 30, 2013, up from $814 at December 31, 2012. At September 30, 2013, non-performing home equity loans were represented by eight relationships with outstanding balances ranging from $6 to $390.
While the level and mix of non-performing loans continued to reflect favorably on the overall quality of the Banks loan portfolio at September 30, 2013, Bank management is cognizant of the still-recovering real estate market, elevated unemployment rates and soft economic conditions overall. Bank management believes that the current credit cycle has yet to reach a definitive turning point and it may be some time before the overall level of credit quality in the Banks loan portfolio returns to pre-recession levels and shows lasting improvement. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Banks customers, including debt service levels, declining collateral values, tourism activity, consumer confidence 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.
53
Delinquencies and Potential Problem Loans:
In addition to the non-performing loans discussed above, the Bank also has loans that are 30 to 89 days delinquent and still accruing. These loans amounted to $6,021 and $3,529 at September 30, 2013 and December 31, 2012, or 0.71% and 0.43% of total loans, respectively, net of any loans classified as non-performing that are within these delinquency categories. These loans and delinquency trends in general are considered in the evaluation of the allowance for loan losses and the related determination of the provision for loan losses.
Periodically, the Bank reviews the commercial loan portfolio for evidence of potential problem loans. Potential problem loans are loans that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the borrower causes doubt about the ability of the borrower to comply with the loan payment terms and may result in disclosure of such loans as non-performing at some time in the future.
At September 30, 2013, the Bank identified twenty-six commercial relationships totaling $9,849 as potential problem loans, or 1.16% of total loans. At December 31, 2012, the Bank identified thirty-three commercial relationships totaling $10,297 as potential problem loans, or 1.26% of total loans. Factors such as payment history, value of supporting collateral, and personal or government guarantees led the Bank to conclude that the current risk exposure on these potential problem loans did not warrant accounting for the loans as non-performing. Although in a performing status as of quarter-end, these loans exhibited certain risk factors, which have the potential to cause them to become non-performing at some point in the future.
Troubled Debt Restructures:
A Troubled Debt Restructure (TDR) results from a modification to a loan to a borrower who is experiencing financial difficulty in which the Bank grants a concession to the debtor that it would not otherwise consider but for the debtors financial difficulties. Financial difficulty arises when a debtor is bankrupt or contractually past due, or is likely to become so, based upon its ability to pay. A concession represents an accommodation not generally available to other customers, which may include below-market interest rate, deferment of principal payments, extension of maturity dates, etc. Such accommodations extended to customers who are not experiencing financial difficulty do not result in TDR classification.
As of September 30, 2013, the Bank had seven real estate secured loans, four commercial and industrial loans, and one consumer loan, to nine relationships totaling $1,329 that were classified as TDRs. At September 30, 2013, six of these TDRs totaling $348 were classified as non-accrual, and none were past due 30 days or more and still accruing.
As of December 31, 2012, the Bank had four real estate secured and three commercial and industrial loans to four relationships totaling $934 that were classified as TDRs, of which three TDRs totaling $114 were past due or classified as non-performing.
Allowance for Loan Losses:
At September 30, 2013, the allowance for loan losses (the allowance) stood at $8,380, compared with $8,097 at December 31, 2012, representing an increase of $283, or 3.5%. The moderate increase in the allowance from December 31, 2012 largely reflected an overall improvement in the Banks credit quality metrics and charge-off experience, partially offset by loan growth. As of September 30, 2013, total non-performing loans to total loans stood at 0.92%, down from 1.21% at December 31, 2012. At September 30, 2013, the allowance expressed as a percentage of non-performing loans stood at 107.8%, up from 82.1% at December 31, 2012.
54
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 based upon a discounted cash flows analysis, or as appropriate, a collateral shortfall analysis. The amount of collateral dependent impaired loans totaled $1,845 as of September 30, 2013, compared with $3,149 as of December 31, 2012. The related allowances for loan losses on these loans amounted to $20 as of September 30, 2013, compared with $120 as of December 31, 2012.
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 substantially 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.
55
The following table details changes in the allowance and summarizes loan loss experience by loan type for the nine-month periods ended September 30, 2013, and 2012.
ALLOWANCE FOR LOAN LOSSES
NINE MONTHS ENDED
SEPTEMBER 30, 2013 AND 2012
|
|
|
|
2013
|
2012
|
|
|
|
Balance at beginning of period
|
$8,097
|
$8,221
|
Charge offs:
|
|
|
Commercial real estate mortgages
|
$ 139
|
$ 252
|
Commercial and industrial
|
186
|
42
|
Commercial construction and land development
|
---
|
300
|
Agricultural and other loans to farmers
|
81
|
148
|
Residential real estate mortgages
|
319
|
514
|
Other consumer loans
|
80
|
263
|
Home equity loans
|
34
|
92
|
Tax exempt loans
|
---
|
---
|
Total charge-offs
|
839
|
1,611
|
|
|
|
Recoveries:
|
|
|
Commercial real estate mortgages
|
$ 105
|
$ 9
|
Commercial and industrial loans
|
22
|
9
|
Commercial construction and land development
|
---
|
---
|
Agricultural and other loans to farmers
|
25
|
81
|
Residential real estate mortgages
|
6
|
14
|
Other consumer loans
|
17
|
28
|
Home equity loans
|
19
|
---
|
Tax exempt loans
|
---
|
---
|
Total recoveries
|
194
|
141
|
|
|
|
Net charge-offs
|
645
|
1,470
|
Provision charged to operations
|
928
|
1,302
|
|
|
|
Balance at end of period
|
$8,380
|
$8,053
|
For the nine months ended September 30, 2013, total net loan charge-offs amounted to $645, or annualized net charge-offs to average loans outstanding of 0.10%, down from $1,470 and 0.25%, during the first nine months of 2012.
General allowances for loan losses account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There were no material changes in loan concentrations during the nine months ended September 30, 2013.
Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, Company management believes the allowance for loan losses at September 30, 2013 is appropriate for the amount of risk inherent in the current loan portfolio and adequate to provide for estimated probable losses.
56
Further information regarding loans and the allowance for loan losses, is incorporated by reference to above Notes 6, Loans and Allowance for Loan Losses, of the interim unaudited consolidated financial statements in Part I, Item 1 of this report on Form 10-Q.
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, 2013, the Banks OREO amounted to $1,782, compared with $2,780 as of December 31, 2012, representing a decline of $998, or 35.9%. Six residential and six commercial properties comprised the September 30, 2013 balance of OREO.
During the nine months ended September 30, 2013, three properties were added to OREO. There were three properties written-down for an aggregate total of $187 in write-downs, and there were four sales of OREO properties, one of which was sold at a gain of $53, and three were sold at an aggregate loss of $30.
Deposits
Historically, the banking business in the Banks market area has been seasonal, with lower deposits in the winter through late 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 FHLB of Boston, brokered certificates of deposit obtained from the national market and cash flows from the securities portfolio.
At September 30, 2013, total deposits stood at $884,596, compared with $795,765 at December 31, 2012, representing an increase of $88,831, or 11.2%. Demand deposits and NOW accounts experienced a combined seasonal increase of $25,583, or 13.1%, compared with December 31, 2012, while savings and money market accounts were up $47,179, or 20.5%. The increase in savings and money market accounts included $33,617 of reciprocal money market deposits obtained from the national market, which were utilized to reduce brokered certificates of deposit obtained from the national market. The Banks time deposits were up $16,070, or 4.3% compared with December 31, 2012.
Borrowed Funds
Borrowed funds principally consist of advances from the FHLB of Boston (the FHLB) and, to a lesser extent, securities sold under agreements to repurchase and Fed funds purchased. Advances from the FHLB are secured by stock in the FHLB, investment securities, blanket liens on qualifying mortgage loans and home equity loans, and certain commercial real estate loans.
The Bank utilizes borrowed funds to leverage its strong capital position and support 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.
57
At September 30, 2013, total borrowings amounted to $364,014, compared with $371,567 at December 31, 2012, representing a decline of $7,553, or 2.0%. The decline in total borrowings principally reflected seasonal increases in retail deposits that were partially utilized to pay down borrowings.
Capital Resources
Consistent with its long-term goal of operating a sound and profitable organization, at September 30, 2013, the Company maintained its strong capital position and continued to be a well-capitalized financial institution according to applicable regulatory standards. Management believes this to be vital in promoting depositor and investor confidence and providing a solid foundation for future growth.
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 possible additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the Company's financial statements.
As of September 30, 2013, the Company and the Bank were considered
well
-
capitalized
under the regulatory framework for prompt corrective action. Under the capital adequacy guidelines, a
well-capitalized
institution must maintain a minimum total risk-based capital to total risk-weighted assets ratio of at least 10.0%, a minimum Tier I capital to total risk-weighted assets ratio of at least 6.0%, and a minimum Tier I Leverage ratio of at least 5.0%. At September 30, 2013, the Companys Total Risk-based, Tier I Risk-based, and Tier I Leverage ratios were 16.44%, 14.80% and 8.91%, respectively.
The following tables set forth the Company's and the Banks regulatory capital at September 30, 2013, and December 31, 2012, under the rules applicable at that date.
|
|
|
|
|
|
|
|
Consolidated
|
For Capital
Adequacy Purposes
|
To be well
Capitalized under
Prompt corrective
Action provisions
|
|
Actual
Amount
|
Ratio
|
Required
Amount
|
Ratio
|
Required
Amount
|
Ratio
|
September 30, 2013
|
|
|
|
|
|
|
Total Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
Consolidated
|
$135,210
|
16.44%
|
$65,778
|
8.0%
|
N/A
|
|
Bank
|
$136,106
|
16.57%
|
$65,717
|
8.0%
|
$82,146
|
10.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
Consolidated
|
$121,723
|
14.80%
|
$32,889
|
4.0%
|
N/A
|
|
Bank
|
$122,619
|
14.93%
|
$32,859
|
4.0%
|
$49,288
|
6.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Average Assets)
|
|
|
|
|
|
|
Consolidated
|
$121,723
|
8.91%
|
$54,673
|
4.0%
|
N/A
|
|
Bank
|
$122,619
|
8.98%
|
$54,637
|
4.0%
|
$68,297
|
5.0%
|
58
|
|
|
|
|
|
|
|
Consolidated
|
For Capital
Adequacy Purposes
|
To be well
Capitalized under
Prompt corrective
Action provisions
|
|
Actual
Amount
|
Ratio
|
Required
Amount
|
Ratio
|
Required
Amount
|
Ratio
|
December 31, 2012
|
|
|
|
|
|
|
Total Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
Consolidated
|
$127,857
|
15.78%
|
$64,812
|
8.0%
|
N/A
|
|
Bank
|
$128,791
|
15.92%
|
$64,718
|
8.0%
|
$80,897
|
10.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
|
|
|
|
|
Consolidated
|
$114,667
|
14.15%
|
$32,406
|
4.0%
|
N/A
|
|
Bank
|
$115,601
|
14.29%
|
$32,359
|
4.0%
|
$48,538
|
6.0%
|
Tier 1 Capital
|
|
|
|
|
|
|
(To Average Assets)
|
|
|
|
|
|
|
Consolidated
|
$114,667
|
8.87%
|
$51,730
|
4.0%
|
N/A
|
|
Bank
|
$115,601
|
8.94%
|
$51,701
|
4.0%
|
$64,626
|
5.0%
|
Shareholders Equity:
Total shareholders equity ended the third quarter at $123,403, down from $128,046 at December 31, 2012. Likewise, the Companys book value per share of common stock ended the quarter at $31.34, down from $32.66 at December 31, 2012. The decline in shareholders equity was attributed to an $11,629 decline in accumulated other comprehensive income. This decline was principally the result of a reduction in unrealized gains in the Banks investment securities portfolio, which declined from a tax effective unrealized gain of $8,098 at December 31, 2012 to a tax effected unrealized loss of $3,450 at September 30, 2013. The net unrealized losses at September 30, 2013 were attributed to a significant increase in interest rates and pricing spreads during the nine months ended September 30, 2013, which negatively impacted the fair value of the Banks fixed income securities portfolio.
Trends, Events or Uncertainties:
There are no known trends, events or uncertainties, nor any recommendations by any regulatory authority, that are reasonably likely to have a material effect on the Companys capital resources, liquidity, or financial condition.
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 a regular cash dividend of $0.315 per share of common stock in the third quarter of 2013, representing an increase of $0.02 or 6.8% compared with the dividend paid for the same quarter in 2012. The Companys Board of Directors recently declared a fourth quarter 2013 regular cash dividend of $0.32 per share of common stock, representing an increase of $0.02, or 6.7% compared with the fourth quarter of 2012. This represented the tenth consecutive quarter where the Company increased its quarterly cash divided to shareholders.
Stock Repurchase Plan:
In August 2008, the Companys Board of Directors approved a program to repurchase up to 300,000 shares of the Companys common stock, or approximately 10.2% of the shares then currently outstanding. The new stock repurchase program became effective as of August 21, 2008, and was authorized to continue for a period of up to twenty-four consecutive months. In August of 2010, the Companys Board of Directors authorized the continuance of this program through August 17, 2012. In August of 2012, the Companys Board of Directors authorized the continuance of this program through August 17, 2014. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time to time, without prior notice and may be made in the open market or through privately negotiated transactions.
As of September 30, 2013, the Company had repurchased 104,952 shares of stock under this plan, at a total cost of $2,937 and an average price of $27.98 per share. During the three and nine months ended September 30, 2013, 700 shares were repurchased under the plan. The Company records repurchased shares as treasury stock.
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.
59
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, 2013, commitments under existing standby letters of credit totaled $378, compared with $307 at December 31, 2012. The fair value of the standby letters of credit was not significant as of the foregoing dates.
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 details the notional or contractual amount for financial instruments with off-balance sheet risk as of September 30, 2013, and December 31, 2012:
|
|
|
|
|
September 30,
2013
|
|
December 31,
2012
|
|
|
|
|
Commitments to originate loans
|
$ 26,058
|
|
$ 20,843
|
Unused lines of credit
|
95,946
|
|
106,773
|
Un-advanced portions of construction loans
|
16,818
|
|
22,047
|
Total
|
$138,822
|
|
$149,663
|
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. A portion of the Banks deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Banks liquidity position tightens.
60
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 general policy is to maintain a liquidity position of at least 4.0% of total assets over the 30 day horizon. At September 30, 2013, liquidity, as measured by the basic surplus/deficit model, was 10.2% over the 30-day horizon and 9.4% over the 90-day horizon.
At September 30, 2013, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB of Boston approximating $193 million. The Bank also had capacity to borrow funds on a secured basis utilizing the Borrower-In-Custody (BIC) program and the Discount Window at the Federal Reserve Bank of Boston. At September 30, 2013, the Banks available secured line of credit at the Federal Reserve Bank of Boston stood at $170,935, or 12.4% of the Banks total assets. The Bank also has access to the national brokered deposit market, and periodically uses this funding source to bolster its on-balance sheet 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.
Recent Accounting Developments
The following information presents a summary of Accounting Standards Updates (ASUs) that were recently adopted by the Company, as well as those that will be subject to implementation in future periods.
61
ASU No. 2011-11,
Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities
. ASU 2011-11 amends Topic 210,
Balance Sheet,
to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and did not have a material impact on the Companys consolidated financial statements.
ASU 2012-02, Intangibles
Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.
Under the guidance in this ASU, an entity has the option to bypass the qualitative assessment outlined in ASU 2011-08, IntangiblesGoodwill and Other (Topic 350): Testing Goodwill for Impairment, for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entitys financial statements for the most recent annual or interim period have not yet been issued or, for non-public entities, have not yet been made available for issuance. The adoption of this ASU did not have a significant impact to the Companys financial statements.
62
ASU 2012-03,
Technical Amendments and Corrections to SEC SectionsAmendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22
.
The amendments in ASU 2012-03 that have no transition guidance are effective immediately for public and private entities. Amendments that are subject to transition guidance will be effective for public companies for fiscal periods beginning after December 15, 2012, and for nonpublic entities for fiscal periods beginning after December 15, 2013. The adoption of this ASU did not have a significant impact to the Companys financial statements.
ASU 2013-02,
Comprehensive Income (Topic 220) Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income
. The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments in this update apply to all entities that issue financial statements that are presented in conformity with U.S. GAAP and that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods presented, including interim periods. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. Adoption of this update did not have a material impact on our financial condition or results of operations.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Companys business activities.
Interest Rate Risk:
Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.
The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by the Asset/Liability Committee ("ALCO") and the Banks Board of Directors.
The Bank's Asset Liability Management Policy, approved annually by the Banks Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.
The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense of all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.
The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage backed securities are developed from industry median
63
estimates of prepayment speeds, based upon similar coupon ranges and seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:
·
A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption.
·
A 200 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve-month 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, re-pricing opportunities driven by maturities, cash flow, and adjustable rate products will continue to change the balance sheet profile for each of the rate conditions.
Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines.
The following table summarizes the Bank's net interest income sensitivity analysis as of September 30, 2013, over one and two-year horizons and under rising and declining interest rate scenarios. In light of the Federal Funds rate of 0% to 0.25% and the two-year U.S. Treasury note of 0.32% on the date presented, the analysis incorporates a declining interest rate scenario of 100 basis points, rather than the 200 basis points, as would traditionally be the case.
INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
September 30, 2013
|
|
|
|
-100 Basis Points Parallel Yield Curve Shift
|
+200 Basis Points Parallel Yield Curve Shift
|
Year 1
|
|
|
Net interest income ($)
|
$(425)
|
$(797)
|
Net interest income (%)
|
-0.99%
|
-1.88%
|
Year 2
|
|
|
Net interest income ($)
|
$(117)
|
$ (74)
|
Net interest income (%)
|
-0.27%
|
-0.17%
|
As more fully discussed below, the September 30, 2013, interest rate sensitivity modeling results indicate that the Banks balance sheet was about evenly matched over the one and two-year horizons.
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 remain relatively stable over the one and two-year horizons. The relatively stable trend over the one and two-year horizons principally results from funding costs rolling over at lower prevailing rates, while largely offsetting expected declines in earning asset yields.
64
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 decline moderately over the one and two-year horizons as declining earning assets yields outpace reductions in funding costs. Should the yield curve steepen as rates fall, the model suggests that accelerated earning asset prepayments will slow, resulting in a more stabilized level of net interest income. Management anticipates that moderate to strong earning asset growth will be needed to meaningfully increase the 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 with the balance of the yield curve shifting in parallel with these increases, management believes net interest income will decline moderately over the one-year horizon and then trend steadily upward over the two-year horizon and beyond. The interest rate sensitivity simulation model suggests that as interest rates rise, the Banks funding costs will initially re-price proportionately with earning asset yields. As funding costs begin to stabilize late in the first year of the simulation, the model suggests that the earning asset portfolios will continue to re-price at prevailing interest rate levels and cash flows from the Banks earning asset portfolios will be reinvested into higher yielding earning assets, resulting in a widening of spreads and increases in net interest income over the two year horizon and beyond. Management believes moderate to strong earning asset growth will be necessary to meaningfully increase the current level of net interest income over the one-year horizon should short-term and long-term interest rates rise in parallel. Over the two-year horizon and beyond, management believes moderate earning asset growth will be necessary to meaningfully increase the current level of net interest income.
Interest rates plummeted during 2008 and have remained historically low ever since, as the global economy slowed at unprecedented levels, unemployment levels soared, delinquencies on all types of loans increased along with decreased consumer confidence and dramatic declines in housing prices. Management believes the most significant ongoing factor affecting market risk exposure and the impact on net interest income continues to be the slow and extended recovery from the severe nationwide recession and the U.S. Governments extraordinary responses, including a variety of government stimulus programs and quantitative easing strategies. Recent actions by the Federal Reserve have posed a further threat to net interest income, given its determination to maintain short-term interest rates at historically low levels for an extended period of time. Net interest income exposure is also significantly affected by the shape and level of the U.S. Government securities and interest rate swap yield curve, and changes in the size and composition of the Banks loan, investment and deposit portfolios.
The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, 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.
65
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 adverse effect on the Company's consolidated financial statements.
Item 1A: Risk Factors
There have been no material changes to the Risk Factors previously disclosed in Part I, Item 1A of the Companys Annual Report on Form 10-K for the year-ended December 31, 2012.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
(b) The following table sets forth the Companys repurchases of its common stock under the Companys stock repurchase plan for the three months ended September 30, 2013.