UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
Commission File Number: 0-13666
BAR HARBOR BANKSHARES
(Exact name of registrant as specified in its charter)
Maine | 01-0393663 | |
P.O. Box 400, 82 Main Street | 04609-0400 | (207) 288-3314 |
Securities registered pursuant to Section 12(g) of the Act:
Title of class |
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Common Stock, $2.00 par value per share |
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Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: YES _______ NO x X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act: YES _______ NO x X
Indicate by check mark if the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: YES xX NO ___NO___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act: Large accelerated filer _______ Accelerated filer xX Non-accelerated filer (do not check if a smaller reporting company) _______ Smaller reporting company _______
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): YES ____NO ___ NO xX
As of June 30, 2007,2008, the aggregate market value of the 2,990,7742,885,486 shares of Common Stock of the Registrant issued and outstanding on such date, excluding the approximately 53,06456,542 shares held by all directors and executive officers of the Registrant as a group (which does not include unexercised stock options), was $94,801,037.$80,447,350. This aggregate market value is based on the last sale price of $31.70$27.88 per share of the Registrant’s Common Stock on June 30, 2007,2008, as reported in The Wall Street Journal on July 2, 2007.1, 2008. Although directors of the Registrant and executive officers of the Registrant and its subsidiaries were assumed to be "affiliates" of the Registrant for purposes of this calculation, the classification is not to be interpreted as an affirmation of such status.
Number of shares of Common Stock par value $2.00 outstanding as of March 3, 2008:03, 2009: 2,978,4912,870,221
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 20, 200819, 2009 are incorporated by reference into Part III, Items 10-14 of this Annual Report on Form 10-K.
FORWARD-LOOKING STATEMENTS DISCLAIMER
Certain statements, as well as certain other discussions contained in this Annual Report on Form 10-K, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. You can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.
Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operations, financial condition, and the business of Bar Harbor Bankshares (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 Company’s 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 securities and the interest expense paid on deposits and borrowings) generated by the Company’s | |
(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 nontraditional institutions, such as credit unions and finance companies; | |
(iv) | A significant portion of the Bank's loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other intangible factors which are considered in making commercial loans and, accordingly, the Company's profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions; | |
(v) | A significant delay in or inability to execute strategic initiatives designed to increase revenues and or control expenses; | |
(vi) | The potential need to adapt to changes in information technology systems, on which the Company is highly dependent, could present operational issues or require significant capital spending; | |
(vii) | Significant changes in the Company’s 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 Company’s markets, which could have an adverse effect on the Company’s financial performance and that of borrowers and on the financial markets and the price of the Company’s 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 | |
(x) | The effectiveness of the Emergency Economic Stabilization Act of 2008 ("EESA") and the other legislative and regulatory efforts to stabilize the U. S. financial markets. | |
(xi) | Changes in general, national, international, regional or local economic conditions and credit markets which are less favorable than those anticipated by Company management, including fears of global economic depression and continued subprime loan and credit issues, impacting the Company's investment securities portfolio, quality of credits, or the overall demand for the Company's products or services; and | |
(xii) | The Company’s success in managing the risks involved in all of the foregoing matters. |
The forward-looking statements contained herein represent the Company's judgment as of the date of this Annual Report on Form 10-K, 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 Annual Report on Form 10-K, except to the extent required by federal securities laws.
TABLE OF CONTENTS
PART I | ||
ITEM 1 | BUSINESS | 6 |
Organization | 6 | |
Bar Harbor Bank & Trust | 6 | |
Bar Harbor Trust Services | 8 | |
Competition | 8 | |
Management and Employees | 9 | |
Supervision and Regulation |
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Financial Information About Industry Segments |
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Availability of Information – Company Website |
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ITEM 1A | RISK FACTORS |
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ITEM 1B | UNRESOLVED STAFF COMMENTS |
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ITEM 2 | PROPERTIES |
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ITEM 3 | LEGAL PROCEEDINGS |
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ITEM 4 | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
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PART II | ||
ITEM 5 | MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
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Quarterly Stock Prices |
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Dividends Paid to Shareholders |
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Stock Repurchase Plan |
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Incentive Stock Option Plan |
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Transfer Agent Services |
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Recent Sales of Unregistered Securities: Use of Proceeds from Unregistered Securities | 31 | |
ITEM 6 | SELECTED CONSOLIDATED FINANCIAL DATA |
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ITEM 7 | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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Executive Overview |
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Application of Critical Accounting Policies |
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Financial Condition |
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Results of Operations |
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ITEM 7A | QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK | 84 | |
ITEM 8 | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | 90 | |
ITEM 9 | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES | 131 | |
ITEM 9A | CONTROLS AND PROCEDURES | 131 | |
ITEM 9B | OTHER INFORMATION | 133 | |
PART III | |||
ITEM |
| 133 | |
ITEM |
| 133 | |
ITEM 12 | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 134 | |
ITEM 13 | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE | 134 | |
ITEM 14 | PRINCIPAL ACCOUNTING FEES AND SERVICES | 134 | |
PART IV | |||
ITEM 15 | EXHIBITS, FINANCIAL STATEMENTS SCHEDULES | 134 | |
SIGNATURES | 138 |
PART I
ITEM 1. BUSINESS
Organization
Bar Harbor Bankshares (the "Company") ("BHB") was incorporated under the laws of the state of Maine on January 19, 1984. As of March 3, 2008,2009, the Company’s authorized securities consisted of one classof: 10,000,000 shares of common stock, par value of $2.00 per share, of which there were 2,978,4912,870,221 shares outstanding held of record by approximately 1,011 shareholders. 1,001 shareholders; and 1,000,000 shares of preferred stock, of which 18,751 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share, $1,000 per share liquidation, are issued and outstanding and entirely owned by the U.S. Treasury in connection with the Company’s participation in the U.S. Treasury’s Capital Purchase Program ("CPP").
The Company has one, wholly ownedwholly-owned first tier operating subsidiary, Bar Harbor Bank & Trust (the "Bank"), a community bank, which offers a wide range of deposit, loan, and related banking products, as well as brokerage services provided through a third-party brokerage arrangement. In addition, the Company offers trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services ("Trust Services"), a Maine chartered non-depository trust company. These products and services are offered to individuals, businesses, not-for-profit organizations and municipalities.
The Company is a bank holding company ("BHC") registered under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the "FRB"). The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the Statestate of Maine, and as such is subject to the jurisdiction of the Superintendent (the "Superintendent") of the Maine Bureau of Financial Institutions ("BFI").
Bar Harbor Bank & Trust
The Bank, originally founded in 1887 and now a direct, wholly ownedwholly-owned subsidiary of the Company, is a Maine financial institution, and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum extent permitted by law. The Bank is subject to the supervision, regulation, and examination of the FDIC and the BFI. It is not a member of the Federal Reserve Bank.
The Bank has twelve (12) branch offices located throughout downeast and midcoast Maine, including its principal office located at 82 Main Street, Bar Harbor. The Bank’s offices are located in Hancock, Washington, and Knox Counties, representing the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in Blue Hill, Deer Isle, Ellsworth, Northeast Harbor, Somesville, Southwest Harbor, and Winter Harbor. The Washington County offices are located in Milbridge, Machias, and Lubec. The Knox County office is located in Rockland. The Bank delivers its operations and technology support services from its operations center located in Ellsworth, Maine.
The Bank is a retail bank serving individual and business customers, retail establishments and restaurants, seasonal lodging, and a large contingent of retirees. As a coastal bank, it serves the tourism, hospitality, lobstering, fishing, boat building and marine services industries. It also serves Maine’s wild blueberry industry through its Hancock and Washington County offices. The Bank operates in a competitive market that includes other community banks, savings institutions, credit unions, and branch offices of statewide and interstate bank holding companies located in the Bank’s market area. The Bank continues to be one of the larger independent commercial banks in the state of Maine.
The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a materiallymaterial adverse effect on its business. Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring, and higher deposits in the summer and fall.autumn. These seasonal swings have been fairly predictable and have historically not had a material adverse impact on the Bank or its liquidity position. Approximately 88%90% of the Bank’s deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on all of the deposit account products it offers and does not anticipate any material loss of these deposits.
The Bank emphasizes personal service to the community, with a concentration on retail banking. Customers are primarily individuals and small businesses to which the Bank offers a wide variety of products and services.
Retail Products and Services: The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and borrowing needs of its retail customers. The Bank’s retail deposit products and services include checking accounts, interest bearing NOW accounts, money market accounts, savings accounts, club accounts, short-term and long-term certificates of deposit, Health Savings Accounts, and Individual Retirement Accounts. Credit products and services include home mortgages, residential construction loans, home equity loans and lines of credit, student loans, credit cards, installment loans, and overdraft protection services. The Bank provides secured and unsecured installment loans for new or used automobiles, boats, recreational vehicles, mobile homes and other personal needs. The Bank also offers other customary products and services such as safe deposit box rentals, wire transfers, check collection services, foreign currency exchange, money orders, and U.S. Savings Bonds.
The Bank staffs a customer service center, providing customers with telephone and e-mail responses to their questions and needs. The Bank also offers free banking-by-mail services.
Retail Brokerage Services: The Bank retains Infinex Investments, Inc,Inc., ("Infinex") as a full service third-party broker-dealer, conducting business under the assumed business name "Bar Harbor Financial Services." Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or its subsidiaries. These products are not deposits, are not insured by the FDIC or any other government agency, are not guaranteed by the Bank or any affiliate, and may be subject to investment risk, including possible loss of value.
Bar Harbor Financial Services principally serves the brokerage needs of individuals, from first-time purchasers, to sophisticated investors. It also offers a line of life insurance, annuity, and retirement products, as well as financial planning services. Infinex was formed by a group of member banks, and is reportedly the current largest provider of third party investment and insurance services to banks and their customers in New England. Through Infinex, the Bank is able to take advantage of the expertise, capabilities, and experience of a well-established third-party broker-dealer in a cost effective manner.
Electronic Banking Services: The Bank continues to offer free Internet banking services, including free check images and electronic bill payment, through its dedicated website at www.BHBT.com. Additionally, the Bank offers TeleDirect, an interactive voice response system through which customers can check account balances and activity, as well as initiate money transfers between their accounts. Automated Teller Machines (ATMs) are located at each of the Bank’s twelve (12) branch locations, as well as threetwo machines in non-Bank locations. These ATMs access major networks throughout the United States, including Plus, NYCE, and other major ATM and credit card companies. The Bank is also a member of Maine Cash Access, providing customers with surcharge-free access to 224230 ATMs throughout the state of Maine. Visa debit cards are also offered, providing customers with free access to their deposit account balances at point of sale locations throughout most of the world.
Commercial Products and Services: The Bank serves the small business market throughout downeast and midcoast Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate and equipment financing, working capital, real estate development, and a broad range of other business purposes. Business loans are provided primarily to organizations and sole proprietors in the tourism, hospitality, healthcare, blueberry, boatbuilding, and fishing industries, as well as to other small and mid-size businesses associated with coastal communities. Certain larger loans, which exceed the Bank’s lending limits, are written on a participation basis with other financial institutions, whereby the Bank retains only such portions of those loans that are within its lending limits and credit risk tolerances.
The Bank offers a variety of commercial deposit accounts, most notably business checking and tiered money market accounts. These accounts are typically used as operating accounts or short-term savings vehicles. The Bank’s cash management services provide business customers with short-term investment opportunities through a cash management sweep program, whereby excess operating funds over established thresholds are swept into overnight securities sold under agreements to repurchase. The Bank also offers Business On Line Direct ("BOLD") an Internet banking service for businesses. This service allows business clients to view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, transmit Automated Clearing House (ACH) files, and order both domestic and foreign wire transfers. The Bank also offers remote deposit capture, enabling its business customers to deposit checks remotely. Other commercial banking services include merchant credit card processing provided through a third party vendor, night depository, and coin and currency handling.
Bar Harbor Trust Services
Trust Services is a Maine chartered non-depository trust company and a wholly ownedwholly-owned subsidiary of the Bank. Trust Services provides a comprehensive array of trust and investment management services to individuals, businesses, not-for-profit organizations, and municipalities of varying asset size.
Trust Services serves as trustee of both living trusts and trusts under wills, including revocable and irrevocable, charitable remainder and testamentary trusts, and in this capacity holds, accounts for and manages financial assets, real estate and special assets. Trust Services offers custody, estate settlement, and fiduciary tax services. Additionally, Trust Services offers employee benefit trust services for which it acts as trustee, custodian, administrator and/or investment advisor, for employee benefit plans and for corporate, self employed, municipal and not-for-profit employers located throughout the Company’s market areas.
The staff includes credentialed investment and trust professionals with extensive experience. At December 31, 2007,2008, Trust Services served 760781 client accounts, with assets under management and held in custody amounting to $278$230 million and $23$17 million, respectively.
Competition
The Company competes principally in downeast and midcoast Maine, which can generally be characterized as rural areas. The Company considers its primary market areas to be in Hancock, Knox, and Washington counties, each in the state of Maine. According to the most recent Census Bureau Report (2006), the population of these three counties iswas 53,797, 41,096 and 33,288 respectively, representing a combined population of approximately 128,181. TheirThe economies in these three counties are based primarily on tourism, healthcare, fishing, aquaculture, agriculture, and small local businesses, but are also supported by a large contingent of retirees. Major competitors in these market areas include local independent banks, local branches of large regional bank affiliates, thrift institutions, savings and loan institutions, mortgage companies, and credit unions. Other competitors in the Company’s primary market area include financing affiliates of consumer durable goods manufacturers, insurance companies, brokerage firms, investment advisors, and other non-bank financial service providers.
Like most financial institutions in the United States, the Company competes with an ever-increasing array of financial service providers. As the national economy moves further towards a concentration of service companies, competitive pressures will mount.
As a bank holding company and state-chartered commercial financial institution, respectively, the Company and the Bank are subject to extensive regulation and supervision, including, in many cases, regulations that limit the type and scope of their activities. The non-bank financial service providers that compete with the Company and the Bank may not be subject to such extensive regulation, supervision, and tax burden. Competition from nationwide banks, as well as local institutions, continues to be aggressive.
The financial services industry is undergoing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Further technological advances are likely to intensify competition by enabling more companies to provide financial resources. Accordingly, the Company’s future success will depend in part on its ability to address customer needs by using technology. There is no assurance that the Company will be able to develop new technology-driven products and services or be successful in marketing these products to its customers. Many of the Company’s competitors have far greater resources to invest in technology.
The Company has generally been able to compete effectively with other financial institutions by emphasizing quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers; however, no assurance can be given that the Company will continue to be able to compete effectively with other financial institutions in the future.
No material part of the Company’s business is dependent upon one, or a few customers, or upon a particular industry segment, the loss of which would have a material adverse impact on the operations of the Company.
Management and Employees
The Company has two principal officers: Joseph M. Murphy, President and Chief Executive Officer, and Gerald Shencavitz, Executive Vice President, Chief Financial Officer and Treasurer.
Joseph M. Murphy also serves as President and Chief Executive Officer of the Bank. Gerald Shencavitz also serves as Executive Vice President, Chief Financial Officer, Chief Operating Officer and Treasurer of the Bank, and Chief Financial Officer of Trust Services. Other senior operating positions in the Company include a President of Trust Services, and Senior Vice Presidents in charge of retail banking, business banking, credit administration, operations, human resources and marketing.
As of December 31, 2007,2008, the Bank employed 139 full-time equivalent employees, Trust Services employed 12 full-time equivalent employees, and the holding company employed 3 full-time employees, representing a full-time equivalent complement of 154 employees of the Company.
The Company maintains comprehensive employee benefit programs, which provide health, dental, long-term and short-term disability, and life insurance. All Company employees are eligible for participation in the Bar Harbor Bankshares 401(k) Plan provided they meet minimum age and service requirements. Certain officers and employees of the Company and its subsidiaries also participate in the Company’s 2000 Stock Option Plan and/or have incentive bonus compensation plans, deferred compensation arrangements, supplemental executive retirement agreements and change in control, confidentiality and non-compete agreements.
The Company’s management believes that employee relations are good and there are no known disputes between management and employees.
Supervision and Regulation
The business in which the Company and its subsidiaries are engaged is subject to extensive supervision, regulation, and examination by various federal and state bank regulatory agencies, including the FRB, the FDIC, and the Superintendent, as well as other governmental agencies in the states in which the Company and its subsidiaries operate. The supervision, regulation, and examination to which the Company and its subsidiaries are subject are intended primarily to protect depositors and other customers, or are aimed at carrying out broad public policy goals, and are not necessarily for the protection of the shareholders.
Some of the more significant statutory and regulatory provisions applicable to banks and BHCs, to which the Company and its subsidiaries are subject, are described more fully below, together with certain statutory and regulatory matters concerning the Company and its subsidiaries. The description of these statutory and regulatory provisions does not purport to be complete and is qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable law or regulation may have a material effect on the Company’s business and operations, as well as those of its subsidiaries. Because of deterioration of the financial markets in 2008, more laws and regulations imposing requirements and restrictions on banks and bank holding companies are expected to be adopted in 2009. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statue or regulation.
Bank Holding Company Act: As a registered BHC and a Maine financial institution holding company, the Company is subject to regulation under the BHC Act and Maine law and to examination and supervision by the Board of Governors of the FRB and the Superintendent, and is required to file reports with, and provide additional information requested by, the FRB and the Superintendent. The FRB has the authority to issue orders to BHCs to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals that violate the BHC Act or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of BHCs, and to order termination of ownership and control of a non-banking subsidiary of a BHC.
Under the BHC Act, the Company may not generally engage in activities or acquire more than 5% of any class of voting securities of any company engaged in activities other than banking or activities that are closely related to banking. However, a bank holding company that has elected to be treated as a "financial holding company" may engage in activities that are financial in nature or incidental or complementary to such financial activities, as determined by the FRB alone, or together with the Secretary of the Department of the Treasury. The Company has not elected financial holding company status. Under certain circumstances, the Company may be required to give notice to or seek approval of the FRB before engaging in activities other than banking. In addition, Maine law requires approval by the Superintendent prior to acquisition of more than 5% of the voting shares of a Maine financial institution or any financial institution holding company that controls a Maine financial institution. The Superintendent also must approve acquisition by a Maine financial institution holding company of more than 5% of a financial institution or financial institution holding company domiciled outside of the state of Maine.
Bank Holding Company Support of Subsidiary Banks: Under FRB policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiaries and to commit resources to their support. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, under the cross-guarantee provisions of Federal Deposit Insurance Act, as amended, the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (1) the "default" of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution "in danger of default." The Company’s bank subsidiary, Bar Harbor Bank & Trust, is an FDIC insured depository institution.
Regulatory Capital Requirements: The FRB and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, these regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated growth.
The FRB risk-based guidelines define a three-tier capital framework. Tier 1 capital includes common shareholders’ equity and qualifying preferred stock, less goodwill and other adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for credit losses up to 1.25% of risk-weighted assets. Tier 3 capital includes subordinated debt that is unsecured, fully paid, has an original maturity of at least two years, is not redeemable before maturity without prior approval by the FRB and includes a lock-in clause precluding payment of either interest or principal if the payment would cause the issuing bank’s risk-based capital ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents qualifying total capital. Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk. The minimum Tier 1 capital ratio is 4% and the minimum total capital ratio is 8%. The Company’s Tier 1 capital ratio as of December 31, 20072008, was 10.76%9.95% and its total capital ratio was 11.59%11.60%.
The leverage ratio is determined by dividing Tier 1 capital by adjusted average total assets. Although the stated minimum ratio is 100 to 200 basis points above 3%, banking organizations are required to maintain a ratio of at least 5% to be classified as well capitalized.well-capitalized. The Company’s leverage ratio as of December 31, 20072008 was 7.10%6.61%.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), among other things, identifies five capital categories for insured depository institutions (well capitalized,(well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee that bank’s compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of 5% of the bank’s assets at the time it became "undercapitalized" or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation, and permits regulatory action against a financial institution that does not meet such standards.
The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a bank generally shall be deemed to be:
Regulators also must take into consideration (1) concentrations of credit risk; (2) interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and (3) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination. In addition, the Company, and any bank with significant trading activity, must incorporate a measure for market risk into their regulatory capital calculations. At December 31, 2007,2008, and at the time of this report, the Company’s risk-based capital ratio and leverage ratio were well in excess of regulatory requirements, and its management expects these ratios to remain in excess of regulatory requirements. In addition, at December 31, 2007,2008, and at the time of this report the Bank was well in excess of applicable FDIC requirements.
An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate FDIC regional director within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. An institution, which is required to submit a capital restoration plan, must concurrently submit a performance guaranty by each company that controls the institution. A critically undercapitalized institution generally is to be placed in conservatorship or receivership within 90 days unless the FDIC formally determines that forbearance from such action would better protect the deposit insurance fund.
Immediately upon becoming undercapitalized, an institution becomes subject to the provisions of Section 38 of the FDIA,Federal Deposit Insurance Act ("FDIA"), including for example, (i) restricting payment of capital distributions and management fees, (ii) requiring that the FDIC monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution’s assets and (v) requiring prior approval of certain expansion proposals.
In 2005, theThe federal banking agencies issued an advancea final rule entitled "Risk Based Capital Standards: Advanced Capital Adequacy Framework-Basel II" ("Basel II") which became effective on April 1, 2008, and "core" banks ("core" banks are the approximately 20 largest U. S. bank holding companies) were required to adopt a board-approved plan to implement Basel II by October 1, 2008. Basel II will result in significant changes to the risk-based capital standards for "core" banks subject to Basel II and other banks that elect to use such rules to calculate their risk-based capital requirements. In connection with Basel II, the Agencies published a joint notice of proposed rulemaking ("ANPR"entitled "Risk-Based Capital Guidelines: Capital Adequacy Guidelines: Standardized Framework" on July 29, 2008 (the "Standardized Approach Proposal") concerning potential changes in. The Standardized Approach Proposal, if adopted by the risk-based capital rules ("Basel 1-A") that are designed to apply to, and potentially reduce the risk capital requirements of bank holding companies, such as the Company, that are not among the 20 or so largest U.S. bank holding companies. In December 2006, the FDIC issued a revised Interagency Notice of Proposed Rulemaking concerning Basel 1-A (the "NPR"), whichAgencies, would allow banks and bank holding companies that are not among the 20 or so largest U.S. bank holding companies ("Core Banks") to either adopt Basel 1-A or remain subject to the existing risk-based capital rules. In July 2007 an interagency press release stated that the federal banking agencies have agreed to issue a proposed rule that would provide all non-core banks with the option to adopt an approach consistent withoptional framework, based upon the standardized approach of Basel II. This proposal would replace Basel 1-A. In November 2007under the federal banking agencies implementedinternational Basel II Accord, for the Core Banks, permitting only the advance approach.calculating their risk-based capital requirements. The final rule implementingBank does not currently expect to calculate its capital ratios under Basel II reiterated that non-core banks would haveor in accordance with the option to take the standardized approach and that it is the agencies intention to have the standardized proposal finalized before the Core Banks begin the first transitional floor period under Basel II.Standardized Approach Proposal. Accordingly, the Company is not yet in a position to determine the effect of such rules on its risk capital requirements.
Information concerning the Company and its subsidiaries with respect to capital requirements is incorporated by reference from Part II, Item 7, section entitled "Capital Resources" and from Part II, Item 8, Notes to Consolidated Financial Statements, Note 12 "Shareholders’ Equity," each in this Annual Report on Form 10-K for the year ended December 31, 20072008.
Transactions with Affiliates: Under Sections 23A and 23B of the FRA and Regulation W thereunder, there are various legal restrictions on the extent to which a bank holding company and its non-bank subsidiaries may borrow, obtain credit from or otherwise engage in "covered transactions" with its FDIC-insured depository institution subsidiaries. Such borrowings and other covered transactions by an insured depository institution subsidiary (and its subsidiaries) with its non-depository institution affiliates are limited to the following amounts:
"Covered transactions" are defined by statute for these purposes to include a loan or extension of credit to an affiliate, a purchase of or investment in securities issued by an affiliate, a purchase of assets from an affiliate unless exempted by the FRB, the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company, or the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. Covered transactions are also subject to certain collateral security requirements. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property of any kind, or furnishing of any service.
Change in Bank Control Act: The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a BHC, unless the FRB has been notified and has not objected to the transaction. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a BHC with a class of securities registered under section 12 of the Securities Exchange Act of 1934 as amended (the "Act""Exchange Act"), would, under the circumstances set forth in the presumption, constitute acquisition of control of the BHC. In addition, a company is required to obtain the approval of FRB under the BHC Act before acquiring 25% (5% in the case of an acquirer that is a BHC) or more of any class of outstanding voting securities of a BHC, or otherwise obtaining control or a "controlling influence" over that BHC. In September 2008 the FRB released guidance on minority investment in banks which relaxed the presumption of control for investments of greater than 10% of a class of outstanding voting securities of a bank holding company in certain instances discussed in the guidance.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994: Riegle-Neal permits adequately or well capitalizedwell-capitalized and adequately or well managed bank holding companies, as determined by the FRB, to acquire banks in any state subject to certain concentration limits and other conditions. Riegle-Neal also generally authorizes the interstate merger of banks. In addition, among other things, Riegle-Neal permits banks to establish new branches on an interstate basis provided that the law of the host state specifically authorizes such action. However, as a bank holding company, we areThe Company is required to obtain prior FRB approval before acquiring more than 5% of a class of voting securities, or substantially all of the assets, of a bank holding company, bank or savings association.
Declaration of Dividends: The FRB has authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The FRB has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality and overall financial condition. The Company depends in part upon dividends received from its subsidiary banksBank to fund its activities, including the payment of dividends. As described below, the Federal Deposit Insurance Corporation ("FDIC") may also regulate the amount of dividends payable by the subsidiary banks. The inability of the banks to pay dividends may have an adverse effect on the Company.
Under current Maine corporation law, the directors of a corporation may make distributions (including declaration of a dividend) to its shareholders (subject to restriction by the articles of incorporation) unless, after giving effect to the distribution: (1) the corporation’s total assets would be less than its total liabilities, with liquidation preferences of any senior preferred shares treated as liabilities (the "balance sheet test"); or (2) the corporation would not be able to pay its debts as they become due in the usual course of business (the "equity solvency test"). In order for a distribution to be lawful under Maine corporate law, it must satisfy both the balance sheet test and equity solvency test. These limitations generally apply to investor owned Maine financial institutions and financial institution holding companies.
In addition to the foregoing, and as more fully described below under the caption "Capital Purchase Program," the consent of the U. S. Treasury is generally required for any increase in common dividends per share.
Limitations on Bank Dividends: The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis.
Activities and Investments of Insured State-Chartered Banks: FDIC insured, state-chartered banks, such as the Bank, are also subject to similar restrictions on their business and activities. Section 24 of the Federal Deposit Insurance Act ("FDIA"), generally limits the activities as principal and equity investments of FDIC insured, state-chartered banks to those activities that are permissible to national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of state-chartered banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notices to engage in such activities.
Safety and Soundness Standards: The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),FDICIA, as amended, directs each federal banking agency to prescribe safety and soundness standards for depository institutions relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk, asset growth, compensation, asset quality, earnings, and stock valuation. The Community Development and Regulatory Improvement Act of 1994 amended FDICIA by allowing federal banking agencies to publish guidelines rather than regulations covering safety and soundness.
FDICIA also contains a variety of other provisions that may affect the Company’s and the Bank’s operations, including reporting requirements, regulatory guidelines for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days prior written notice to customers and regulatory authorities before closing any branch.
Community Reinvestment: The Community Reinvestment Act ("CRA") requires lenders to identify the communities served by the institution’s offices and other deposit taking facilities and to make loans and investments and provide services that meet the credit needs of these communities. Regulatory agencies examine each of the banks and rate such institutions’ compliance with CRA as "Outstanding," "Satisfactory," "Needs to Improve" or "Substantial Noncompliance." Failure of an institution to receive at least a "Satisfactory" rating could inhibit such institution or its holding company from undertaking certain activities, including engaging in activities newly permitted as a financial holding company under the GLBAGramm-Leach-BlileyAct ("GLBA") and acquisitions of other financial institutions. The FRB must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low-and moderate-income neighborhoods. The Bank has achieved a rating of Satisfactory"Satisfactory" on their respective most recent examination. Maine also has enacted substantially similar community reinvestment requirements. The federal banking agencies adopted less burdensome CRA requirements, effective in 2006, for "intermediate – small banks," which are banks with $250 million or more, but less than $1 billion in total assets, (including the Bank) under which such banks are being or will be examined using only two tests, a Lending Test and a new Community Development Test, and will be relieved of certain data collection and reporting requirements.
Customer Information Security: The FDIC and other bank regulatory agencies have adopted final guidelines for establishing standards for safeguarding nonpublic personal information about customers. These guidelines implement provisions of the Gramm-Leach-Bliley Act of 1999 ("GLBA"), which establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The federal banking regulators have issued guidance for banks on response programs for unauthorized access to customer information. This guidance, among other things, requires notice to be sent to customers whose "sensitive information" has been compromised if unauthorized use of this information is "reasonably possible." A majority of states have enacted legislation concerning breaches of data security and Congress is considering federal legislation that would require consumer notice of data security breaches.
Privacy: The FDIC and other regulatory agencies have published final privacy rules pursuant to provisions of the GLBA ("Privacy Rules"). The Privacy Rules, which govern the treatment of nonpublic personal information about consumers by financial institutions, require a financial institution to provide notice to customers (and other consumers in some circumstances) about its privacy policies and practices, describe the conditions under which a financial institution may disclose nonpublic personal information to nonaffiliated third parties, and provide a method for consumers to prevent a financial institution from disclosing that information to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions.
USA Patriot Act: The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act, together with the implementing regulations of various federal regulatory agencies, has caused financial institutions, including the Bank and Trust Services, to adopt and implement additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions. It also requires the Federal Reserve Board (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money-laundering activities when considering applications filed under Section 3 of the BHC Act, or under the Bank Merger Act. In 2006, final regulations under the USA Patriot Act were issued requiring financial institutions, including the Bank, to take additional steps to monitor their correspondent banking and private banking relationships as well as their relationships with "shell banks." Management believes the Company is in compliance with all of the requirements prescribed by the Patriot Act and all applicable final implementing regulations.
Identity Theft Red Flags: The federal banking agencies (the "Agencies") jointly issued final rules and guidelines in November 2007, implementing section 114 of the Fair and Accurate Credit Transactions Act of 2003 ("FACT Act") and final rules implementing section 315 of the FACT Act. The rules implementing section 114 require each financial institution or creditor to develop and implement a written Identity Theft Prevention Program (the "Program") to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts. In addition, the Agencies issued guidelines to assist financial institutions and creditors in the formulation and maintenance of a Program that satisfies the requirements of the rules. The rules implementing section 114 also require credit and debit card issuers to assess the validity of notifications of changes of address under certain circumstances. Additionally, the Agencies are issuing joint rules under section 315 that provide guidance regarding reasonable policies and procedures that a user of consumer reports must employ when a consumer reporting agency sends the user a notice of address discrepancy. The joint final rules and guidelines arewere effective January 1, 2008. The mandatory compliance date for this rule iswas November 1, 2008. Management believes the Company is in compliance with all of the requirements prescribed by the FACT Act and all applicable final implementing rules.
Fair Credit Reporting Affiliate Marketing Regulations: In November 2007, the federal banking agencies (the "Agencies") published final rules to implement the affiliate marketing provisions in section 214 of the FACT Act, which amends the Fair Credit Reporting Act. The final rules generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations. These rules arewere effective January 1, 2008. The mandatory compliance date for these rules iswas October 1, 2008. Management believes the Company is in full compliance with the final rules implementing the affiliate marketing provisions in section 214 of the FACT Act.
Insurance of Accounts and FDIC Regulation: The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC. In 2006, the FDIC enacted various rules to implement the provisions of the Federal Deposit Insurance Reform Act of 2005 (the "FDI Reform Act"). Pursuant to the FDI Reform Act, in 2006 the FDIC merged the Bank Insurance Fund with the Savings Association Insurance Fund to create a newly named Deposit Insurance Fund (the "DIF") that covers both banks and savings associations. The FDIC also revised, effective January 1, 2007, the risk-based premium system under which the FDIC classifies institutions based on the factors described below and generally assesses higher rates on those institutions that tend to pose greater risks to the DIF. For most banks and savings associations, including the Bank, FDIC rates will depend upon a combination of CAMELS component ratings and financial ratios. CAMELS ratings reflect the applicable bank regulatory agency’s evaluation of the financial institution’s capital, asset quality, management, earnings, liquidity and sensitivity to interest rate risk. For large banks and savings associations that have long-term debt issuer ratings, assessment rates will depend upon such ratings, and CAMELS component ratings. For institutions that are in the lowest risk category, assessment rates will vary initially from five (5) to seven (7) basis points per $100 of insured deposits. Beginning January 1, 2009, the FDIC assessment rates were raised seven (7) basis points and vary initially from twelve (12) to fourteen (14) basis points per $100 of insured deposits. Further rate changes will likely take effect on April 1, 2009, after which assessment rates will vary initially from then (10) to fourteen (14) basis points per $100 of insured deposits with additional adjustments that could result in total base assessment rates of eight (8) to twenty-one (21) basis points per $100 of insured deposits.
The Federal Deposit Insurance Act ("FDIA") as amended by the FDI Reform Act requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits, the designated reserve ratio (the "DRR") for a particular year within a range of 1.15% to 1.50%. For 2007,2008, the FDIC has set the initial DRR at 1.25%. Under the FDI Reform Act and the FDIC’s revised premium assessment program, every FDIC-insured institution will pay some level of deposit insurance assessments regardless of the level of the DRR. In 2008, FDIC deposit insurance was temporarily increased from $100,000 to $250,000 per depositor through December 31, 2009.
In 2007,2008, the Bank was classified in the lowest risk category with an insurance premium rate of $.05$0.05 per $100 of deposits. The Company cannot predict whether, as a result of an adverse change in economic conditions or other reasons, the FDIC will be required in the future to increase deposit insurance assessments above 20072008 levels. In 2008, in response to the level of claims against the Bank Insurance Fund, the FDIC announced it would raise the lowest rate from 5 cents to 12 cents per $100 of assessable deposits beginning with the first quarter of 2009. In addition, beginning with the second quarter of 2009, the FDIC will add four new factors to the assessment rate calculation, including factors for brokered deposits, secured liabilities and unsecured liabilities. These changes will dramatically increase FDIC insurance expenses for all insured institutions, including the Bank.
On February 27, 2009, the FDIC adopted an interim rule, with request for comment, which would institute a one-time special assessment of 20 cents per $100 of domestic deposits on FIDC insured institutions as of June 30, 2009. The assessment would be payable on September 30, 2009. If the assessment is approved, the Bank estimates its assessment would total approximately $1.2 million. This rule would also allow the FDIC to impose additional special assessments of up to 10 cents per $100 of domestic deposits at the end of any calendar quarter after June 30, 2009, to restore the Deposit Insurance Fund.
The FDI Reform Act required the FDIC to establish a one-time historical assessment credit that provides banks a credit that can be used to offset insurance assessments in 2007 and 2008. This one-time, historical assessment credit was established to benefit banks that had funded deposit insurance funds prior to December 31, 1996. This one-time, historical assessment credit is based upon the Bank’s insured deposits as of December 31, 1996. The Bank’s one-time, historical assessment credit was $344,785 when the credit was established in 2006. During 2007, the Bank utilized a portion of this credit to entirely offset $130,530 of Federal deposit insurance assessments. It is anticipated that theThe remaining credit of $214,244 will bewas completely used in 2008.
Regulatory Enforcement Authority:The enforcement powers available to federal banking regulators include, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities. Under certain circumstances, federal and state law requires public disclosure and reports of certain criminal offenses and also final enforcement actions by the federal banking agencies.
Securities Regulation: The common stock of the Company is registered with the U. S. Securities and Exchange Commission ("SEC") under Section 12(g) of the Securities Exchange Act of 1934, as amended. Accordingly, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Act.
Temporary Liquidity Guarantee Program: The Bank is participating in the FDIC’s Temporary Liquidity Guarantee Program ("TLGP"), which consists of the Transaction Account Guarantee Program ("TAGP") and Debt Guarantee Program ("DGP"). Through the TAGP, the FDIC will provide unlimited deposit insurance coverage for all noninterest-bearing transaction accounts through December 31, 2009. This includes traditional non-interest bearing checking accounts, certain types of attorney trust accounts, and NOW accounts as long as the interest rate does not exceed 0.50%. Through the DGP, the Bank will have the option to issue senior unsecured debt (fully guaranteed by the FDIC) on or before June 30, 2009, with a maturity of June 30, 2012, or sooner. If the Bank chooses to issue debt under the DGP program it will be limited to two percent of its liabilities as of September 30, 2008, or approximately $17,565.
Capital Purchase Program ("CPP"): In 2008, the U.S. Treasury instituted the Troubled Asset Relief Program ("TARP") in response to adverse economic conditions in the financial markets, particularly the inability of creditworthy borrowers to obtain credit. Under the TARP, the U.S. Treasury developed the Capital Purchase Program ("CPP"), whereby it purchased non-voting senior preferred shares of participating financial institutions. The Company sold $18,751 of Senior Fixed Rate Cumulative Perpetual Preferred Shares, Series A, no par value per share, liquidation preference $1,000 per share (the "CPP Shares"), to the Treasury under the CPP in January 2009. The CPP Shares will pay cumulative dividends at a rate of five percent (5%) per year for the first five (5) years and will reset to a rate of nine percent (9%) per year after the fifth year. The CPP Shares are callable at par after three (3) years, including any accrued and unpaid dividends, and may be redeemed with the proceeds from a qualified equity offering of any Tier 1 perpetual preferred or common stock (a "Qualified Equity Offering") prior to the end of three (3) years. For as long as any CPP Shares are outstanding, no dividend may be declared or paid on any junior preferred shares, preferred shares ranking pari passu with the CPP Shares, or common shares unless all the accrued and unpaid dividends for the cumulative CPP Shares are fully paid. Dividends may be declared on pari passu preferred shares on a pro rata basis with the CPP Shares. The Company may not repurchase or redeem any junior preferred shares, preferred shares ranking pari passu with the CPP Shares or common shares unless all the accrued and unpaid dividends for the CPP Senior Preferred Shares are fully paid.
In addition, the consent of the Treasury will be required for any increase in common dividends per share for the first three (3) years (other than regular quarterly cash dividends of not more than $0.26 per share of common stock), unless prior to the end of three (3) years the CPP Shares have been redeemed in full or the Treasury has transferred all of the CPP Shares to third parties. The consent of the Treasury will also be required for repurchase of any shares or common shares in connection with any benefit plan in the ordinary course of business consistent with past practice, for the first three (3) years, unless prior to the end of three years the CPP Shares have been redeemed in full or the Treasury has transferred all of the CPP Senior Preferred Shares to third parties. No repurchases of junior preferred shares, preferred shares ranking pari passu with the CPP Shares or common shares will be allowed if such repurchase is prohibited by a restriction on dividends.
In conjunction with the purchase of CPP Shares, the Treasury received warrants to purchase 104,910 shares of common stock with an aggregate market price equal to 15 percent of its investment in the CPP Senior Preferred Shares (the "CPP Warrants"). The exercise price on the CPP Warrants is $26.81 per share. The CPP Warrants have a term of 10 years and will be immediately exercisable, in whole or in part. The CPP Warrants will be freely transferable; however, the Treasury may only transfer or exercise an aggregate of one-half of the warrants prior to the earlier of (i) the date on which the Company has received aggregate gross proceeds of at least one hundred percent of the issue price of the CPP Shares from one or more Qualified Equity Offerings, or (ii) December 31, 2009. In the event that the participating financial institution has received aggregate gross proceeds of at least one hundred percent of the issued price of the CPP Shares from one or more Qualified Equity Offerings on or prior to December 31, 2009, the number of shares of common stock underlying the CPP Warrants then held by the Treasury shall be reduced by a number of shares equal to the product of (i) the number of shares originally underlying the CPP Warrants (taking into account all adjustments), and (ii) 0.5.
Rules issued by Treasury and certain provisions of the American Recovery and Reinvestment Act of 2009 require participating institutions in the CPP, including the Company, to adopt certain standards for executive compensation and corporate governance rules for the period during which Treasury holds CPP Senior Preferred Shares. These standards include: (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) requiring "clawback" of any bonus or incentive compensation paid to a senior executive based on statement of earnings, gains, or other criteria that are later proven to be materially inaccurate; (3) prohibiting the financial institution from making any golden parachute payment to a senior executive (generally, severance payment in excess of three times the senior executive’s prior five-year average compensation); and (4) agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. These standards generally apply to the chief executive officer, chief financial officer, plus the next three (3) most highly compensated executive officers. The Company and the officers covered by these standards have granted the Treasury a waiver releasing the Treasury from any claims that the Company or such officer may otherwise have as a result of the issuance of any regulation which modify the terms of benefits plans, arrangements and agreements to eliminate any provisions that would not be in compliance with these executive compensation, and corporate governance standards. In addition, the American Recovery and Reinvestment Act requires CPP participants to hold a non-binding "say-on-pay" shareholder vote to approve the compensation of their executives.
Importantly, the CPP Securities Purchase Agreement may be unilaterally amended by the Treasury to the extent required to comply with any changes after January 16, 2009 (the "signing date") in applicable federal statutes. Accordingly, the Company or the Bank may be subject to further restrictions or obligations as a result of participation in the CPP.
Other Proposals: Other legislative and regulatory proposals regarding changes in banking, and the regulation of banks and other financial institutions, are regularly considered by the executive branch of the federal government, Congress and various state governments, including Maine and state and federal regulatory authorities. It cannot be predicted what additional legislative and/or regulatory proposals, if any, will be considered in the future, whether any such proposals will be adopted or, if adopted, how any such proposals would affect the Company or the Bank.
Taxation: The Company is subject to those rules of federal income taxation generally applicable to corporations under the Internal Revenue Code. The Company is also subject to state taxation under the laws of the Statestate of Maine.
Financial Information Aboutabout Industry Segments
The information required under this item is included in the Company’s financial statements, which appear in Part II, Item 8 of this Annual Report on Form 10-K, and is incorporated herein by reference.cross reference thereto.
Availability of Information – Company Website
The Company maintains a website on the Internet at www.BHBT.com.www.bhbt.com. The Company makes available, free of charge, on its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K (proxy materials), and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. The Company’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. Information contained on the Company’s website does not constitute a part of this report.
ITEM 1A. RISK FACTORS
In its normal course of business, the Company is subject to many risks and uncertainties inherent with providing banking and financial services. Although the Company continually seeks ways to manage these risks, and has established programs and procedures to ensure controls are in place and operating effectively, the Company ultimately cannot predict the future. Actual results may differ materially from the Company’s expectations due to certain risks and uncertainties. The following discussion sets forth the most significant risk factors that the Company believes could cause its actual future results to differ materially from expected results.
The risks and uncertainties discussed below are not all inclusive. Additional risks and uncertainties that the Company is unaware of, or that it currently deems immaterial, may also become important factors relating to the Company’s future operating results and financial condition.
Difficult market conditions have adversely affected the banking and financial services industry.
Dramatic declines in the national housing market over the past year, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities as well as major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative and cash securities, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets could adversely affect the Company’s business, financial condition and results of operations. In particular, the Company may face the following risks in connection with these events:
There can be no assurance that recent actions by governmental agencies and regulators, as well as recently enacted legislation authorizing the U.S. government to invest in, and purchase large amounts of illiquid assets from, financial institutions will help stabilize the U.S. financial system.
In recent periods, various Federal agencies and bank regulators have taken steps to stabilize and stimulate the financial services industry. Changes also have been made in tax policy for financial institutions. In addition, on October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the "EESA"). The EESA reflects an initial legislative response to the financial crises affecting the banking system and financial markets and going concern threats to financial institutions. Pursuant to the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. There can be no assurance, however, as to the actual impact that the EESA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
There are risks and uncertainties associated with the Company’s participation in Treasury’s Capital Purchase Program.
In 2008 as a part of the EESA, the U. S. Treasury instituted the Troubled Asset Relief Program ("TARP") in response to adverse economic conditions in the financial markets, particularly the inability of creditworthy borrowers to obtain credit. Under the TARP, the U. S. Treasury developed the Capital Purchase Program ("CPP"), whereby it purchased non-voting senior preferred shares ("CPP Shares") of participating financial institutions. Healthy banks were encouraged to apply for participation in the CPP. The Company elected to apply for participation in the CPP in November 2008 and its application was accepted by the Treasury in December 2008. In January 2009 the Company sold $18,751 of Senior Fixed Rate Cumulative Perpetual Preferred Shares, Series A, no par value per share, liquidation preference $1,000 per share ("CPP Shares") to the Treasury under the CPP. In conjunction with the purchase of CPP Shares, the Treasury received warrants to purchase 104,910 shares of common stock with an aggregate market price equal to 15 percent of its investment in the CPP Senior Preferred Shares (the "CPP Warrants"). The exercise price on the CPP Warrants is $26.81 per share. There are a number of risks and uncertainties associated with the Company’s participation in the CPP that could have a material adverse effect on its results of operations from those anticipated by Management. These risks and uncertainties include but are not limited to:
(a) | The Company’s ability to increase its common share dividend is generally limited for up to three (3) years and this restriction could negatively impact the market for the Company’s common shares of stock; | ||
(b) | Possible future unilateral changes in the agreements between Treasury and the Company based on changes to applicable laws and regulations, all of which could materially impact the Company’s ability to deploy CPP capital in the manner originally anticipated by management at the time of issuing the CPP Shares to Treasury; | ||
(c) | The terms and conditions of the CPP Shares could pose some risk to the Company’s ability to participate in future acquisitions and mergers transactions; | ||
(d) | Existing and possible future limits imposed on executive compensation under the CPP and other laws and regulations applicable to participants under the CPP could have a negative impact on the Company’s ability to attract and retain quality executive officers; | ||
(e) | The consent of Treasury is generally required for the Company to repurchase its common stock, which could have a negative impact on the Company’s ability to manage its capital plan; | ||
(f) | Future potential ownership and earnings dilution associated with the CPP Shares and CPP Warrants; | ||
(g) | The possibility of negative public opinion regarding the Company’s participation in the CPP could adversely affect the Company’s ability to attract and keep customers and/or the market for its shares of common stock; and | ||
(h) | The Company may not be able to deploy the CPP capital received from the Treasury in a manner that is accretive to earnings. |
Federal and state governments could pass legislation responsive to current credit conditions.
The Company could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Company could experience higher credit losses because of federal or state legislation or regulatory action that limits the Bank’s ability to foreclose on property or other collateral or makes foreclosure less economically feasible.
If the Company is unable to redeem the CPP Shares after five years, the cost of this capital to the Company will increase substantially.
If the Company is unable to redeem the SPP Shares prior to February 15, 2014, the cost of this capital to the Company will increase substantially on that date, from 5.0% per annum to 9.0% per annum. Depending on the Company’s financial condition at the time, this increase in the annual dividend rate on the CPP Shares could have a material negative effect on the Company’s income available to common shareholders.
The Bank’s allowance for loan losses may not be adequate to cover loan losses.
A significant source of risk for the Company arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most loans originated by the Bank are secured, but some loans are unsecured based upon management’s evaluation of the creditworthiness of the borrowers. With respect to secured loans, the collateral securing the repayment of these loans principally includes a wide variety of real estate, and to a lesser extent personal property, either of which may be insufficient to cover the obligations owed under such loans.
Collateral values and the financial performance of borrowers may be adversely affected by changes in prevailing economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates and debt service levels, changes in oil and gas prices, changes in monetary and fiscal policies of the federal government, widespread disease, terrorist activity, environmental contamination and other external events, which are beyond the control of the Bank. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards might create the impression that a loan is adequately collateralized when in fact it is not. Although the Bank may acquire any real estate or other assets that secure defaulted loans through foreclosures or other similar remedies, the amounts owed under the defaulted loans may exceed the value of the assets acquired.
The Bank has adopted underwriting and credit monitoring policies and procedures, including the establishment and ongoing review of the allowance for loan losses and review of borrower financial statements and collateral appraisals, thatwhich management believes are appropriate to mitigate the risk of loss by assessing the likelihood of borrower non-performance and the value of available collateral. The Bank also manages credit risk by diversifying its loan portfolio. An ongoing independent review, subsequent to management’s review, of individual credits is performed by an independent loan review function, which reports to the Audit Committee of the Board of Directors. However, such policies and procedures have limitations, including judgment errors in management’s risk analysis, and may not prevent unexpected losses that could have a material adverse effect on the Company’s business, financial condition and results of operations.
Interest rate volatility could significantly reduce the Company’s profitability.
The Company’s earnings largely depend on the relationship between the yield on its earning assets, primarily loans and investment securities, and the cost of funds, primarily deposits and borrowings. This relationship, commonly known as the net interest margin, is susceptible to significant fluctuation and is affected by economic and competitive factors that influence the yields and rates, and the volume and mix of the Bank’s interest earning assets and interest bearing liabilities.
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. The Company is subject to interest rate risk to the degree that its interest bearing liabilities re-price or mature more slowly or more rapidly or on a different basis than its interest earning assets. Significant fluctuations in interest rates could have a material adverse impact on the Company’s business, financial condition, results of operations, or liquidity.
The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of its balance sheet and off balanceoff-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. 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, in order to preserve the sensitivity of net interest income to actual or potential changes in interest rates.
The Company is exposed to a variety of operational risks that could result in significant financial losses.
The Company is exposed to many types of operational risk, including reputation risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.
Negative public opinion can result from the Company’s actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect the Company’s ability to attract and keep customers and can expose it to litigation and regulatory action.
Given the volume of transactions at the Company, certain errors may be repeated or compounded before they are discovered and successfully rectified. The Company’s necessary dependence upon automated systems to record and process its transaction volumes may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. The Company may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical telecommunication outages), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.
The Company regularly assesses the level of operational risk throughout the organization and has established systems of internal controls that provide for timely and accurate information. Testing of the operating effectiveness of these control systems is performed regularly. While not providing absolute assurance, these systems of internal controls have been designed to manage operational risks at appropriate, cost-effective levels. Procedures exist that are designed to ensure policies relating to conduct, ethics, and business practices are followed. From time to time losses from operational risk may occur, including the effects of operational errors. Such losses are recorded as non-interest expense.
While the Company continually monitors and improves its system of internal controls, data processing systems, and corporate-wide risk management processes and procedures, there can be no assurances that future losses arising from operational risk will not occur and have a material impact on the Company’s business, financial condition, results of operations, or liquidity.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for more than 15 consecutive months. In the fourth quarter of 2008, the volatility and disruption reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the Company will not experience an adverse effect, which may be material, on its ability to access capital and on its business, financial condition and results of operations.
The Bank’s loans are principally concentrated in certain areas of Maine and adverse economic conditions in those markets could adversely affect the Company’s operations.
The Company's success is dependent to a significant extent upon general economic conditions in the United States and, in particular, the local economies of downeast and midcoast Maine, the primary markets served by the Bank. The Bank is particularly exposed to real estate and economic factors in the downeast and midcoast areas of Maine, as virtually the entiremost of its loan portfolio is concentrated among borrowers in these markets. Furthermore, because a substantial portion of the Bank’s loan portfolio is secured by real estate in these areas, the value of the associated collateral is also subject to regional real estate market conditions.
The second half of 20072008 was highlighted by significant disruption and volatility in the financial and capital marketplaces. This turbulence has been attributable to a variety of factors, including the fallout associated with the subprime mortgage market. One aspect of this fallout has been significant deterioration in the activity of the secondary residential mortgage market. These disruptions have been exacerbated by the continued decline of the real estate housing market along with significant mortgage loan related losses incurred by many lending institutions. The turmoil in the mortgage market has impacted the global markets as well as the domestic markets and led to a significant credit and liquidity crisis during the second half of 2007.2008. In addition, the significant decline in economic growth, both nationally and globally, during the fourth quarter of 20072008 has led to a national economy bordering onin deep recession. The Bank is not immune to negative consequences arising from overall economic weakness and, in particular, a sharp downturn in the real estate market. While the Bank’s loan portfolio has not shown significant signs of credit quality deterioration to the extent of national markets, no assurance can be given that these conditions will continue. An economic downturnrecession in the markets served by the Bank, orand the nation as a whole, could negatively impact household and corporate incomes. This impact could lead to decreased loan demand and increase the number of borrowers who fail to pay the Bank interest or principal on their loans, and accordingly, could have a material adverse effect on the Company’s business, financial condition, results of operations, or liquidity.
The Company may not be able to meet its cash flow needs on a timely basis at a reasonable cost, and its cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates and competitive pressures.
Liquidity is the ability to meet cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to make loans and to repay deposit and borrowing liabilities as they become due, or are demanded by customers and creditors. Many factors affect the Bank’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and standing in the marketplace, and general economic conditions.
The Bank’s primary source of funding is retail deposits, gathered throughout its network of twelve banking offices. Wholesale funding sources principally consist of secured borrowing lines from the Federal Home Loan Bank of Boston of which it is a member, secured borrowing lines from the Federal Reserve Bank of Boston, and brokered certificates of deposit obtained from the national market. The Bank’s securities and loan portfolios provide a source of contingent liquidity that could be accessed in a reasonable time period through sales. The Bank could also borrow through the Federal Reserve’s discount window.
Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered funds and borrowings in the future, which are typically more expensive than deposits.
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.
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 Company’s liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows. For further information about the Company’s liquidity position, refer below in this Report to Part II, Item 7, "Liquidity Risk."
Declines in value may adversely impact the investment securities portfolio.
The Bank may be required to record other-than-temporary impairment charges on its investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including collateral deterioration underlying certain private label mortgage-backed securities, lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for certain investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect the Bank’s securities portfolio in future periods. An other-than-temporary impairment charge could have a material adverse effect on the Company’s results of operations and financial condition.
A substantial decline in the value of the Bank’s Federal Home Loan Bank ("FHLB") of Boston common stock may adversely affect the Company’s results of operations, liquidity and financial condition.
As a requirement of membership in the FHLB of Boston, the Bank must own a minimum required amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB. Borrowings from the FHLB represent the Bank’s primary source of short-term and long-term wholesale funding.
Recent published reports indicate that certain member banks ("branches") of the FHLB system may be subject to accounting rules and asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the capitalization of a FHLB, including FHLB of Boston, could be substantially diminished or reduced to zero. Consequently, given that there is no market for the Bank’s FHLB of Boston common stock, Company management believes that there is a risk that its investment could be deemed other than temporarily impaired at some time in the future. If this occurs, it may adversely affect the Company’s results of operations and financial condition.
In addition, if the capitalization of FHLB of Boston is substantially diminished, the Bank’s liquidity may be adversely impaired if it is not able to obtain alternative sources of funding.
There are 12 branches of the FHLB, including Boston. Several branches have warned that they have either breached risk-based capital requirements or that they are close to breaching those requirements. To conserve capital, some FHLB branches are suspending dividends, cutting dividend payments, and not buying back excess FHLB stock that member banks hold. The 12 FHLB branches are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB branch cannot meet its obligations to pay its share of the system’s debt, other FHLB branches can be called upon to make the payment.
The Company’s information technology systems may be vulnerable to attack or other technological failures, exposing the Company to significant loss.
The Company depends upon data processing software, communication and information exchange on a variety of computing platforms and networks including the Internet. Despite instituted safeguards, the Company cannot be certain that all of its systems are entirely free from vulnerability to electronic attack or other technological difficulties or failures. The Company also relies on the services of a variety of third party vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be misappropriated, services and operations may be interrupted and the Company could be exposed to claims from customers, suffer loss of business and suffer loss of reputation in its marketplace. Any of these results could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.
Strong competition within the Company’s markets may significantly impact its profitability.
The Company competes with an ever-increasing array of financial service providers. As a bank holding company and state-chartered financial institution, respectively, the Company and the Bank are subject to extensive regulation and supervision, including, in many cases, regulations that limit the type and scope of their activities. The non-bank financial service providers that compete with the Company and the Bank may not be subject to such extensive regulation, supervision, and tax burden. Competition from nationwide banks, as well as local institutions, continues to mount in the Company’s markets.
The financial services industry is undergoing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Furthermore, technological advances are likely to intensify competition by enabling more companies to provide financial resources. Accordingly, the Company’s future success will depend in part on its ability to address customer needs by using technology. There is no assurance that the Company will be able to develop new technology driven products and services, or be successful in marketing these products to its customers. Many of the Company’s competitors have far greater resources to invest in technology.
Regional, national and international competitors have far greater assets and capitalization than the Company and have greater access to capital markets and can offer a broader array of financial services than the Company.
No assurance can be given that the Company will continue to be able to compete effectively with other financial institutions in the future. Furthermore, developments increasing the nature or level of competition could have a material adverse affect on the Company’s business, financial condition, results of operations, or liquidity. For further information on competition, refer to Part I, Item 1, "Competition" and "Supervision and Regulation."
The business of the Company and the Bank is highly regulated and impacted by monetary policy, limiting the manner in which the Company and the Bank may conduct its business and obtain financing.
The Company and the Bank are subject to extensive regulation and supervision under federal and state laws and regulations. The restrictions imposed by such laws and regulations limit the manner in which the Company and the Bank conducts its business, undertakes new investments and activities, and obtains financing. These laws and regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit the Company’s shareholders. These laws and regulations may sometimes impose significant limitations on the Company’s operations. The more significant federal and state banking regulations that affect the Company and the Bank are described in this report at Part I, Item 1, "Supervision and Regulation." These regulations, along with the existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time.
The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations, or specific actions of regulators, could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. Furthermore, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit risk and interest rate risk conditions for the Company, and any unfavorable change in these conditions could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.
Non-compliance with the Bank Secrecy Act and USA Patriot Act could result in significant fines or sanctions.
The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent them from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Crimes Enforcement Network. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts or conduct transactions.
Non-compliance with the Bank Secrecy Act, the USA Patriot Act and related laws and regulations could result in significant fines or sanctions. These particular laws and regulations have significant implications for all financial institutions, establish new crimes and penalties, and require the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money-laundering and terrorist activities. Even innocentinadvertent non-compliance and inconsequential failure to follow the regulations may result in significant fines or other penalties, which could have a material adverse impact on the Company’s business, financial condition, results of operations or liquidity.
The Bank could be held responsible for environmental liabilities relating to properties acquired through foreclosure, resulting in significant financial loss.
In the event the Bank forecloses on a defaulted commercial or residential mortgage loan to recover its investment, it may be subject to environmental liabilities in connection with the underlying real property, which could significantly exceed the value of the real property. Although the Bank exercises due diligence to discover potential environmental liabilities prior to acquiring any property through foreclosure, hazardous substances or wastes, contaminants, pollutants, or their sources may be discovered on properties during its ownership or after a sale to a third party. There can be no assurance that the Bank would not incur full recourse liability for the entire cost of any removal and cleanup on an acquired property, that the cost of removal and cleanup would not exceed the value of the property, or that it could recover any of the costs from any third party. Losses arising from environmental liabilities could have a material adverse impact on the Company’s business, financial condition, results of operations, or liquidity.
The preparation of the Company’s financial statements requires the use of estimates that could significantly vary from actual results.
The preparation of the consolidated financial statements in conformity with U. S. generally accepted accounting principles requires management to make significant estimates that affect the financial statements. The most critical estimate is the allowance for loan losses. Due to the inherent nature of estimates, the Company cannot provide absolute assurance that it will not significantly increase the allowance for loan losses and/or sustain credit losses that are significantly higher than the provided allowance, which could have a material adverse effect on the Company’s business, financial condition, results of operations, or liquidity. For further information on the use of estimates, refer to this report at Part II, Item 7, "Application of Critical Accounting Policies."
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The thirteen (13) parcels of real estate owned and utilized by the Company for its operations are described below:
1. The principal office of the Bank is located at 82 Main Street, Bar Harbor, Maine, and includes a building, which houses its banking facilities and corporate offices. The building was renovated in 1998.
2. A retail branch banking office is located at 111 Main Street, Northeast Harbor, Maine. This property consists of a building constructed in 1974 that underwent interior renovations in 1998 to better meet the Bank’s needs at that location.
3. A retail branch banking office is located at 314 Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975. The branch office was added to, and renovated in 1989, to better meet the Bank’s needs at that location.
4. A retail branch banking office is located at 25 Church Street, Deer Isle, Maine. This property consists of a building constructed in 1974 that was added to and renovated in 1994 to better meet the Bank’s needs at that location.
5. A retail branch banking office is located at 21 Main Street, Blue Hill, Maine. This property consists of a building constructed in 1960 that underwent renovations in 1989 to better meet the Bank’s needs at that location. A parcel of land adjacent to the Blue Hill branch was purchased in 1981, but has not been developed. A second improved parcel of land contiguous to this branch was purchased in 2005. The Bank is in the process of obtaining the required permitting and developing blueprints covering a substantial renovation and campus reconfiguration to relieve traffic congestion and better meet the Bank’s needs at that location.
6. A retail branch banking office is located at 2 Bridge Street, Milbridge, Maine. This property consists of a building constructed in 1974, to which a vestibule was added in 1994 to house an ATM that helps to better meet the needs at that location. The Bank is currently assessing its current and future needs at this location, including the possible local relocation of this branch banking office.
7. A retail branch banking office is located at 68 Washington Street, Lubec, Maine. This property consists of a building constructed in 1990 and is considered adequate for the Bank’s needs at that location.
8. A retail branch banking office is located 137 High Street, Ellsworth, Maine. This property consists of a building constructed in 1982. Two additional parcels (one improved) contiguous to this Branch were purchased in 2000. The City of Ellsworth is considered the hub of downeast Maine and the Bank’s Ellsworth office is by far its busiest location. The Bank is currently exploring a substantial reconfiguration of the Ellsworth branch banking office and its surrounding campus to better meet the Bank’s needs at that location.
9. A retail branch banking office is located at 385 Main Street, Winter Harbor, Maine. This property consists of a building constructed in 1995 and is considered adequate for the Bank’s needs at that location.
10. A retail branch banking office is located at 20 Main Street, Machias, Maine. This property consists of a building that was purchased from Key Bank of Maine in May 1990, and was renovated in 1995 to better meet the Bank’s needs at that location.
11. A retail branch banking office is located at 245 Camden Street (Route 1), Rockland, Maine. The property consists of a building that was purchased from Androscoggin Savings Bank in February 2004. The branch facility was built in 1977 and is considered adequateinadequate for the Bank’s needs at that location.
12. An Operations Center is located in Ellsworth, Maine, that houses the Company’s operations and data processing centers. The building was constructed in 1996 and is currently adequate for the Company’s needs.
13. The Bank and its wholly ownedwholly-owned subsidiary, Trust Services, own and occupy a 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. The facility was renovated in 2001.
Additional real estate owned by the Company includes two additional parcels (one improved) contiguous to the Bank’s 135 High Street, Ellsworth location.
The Bank’s Somesville branch banking office located at 1055 Main Street, Somesville, Maine, is a leased property. The Bank and Trust Services also lease office space at One Cumberland Place in Bangor, Maine.
The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is provided in Item 8, Note 6 of the Consolidated Financial Statements contained in this Annual Report on Form 10-K and incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management based upon currently available information will have no material effect on the Company's consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company’s security holders in the fourth quarter of 2007.2008.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of the Company is traded on the NYSE Alternext US LLC (formerly the American Stock Exchange ("AMEX"or "AMEX" and hereinafter "NYSE Alternext"), under the trading symbol BHB.
The following table sets forth the market prices per share of BHB Common Stock as reported by AMEX.NYSE Alternext:
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||
High | Low | High | Low | High | Low | High | Low | High | Low | High | Low | High | Low | High | Low | |
2008 | $32.00 | $28.50 | $31.45 | $27.00 | $30.52 | $19.25 | $28.00 | $25.00 | ||||||||
2007 | $33.25 | $30.50 | $32.70 | $29.55 | $31.94 | $28.00 | $32.77 | $30.00 | $33.25 | $30.50 | $32.70 | $29.55 | $31.94 | $28.00 | $32.77 | $30.00 |
2006 | $31.59 | $25.90 | $31.70 | $28.22 | $30.24 | $28.00 | $32.25 | $28.08 |
As of March 3, 2008,2009, there were 1,0111,001 registered holders of record of Bar Harbor BanksharesBHB Common Stock.
The following graph illustrates the estimated yearly percentage change in the Company's cumulative total stockholder return on its Common Stock for each of the last five years. Total stockholder return is computed by taking the difference between the ending price of the Common Stock at the end of the previous year and the current year, plus any dividends paid divided by the ending price of the Common Stock at the end of the previous year. For purposes of comparison, the graph also illustrates comparable stockholder return of AMEXNYSE Alternext listed banks as a group as measured by the AMEXNYSE Alternext Market Index and the peer group index as defined by AMEX.NYSE Alternext. The graph assumes a $100 investment on December 31, 20012003 in the common stock of each of the Company, the AMEXNYSE Alternext peer group banks and the AMEXNYSE Alternext Market Index as a group and measures the amount by which the market value of each, assuming reinvestment of dividends, has increased as of December 31 of each calendar year since the base measurement point of December 31, 2002.2003.
(GRAPH)(Graph)
Market values are based on information obtained from the American Stock Exchange.NYSE Alternext.
12/02 | 12/03 | 12/04 | 12/05 | 12/06 | 12/07 | |
Bar Harbor Bankshares | 100.00 | 144.96 | 160.38 | 150.17 | 186.92 | 190.64 |
AMEX Composite | 100.00 | 143.18 | 175.20 | 215.26 | 257.04 | 299.37 |
AMEX Banks & Financial Services | 100.00 | 124.57 | 146.21 | 131.28 | 143.54 | 133.85 |
12/03 | 12/04 | 12/05 | 12/06 | 12/07 | 12/08 | |
Bar Harbor Bankshares | 100.00 | 110.64 | 103.60 | 128.95 | 131.51 | 111.65 |
NYSE Alternext Composite | 100.00 | 124.13 | 155.00 | 184.30 | 217.52 | 132.72 |
NYSE Alternext. Banks & Financial Services | 100.00 | 117.95 | 105.20 | 116.90 | 106.24 | 81.59 |
Dividends paid by the Company in 20072008 and 20062007 are summarized below:
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | Total | ||||||
Quarter | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | Total | |||||
2008 | $0.250 | $0.250 | $0.260 | $1.020 | ||||||
2007 | $0.235 | $0.235 | $0.240 | $0.245 | $0.955 | $0.235 | $0.235 | $0.240 | $0.245 | $0.955 |
2006 | $0.220 | $0.225 | $0.230 | $0.905 |
During 2007,2008, the Company declared and distributed regular cash dividends in the aggregate amount of $2,899,$3,004, compared with $2,761$2,899 in 2006.2007. The Company’s 20072008 dividend payout ratio amounted to 40.5%,38.8% compared with 40.1%40.5% in 2006.2007. The total regular cash dividends paid in 20072008 amounted to $0.955$1.02 per common share of common stock, compared with $0.905$0.955 in 2006,2007, representing an increase of $0.05,$0.065, or 5.5%6.8%.
In the first quarter of 2008,2009, the Company increased its quarterlyCompany’s Board of Directors declared a regular cash dividend by $0.005 to $0.25of $0.26 per share of common share,stock, unchanged from the prior quarter but representing an increase of $0.015, or 6.4%6.1%, compared with the dividend paid for the same quarter in 2007.2008. The dividend will be paid March 15, 200813, 2009 to shareholders of record as of the close of business on February 15, 2008.17, 2009.
The Company has a history of paying quarterly dividends on its common stock. However, the Company’s ability to pay such dividends depends on a number of factors, including the Company’s financial condition, earnings, its need for funds and restrictions on the Company’s ability to pay dividends under federal laws and regulations. Therefore, there can be no assurance that dividends on the Company’s common stock will be paid in the future.
In January 2009 the Company became subject to certain material restrictions and limitations on its ability to declare or pay dividends on its shares of common stock that arise from the Company’s participation in the Treasury’s CPP. Generally the consent of the U.S. Treasury will be required for any increase in common dividends per share for the first three (3) years (other than quarterly cash dividends of not more than $0.26 per share of common stock), unless prior to the end of the three (3) years, the CPP Shares have been redeemed in full or the Treasury has transferred all of the CPP Shares to a third party. For further information, refer to Item 6, Selected Consolidated Financial Data for dividend related ratios and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, (specifically the "Capital Resources" section), for dividend restrictions, which is incorporated herein by cross reference thereto.
Stock Repurchase Plan
In February 2004,August 2008, the Company'sCompany’s Board of Directors approved a program to repurchase of up to 300,000 shares of the Company’s common stock, or approximately 10.2% of the shares currently outstanding. Purchases began on August 21, 2008 and continued through December 31, 2008.
The new stock repurchase program replaced the Company’s stock repurchase program that had been in place since February 2004, which had authorized the repurchase of up to 310,000 or approximately 10% of the Company'sCompany’s outstanding shares of common stock. As of August 19, 2008, this program was terminated.
For further information about the Company’s stock or approximately 310,000 shares. Purchases began March 4, 2004 and continued through December 2007. In December 2007, the Company announced continuation ofrepurchase program, refer to Part I, item 1, Note 12 Stock Repurchase Plan, in this plan through December 31, 2008. Dependingannual report 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.Form 10-K.
The following table sets forth information with respect to any purchase made by or on behalf of the Company or any "affiliated purchaser," as defined in Sec. 240.10b-18(a)(3) under the Exchange Act, of shares of the Company’s common stock during the periods indicated:
(a) | (b) | (c) | (d) | |
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs |
October 1 - 31, 2007 | 4,097 | $31.98 | 4,097 | 124,954 |
November 1 - 30, 2007 | 14,833 | $31.39 | 14,833 | 110,121 |
December 1 - 31, 2007 | 11,722 | $31.46 | 11,722 | 98,399 |
(a) | (b) | (c ) | (d) | |
Period | Total Number | Average | Total Number of Shares | Maximum Number of |
October 1-31, 2008 | 13,537 | $26.46 | 13,537 | 267,718 |
November 1-30, 2008 | 8,116 | $27.22 | 8,116 | 259,602 |
December 1-31, 2008 | 20,813 | $26.93 | 20,813 | 238,789 |
Incentive Stock Option Plan
On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and Subsidiaries Incentive Stock Option Plan of 2000, which is described more fully in Part II, Item 8, Note 13 of the Consolidated Financial Statements in this Annual Report on Form 10-K.
The following table provides information as of December 31, 20072008 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.
Number of | Weighted average exercise price of outstanding | Number of securities | ||||
Number of securities to be issued upon exercise of outstanding options, warrants, and rights, net of forfeits and exercised shares (a) | Weighted average exercise price of outstanding options, warrants, and rights (b) | Number of securities remaining available for issuance under equity compensation (excluding securities referenced in column (a) (c) | (a) | (b) | (c) | |
Equity compensation plans approved | 275,353 | $21.51 | 46,773 | 288,572 | $22.42 | 23,829 |
Equity compensation plans not approved | --- | N/A | --- | --- | N/A | --- |
Total | 275,353 | $21.51 | 46,773 | 288,572 | $22.42 | 23,829 |
Transfer Agent Services
American Stock Transfer & Trust Company provides transfer agent services for the Company. Inquiries may be directed to: American Stock Transfer & Trust Company, 6201 15th Avenue, 3rd Floor, Brooklyn, NY, 11219, telephone: 1-800-937-5449, Internet address: www.amstock.com.
Recent Sales of Unregistered Securities: Use of Proceeds from Unregistered Securities
On January 16, 2009, the Company sold 18,751 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share, liquidation preference $1,000 per share, (the "CPP Shares"), to the U. S. Treasury in exchange for $18,751 in connection with the Company’s participation in the CPP. In conjunction with the closing of the sale of the CPP Shares, the Company also issued to the U. S. Treasury Warrants for the purchase of 104,910 shares of common stock, par value $2.00 per share (the "CPP Warrants"), with an exercise purchase price of $26.81 per share. The CPP Warrants have a term of 10 years and will be immediately exercisable, in whole or in part. The CPP Warrants will be freely transferable; however, the Treasury may only transfer or exercise an aggregate of one-half of the warrants prior to the earlier of (i) the date on which the Company has received aggregate gross proceeds of at least one hundred percent of the issue price of the CPP Shares from one or more Qualified Equity Offerings, or (ii) December 31, 2009. In the event that the participating financial institution has received aggregate gross proceeds of at least one hundred percent of the issued price of the CPP Shares from one or more Qualified Equity Offerings on or prior to December 31, 2009, the number of shares of common stock underlying the CPP Warrants then held by the Treasury shall be reduced by a number of shares equal to the product of (i) the number of shares originally underlying the CPP Warrants (taking into account all adjustments), and (ii) 0.5.
The CPP Shares and CPP Warrants were issued to Treasury in a private placement exempt from registration pursuant to section 4(2) of the Securities Act of 1933, as amended. The Company received and relied upon certain agreements of Treasury under the sale transactions documents with respect to the exemptions relied upon by the Company in the offer and sale of the CPP Shares and CPP Warrants.
The Company was responsible for all of the costs associated with the offering and sale of the CPP Shares and CPP Warrants to Treasury.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The supplementary financial data presented in the following tables contain information highlighting certain significant trends in the Company’s financial condition and results of operations over an extended period of time.
The following information should be analyzed in conjunction with Item 7 - - Management’s Discussion and Analysis of Financial Condition and Results of Operations, and with the audited consolidated financial statements included in this Annual Report on Form 10-K.
Unless otherwise noted, all dollars are expressed in thousands except share data.
FIVE-YEAR SUMMARY OF FINANCIAL DATAAt orAs of and For the Years Ended December 31,
(in thousands, except share data):
2007 | 2006 | 2005 | 2004 | 2003 | 2008 | 2007 | 2006 | 2005 | 2004 | |
Balance Sheet Data | ||||||||||
Total assets | $889,472 | $824,877 | $747,945 | $666,811 | $583,746 | $972,288 | $889,472 | $824,877 | $747,945 | $666,811 |
Total securities | 264,617 | 213,252 | 183,300 | 176,337 | 158,387 | |||||
Total investment securities | 290,502 | 264,617 | 213,252 | 183,300 | 176,337 | |||||
Total loans | 579,711 | 555,099 | 514,866 | 448,478 | 383,408 | 633,603 | 579,711 | 555,099 | 514,866 | 448,478 |
Allowance for loan losses | (4,743) | (4,525) | (4,647) | (4,829) | (5,278) | (5,446) | (4,743) | (4,525) | (4,647) | (4,829) |
Total deposits | 539,116 | 496,319 | 445,731 | 398,272 | 339,080 | 578,193 | 539,116 | 496,319 | 445,731 | 398,272 |
Total borrowings | 278,853 | 260,712 | 239,696 | 206,923 | 186,431 | 323,903 | 278,853 | 260,712 | 239,696 | 206,923 |
Total shareholders' equity | 65,974 | 61,051 | 56,104 | 56,042 | 53,115 | 65,445 | 65,974 | 61,051 | 56,104 | 56,042 |
Average assets | 841,206 | 788,557 | 689,644 | 646,205 | 560,837 | 926,357 | 841,206 | 788,557 | 689,644 | 646,205 |
Average shareholders' equity | 62,788 | 57,579 | 56,132 | 54,200 | 53,924 | 65,139 | 62,788 | 57,579 | 56,132 | 54,200 |
Results Of Operations | ||||||||||
Interest and dividend income | $ 51,809 | $ 46,145 | $ 37,195 | $ 31,922 | $ 30,493 | $ 53,594 | $ 51,809 | $ 46,145 | $ 37,195 | $ 31,922 |
Interest expense | 28,906 | 24,449 | 15,336 | 11,545 | 11,075 | 26,403 | 28,906 | 24,449 | 15,336 | 11,545 |
Net interest income | 22,903 | 21,696 | 21,859 | 20,377 | 19,418 | 27,191 | 22,903 | 21,696 | 21,859 | 20,377 |
Provision for loan losses | 456 | 131 | --- | 180 | 540 | 1,995 | 456 | 131 | --- | 180 |
Net interest income after provision for loan losses | 22,447 | 21,565 | 21,859 | 20,197 | 18,878 | 25,196 | 22,447 | 21,565 | 21,859 | 20,197 |
Non-interest income | 5,929 | 6,876 | 6,415 | 6,572 | 7,074 | 6,432 | 5,929 | 6,876 | 6,415 | 6,572 |
Non-interest expense | 18,201 | 18,677 | 19,268 | 18,914 | 18,853 | 20,513 | 18,201 | 18,677 | 19,268 | 18,914 |
Income before income taxes | 10,175 | 9,764 | 9,006 | 7,855 | 7,099 | 11,115 | 10,175 | 9,764 | 9,006 | 7,855 |
Income taxes | 3,020 | 2,885 | 2,582 | 2,123 | 1,892 | 3,384 | 3,020 | 2,885 | 2,582 | 2,123 |
Net income | $ 7,155 | $ 6,879 | $ 6,424 | $ 5,732 | $ 5,207 | $ 7,731 | $ 7,155 | $ 6,879 | $ 6,424 | $ 5,732 |
Earnings Per Share: | ||||||||||
Basic | $ 2.36 | $ 2.26 | $ 2.09 | $ 1.85 | $ 1.67 | $ 2.63 | $ 2.36 | $ 2.26 | $ 2.09 | $ 1.85 |
Diluted | $ 2.30 | $ 2.20 | $ 2.03 | $ 1.79 | $ 1.63 | $ 2.57 | $ 2.30 | $ 2.20 | $ 2.03 | $ 1.79 |
Return on total average assets | 0.85% | 0.87% | 0.93% | 0.89% | 0.93% | 0.83% | 0.85% | 0.87% | 0.93% | 0.89% |
Return on total average equity | 11.40% | 11.95% | 11.44% | 10.58% | 9.66% | 11.87% | 11.40% | 11.95% | 11.44% | 10.58% |
Average equity to average assets | 7.46% | 7.30% | 8.14% | 8.39% | 9.61% | 7.03% | 7.46% | 7.30% | 8.14% | 8.39% |
Tangible book value per share | $ 20.88 | $ 18.93 | $ 17.22 | $ 17.06 | $ 17.02 | $ 21.65 | $ 20.88 | $ 18.93 | $ 17.22 | $ 17.06 |
Dividends per share | $ 0.955 | $ 0.905 | $ 0.840 | $ 0.800 | $ 0.760 | |||||
Dividend per share | $ 1.020 | $ 0.955 | $ 0.905 | $ 0.840 | $ 0.800 | |||||
Dividend payout ratio | 40.5% | 40.1% | 40.2% | 43.3% | 45.6% | 38.84% | 40.54% | 40.12% | 40.23% | 43.25% |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis, which follows, focuses on the factors affecting the Company’s consolidated results of operations for the years ended December 31, 2008, 2007, 2006, and 2005,2006, and financial condition at December 31, 2007,2008, and 2006,2007, and where appropriate, factors that may affect future financial performance. The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Annual Report on Form 10-K.
Amounts in the prior period financial statements are reclassified whenever necessary to conform with 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 2008, 2007 2006 and 20052006 interest income was $1,495,$1,992, $1,852,1,495, and $1,620,$1,852, respectively, of tax-exempt interest income from certain investment securities and loans. 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 Management’s Discussion and Analysis, representing tax equivalent adjustments of $899, $655 and $826 in 2008, 2007 and $756 in 2007, 2006, and 2005, respectively, which increased net interest income accordingly. The analysis of net interest income tables included in this Annual Report on Form 10-K provide a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.
Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from their earning asset portfolios. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax-equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices.
EXECUTIVE OVERVIEW
General Information
Bar Harbor Bankshares is a Maine corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2007,2008, the Company had consolidated assets of $889$972 million and was one of the larger independent community banking institutions in the state of Maine.
The Company’s principal asset is all of the capital stock of Bar Harbor Bank & Trust (the "Bank"), a community bank incorporated in the late 19th century. With twelve (12) branch office locations, the Company is a diversified financial services provider, offering a full range of banking services and products to individuals, businesses, governments, and not-for-profit organizations throughout downeast and midcoast Maine.
The Company attracts deposits from the general public in the markets it serves and uses such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage and home equity loans, and a variety of consumer loans. The Company also invests in mortgage-backed securities, obligations of government-sponsored enterprises, obligations of state and political subdivisions, as well as other debt securities. In addition to community banking, the Company provides a comprehensive array of trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services ("Trust Services") a Maine chartered non-depository trust company.
Major Sources of Revenue
The principal source of the Company’s revenue is net interest income, representing the difference or spread between interest income from its earning assets and the interest expense paid on deposits and borrowed funds. In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations. The Company’s non-interest income is derived from financial services including trust, investment management and third-party brokerage services, as well as service charges on deposit accounts, merchant credit card processing referral and transaction processing fees, realized gains or losses on the sale of securities, and a variety of other miscellaneous product and service fees.
Business Strategy
The Company, as a diversified financial services provider, pursues a strategy of achieving long-term sustainable growth, profitability, and shareholder value, without sacrificing its soundness. The Company works toward achieving this goal by focusing on increasing its loan and deposit market share in the coastal communities of Maine, either organically or by way of strategic acquisitions. The Company believes one of its more unique strengths is an understanding of the financial needs of coastal communities and the businesses vital to Maine’s coastal economy, namely: tourism, hospitality, retail establishments and restaurants, seasonal lodging and campgrounds, fishing, lobstering, boat building, and marine services.
The Company’s key strategic focus is vigorous financial stewardship, deploying investor capital safely yet efficiently for the highestbest possible returns. The Company strives to provide unmatched service to its customers, while maintaining strong asset quality and a focus toward improving operating efficiencies. In managing its earning asset portfolios, the Company seeks to utilize funding and capital resources within well-defined credit, investment, interest-rate and liquidity guidelines. In managing its balance sheet the Company seeks to preserve the sensitivity of net interest income to changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity under prevailing and expected conditions, and strives to maintain a balanced and appropriate mix of loans, securities, core deposits, brokered deposits and borrowed funds.
Material Risks and Challenges
In its normal course of business, the Company faces many risks inherent with providing banking and financial services. Among the more significant risks managed by the Company are losses arising from loans not being repaid, commonly referred to as "credit risk," and losses of income arising from movements in interest rates, commonly referred to as "interest rate and market risk." The Company is also exposed to national and local economic conditions, downturns in the economy, or adverse changes in real estate markets, which could negatively impact its business, financial condition, results of operations or liquidity.
Management has numerous policies and control processes in place that provide for the monitoring and mitigation of risks based upon and driven by a variety of assumptions and actions which, if changed or altered, could impact the Company’s business, financial condition, results of operations or liquidity. The foregoing matters are more fully discussed in Part I, Item 1A, "Risk Factors," and throughout this Annual Report on Form 10-K.
Summary Financial Condition
The Company’s total assets increased $65$83 million or 7.8%9.3% in 2007,2008, ending the year at $889$972 million.
- Loans: Total loans ended the year at
$580$634 million, representing an increase of$25$54 million, or4.4%9.3%, compared with December 31,2006.2007. Business lending activity continued at a relatively strong pace during2007,2008, accounting for all of the year-over-year growth in the loan portfolio. At December 31,2007,2008, commercial loans and consumer loans comprised 51% andcommercial loans comprised 53% and 46%48% of the loan portfolio, compared with56%46% and43%53% at December 31,2006,2007, respectively.
- Credit Quality: The Bank’s non-performing loans
increased, but continuedended the year at relatively low levels,during 2007. At year-end, total non-performing loans amounted to $2.1representing $4.4 million or0.36%0.70% of total loans, compared with$628 thousand$2.1 million, or0.11%0.36% at December 31,2006.2007.The Bank’s loan loss experience
continued at historically low levelsincreased during2007,2008, with net loan charge-offs amounting to $1.3 million, or net charge-offs to average loans outstanding of 0.21%, compared with $238 thousand, or net charge-offs to average loans outstanding of 0.04%,compared with $253 thousand,in 2007. Two problem loans accounted for $1.1 million, or 84.7% of total net charge-offsto average loans outstanding of 0.05%in2006. The2008.For the year ended December 31, 2008, the Bank recorded a provision for loan losses
totaled $456 thousand in 2007,(the "provision") of $2.0 million, representing an increase of $1.5 million compared with$131 thousand2007. The increases in2006, principally reflectingthe provision were largely attributed to the increase in net loan charge-offs, growth in the loan portfolio, generally declining real estate values in many of theBank’smarkets served by the Bank, and other qualitative and environmental considerations.The Bank maintains an allowance for loan
portfolio.losses (the "allowance") which is available to absorb losses on loans. The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the loan portfolio and adequate to provide for estimated probable losses. At December 31, 2008 the allowance stood at $5.4 million, representing an increase of $703 thousand or 14.8% compared with year end 2007. At December 31, 2008, the allowance expressed as a percentage of total loans stood at 86 basis points, up from 82 basis points at year end 2007.
- Securities: The securities portfolio is primarily comprised of mortgage-backed securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and other private-label issuers. The securities portfolio also includes tax-exempt obligations of state and political subdivisions, and obligations of other U.S. government-sponsored enterprises. At December 31, 2008, the securities portfolio did not contain any pools of subprime mortgage-backed securities, collateralized debt obligations, or commercial mortgage-backed securities. Additionally, the Bank did not own any equity securities or have any corporate debt exposure in its securities portfolio, nor did it own any perpetual preferred stock in Federal Home Loan Mortgage Corporation ("FHLMC") or Federal National Mortgage Association ("FNMA"), or any interests in pooled trust preferred securities or auction rate securities.
2007.
Securities:Total securities ended the year at
$265$291 million, representing an increase of$51$26 million, or24.1%9.8%, compared with December 31,2006. During 2007, market yields showed meaningful improvement, the benchmark 10-year U.S. Treasury note climbing to a five-year high, presenting opportunities for increasing the Bank’s earning assets and generating higher levels of net interest income.
- Deposits: Total deposits ended the year at
$539$578 million, representing an increase of$43$39 million or8.6%7.2% compared with December 31,2006. Deposit growth included $21 million in certificates of deposit obtained in the national market, as the Bank’s 2007 earning asset growth outpaced retail deposit growth, thus necessitating the use of an additional funding source.2007. Total retail deposits ended the year at$435$490 million, up $54 million or 12.5% compared with year end 2007. Retail deposit growth was principally attributed to time deposits, with NOW accounts and savings and money market accounts also posting increases.Brokered deposits obtained from the national market ended the year at $89 million, representing
an increasea decline of$21$15 million or5.2%,14.6% compared withDecember 31, 2006.year end 2007.
- Borrowings: Borrowed funds principally consist of advances from the Federal Home Loan Bank of Boston. During
20072008 the Bank continued to utilize borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios.Total borrowings ended the year at
$279$324 million, representing an increase of$18$45 million, or7.0%16.2%, compared with December 31,2006.
2007. The increase in borrowings was principally used to fund the growth of the Bank’s securities portfolio and, to a lesser extent, reduce the Bank’s dependence on higher cost and more volatile brokered deposits.
Shareholders’ Equity:Capital: Consistent with its long-term strategy of operating a sound and profitable organization,at December 31, 2008 theCompanyBank continued to exceed regulatory requirements for "well-capitalized"institutions. Company management considers this to be vital in promoting depositor and investor confidence and providing a solid foundation for future growth. At December 31,2007,2008, theCompany’sBank’s Tier I Leverage, Tier I Risk-based, and Total Risk-basedCapitalcapital ratiosamounted to 7.10%were 6.61%,10.76%9.95% and11.59%11.60%, respectively. Under the capital adequacy guidelines administered by the Bank’s principal regulators, "well-capitalized" institutions are those with Tier I leverage, Tier I Risk-based, and Totalshareholders’ equity endedRisk-based ratios of at least 5%, 6% and 10%, respectively.In January 2009, the
year at $66 million, representing an increaseCompany announced the issuance and sale to the U.S. Treasury of$5 million, or 8.1%18,751 shares of Fixed Rate Cumulative Perpetual Preferred Stock. Series A, no par value per share, liquidation preference $1,000 per share (the "CPP Shares") and a warrant for the purchase of 104,910 shares of Company common stock, par value $2.00 per share (the "CPP Warrants"),comparedall for a purchase price of $18.751 million. The CPP Shares and the CPP Warrants were issued to the U.S. Treasury in connection withDecember 31, 2006.
the Company’s participation in the U.S. Treasury’s Capital Purchase Program ("CPP"). The CPP is a voluntary program designed by the U.S. Treasury to provide additional capital to healthy, well-capitalized banks, to help provide economic stimulus through the creation of additional lending capacity in local banking markets. The investment by the U.S. Treasury through the CPP increases the Company’s already strong Tier I Leverage, Tier I Risk-based and Total Risk-based capital ratios by approximately 200, 300 and 300 basis points, respectively.
- Tangible Book Value: At December 31,
2007,2008, the Company’s tangible book value per share of common stock outstanding amounted to$20.88,$21.65, compared with$18.93$20.88 at December 31,2006,2007, representing an increase of10.3%3.7%.Summary Results of Operations
Net income for the year ended December 31,
20072008 amounted to $7.7 million, or fully diluted earnings per share of $2.57, compared with $7.2 million or fully diluted earnings per share of $2.30compared with $6.9 million or fully diluted earnings per share of $2.20for the year ended December 31,2006,2007, representing increases of4.0%$576 thousand and4.5%$0.27 or 8.1% and 11.7%, respectively.The Company’s return on average equity ("ROE") amounted to 11.87% in 2008, compared with 11.40% in
2007, compared with 11.95% in 2006.2007.The Company’s return on average assets ("ROA") amounted to 0.83% in 2008, compared with 0.85% in
2007, compared with 0.87% in 2006.2007.
- Net Interest
Income: Net interest income continued to be the principal component of the Company’s income stream in 2007.Income: For the year ended December 31,2007,2008, net interest income on a fully tax-equivalent basis amounted to$22.9$28.1 million, representing an increase of$1.2$4.5 million, or5.6%19.2%, compared with2006.2007. Theincreaseincreases in net interest incomewaswere principally attributed to an improved net interest margin, combined with 2008 average earning asset growth of$52.9$87.5 million or7.0%, as10.8%. The decline in short-term interest rates over the past fifteen months favorably impacted the Bank’s net interest margin, as the cost of interest bearing liabilities declinedfourfaster and to a greater degree than the decline in earning asset yields.For the year ended December 31, 2008, the fully tax-equivalent net interest margin amounted to 3.13%, representing an improvement of 22 basis
points.points compared with 2007. In the fourth quarter of 2008, the fully tax-equivalent net interest margin amounted to 3.21%, representing an improvement of 24 basis points compared with the same quarter in 2007.
- Non-interest Income: For the year ended December 31,
2007,2008, total non-interest income amounted to$5.9$6.4 million, representinga declinean increase of$947$503 thousand or13.8% compared with 2006. The decline in non-interest income was principally attributed to a $1.4 million decline in net securities gains. During 2007, net securities losses of $671 thousand were recorded, principally resulting from the Company’s restructuring of a portion of its securities portfolio, compared with net securities gains of $755 thousand recorded during 2006. Excluding securities gains and losses, non-interest income was up $479 thousand, or 7.8%8.5%, compared with2006.2007. Total non-interest income included a $313 thousand gain recorded in the first quarter of 2008 representing the proceeds from shares redeemed in connection with the Visa, Inc. initial public offering.For the year ended December 31, 2008 net securities losses amounted to $831 thousand, compared with net securities losses of $671 thousand in 2007,
creditrepresenting an increase in net securities losses of $160 thousand, or 23.8%. The $831 thousand in 2008 net securities losses were comprised of other-than-temporary securities impairment losses of $1.4 million, largely offset by realized gains on the sale of securities amounting to $604 thousand.Trust and
debit card fees, trust andother financial services feesand service charges on deposits were up 15.9%amounted to $2.5 million in 2008, representing an increase of $178 thousand or 7.6%,11.4% and 4.2%, respectively,compared with2006.2007.
- Non-interest Expense: For the year ended December 31,
2007,2008, total non-interest expense amounted to$18.2$20.5 million, representinga declinean increase of$476 thousand$2.3 million or2.6%12.7%, compared with2006.2007.The
declineincrease in non-interest expense wasprincipallylargely attributed to the settlement of the Company’s limitedpost retirement benefitpostretirement program in thefinancial impactfirst quarter of 2007, which reduced2007that reporting period’s non-interest expense by $832 thousand.
SalariesThe increase in non-interest expense was also attributed to higher levels of salaries and employee benefits,amounted to $9.4which were up $1.5 millionin 2007, representing an increase of $76 thousand,or0.8%,15.6% compared with2006.2007. Therelatively smallincrease in salaries and employee benefitsexpense reflects modificationswas attributed to a variety of factors including: strategic additions to staff; normal increases in base salaries and employeebenefit programsbenefits; higher levels of employee incentive compensation; andchanges in overall staffing levels and mix.certain employee severance payments.
- Income Tax Expense: For the year ended December 31,
2007,2008, total income taxes amounted to$3.0$3.4 million, representing an increase of$135$364 thousand, or4.7%12.1%, compared with2006.2007. The Company’s effective tax rate amounted to 30.4% in 2008, compared with 29.7% in2007, compared with 29.5% in 2006.2007.
Other 2007 Financial Highlights
Trust and Investment Management Services:Assets under management at Trust Services ended the year at $278 million, representing an increase of $26 million, or 10.4%, compared with December 31, 2006.
Cash Dividends: The Company paid cash dividends of 95.5 cents per share of common stock in 2007, representing an increase of 5.0 cents, or 5.5%, compared with 2006. In the first quarter of 2008 the Company increased its quarterly cash dividend to 25.0 cents per share, representing an increase of 1.5 cents per share, or 6.4%, compared with the first quarter of 2007. In 2007, the dividend payout ratio amounted to 40.5%, compared with 40.1% in 2006.
Stock Repurchase Plan:In December 2007 the Company announced the continuation of its stock repurchase plan through December 31, 2008. As of December 31, 2007, the Company had repurchased 211,601 shares of stock under the plan, or 68.3% of the total authorized, at an average price of $28.93 per share.Outlook
Recent data suggest that the U.S. economy
may be falling intois currently in a deep recession which began in December 2007, driven by sharp downturns in the nationwide housing and credit markets. Business activity across a wide range of industries and regions is greatly reduced and local governments and many businesses are in serious difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. Nationwide unemployment has increased significantly.The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, is highly dependent upon the business environment in the markets served by the Bank. On an overall basis, the 2008 business environment was adverse for many households and businesses in the United States and worldwide. While the weaknesses in the national economy have not yet surfaced in coastal Maine to the same extent as in most other parts of the United States, Company management assumes that some aspects of the overall economic downturn will continue to affect the economy in its markets as well, causing continued deterioration in the foreseeable future. Such national and local conditions could adversely affect the credit quality of the Company’s loans and securities, results of operations, and financial condition.
Company management expects a continued contraction in economic activity throughout 2009 and early 2010. Management anticipates lower demand for business loans in 2009 and added pressure on its ability to
contract modestly throughout 2008, followed by a gradual recovery in the course of 2009. The current Fed Funds futures contracts indicate that Federal Reserve officials are likely to respond by cutting the Fed Funds target rate to 2.50% by the end of the second quarter of 2008, representing an aggregate decline of 275 basis points since they started cutting rates in late September 2007. Given the Bank’s liability sensitive balance sheet, these actualretain andanticipated rate declines are expected to favorably impact 2008 net interest income and provide some flexibility with respect to growing the Bank’s loan and securities portfolios to generate future earnings.attract core deposits.The Bank’s credit quality has been strong over the past several years and this continued to be the case at December 31,
2007.2008. However, management is cognizant ofsofteningdeteriorating economic conditions overall and declining real estate (and loan collateral) values in particular. Accordingly, management believes the continuation of strong credit quality will be a significant determinant of the Company’s future financial performance.Considering the Company’s strong balance sheet, liquidity position, earnings fundamentals and capitalization, Company management believes the Company is well positioned to successfully manage its way through the many uncertainties that lie ahead for the banking industry through 2009 and beyond.
Other factors, which could affect the Company’s financial performance and that of its common stock, are more fully enumerated in the "Forward-Looking Statements" discussion at the beginning of this Annual Report on Form 10-K and the Company’s discussion of certain "Risk Factors" set forth in Part I, Item 1A of this Report.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of the Company’s financial condition and results of operations are based on the Consolidated Financial Statements, which are prepared in accordance with U.S. generally accepted accounting principles. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management evaluates its estimates, including those related to the allowance for loan losses, on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from management’s estimates and assumptions under different assumptions or conditions.
The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s financial performance is reported. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements:
Allowance for Loan Losses:
Management believes theThe allowance for loan losses ("allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of probable loss in the loan portfolio. Management regularly evaluates the allowancefor loan lossesfor adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income, and when a greater amount of provision for loan losses is necessary, the result is lower net income. Refer to Part II, Item 7, Allowance for Loan Losses and Provision, in this Annual Report on Form 10-K, for further discussion and analysis concerning the allowance.Other-Than-Temporary Impairments on Securities: One of the significant estimates related to investment securities is the evaluation of other-than-temporary impairments. The evaluation of securities for other-than- temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses.
Securities that are in an unrealized loss position, are reviewed at least quarterly to determine if an other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. The primary factors considered in evaluating whether a decline in value for securities is other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the securities market price (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of receipt of all principal and interest due.
For securitized financial assets with contractual cash flows, such as private-label mortgage-backed securities, the Company periodically updates its best estimate of cash flows over the life of the security. The Company’s best estimate of cash flows is based upon assumptions consistent with an economic recession, similar to those the Company believes market participants would use. If the fair value of a securitized financial asset is less than its cost or amortized cost and there has been an adverse change in timing or amount of anticipated future cash flows since the last revised estimate to the extent that the Company does not expect to receive 100% of future contractual principal and interest, an other-than-temporary impairment charge is recognized.. The Company also considers its intent and ability to retain a temporarily depressed security until recovery, which may be at maturity. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third party sources along with certain assumptions and judgments regarding the future performance of the underlying collateral. In addition, projections of expected future cash flows may change based upon new information regarding the performance of the underlying collateral.
Refer to Part II, Item 7, Impaired Securities,and Part II, Item 8, Note 1 of the Consolidated Financial Statementsin this Annual Report on Form 10-K, for further discussion and analysis concerning other-than-temporary impairments.
Income Taxes: The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary differences resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from historical taxes paid and future taxable income and, to the extent that the recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31,
20072008 and2006,2007, there was no valuation allowance for deferred tax assets, which are included in other assets on the consolidated balance sheet.
Goodwill and Other Intangible Assets:Goodwill: The valuation techniques used by the Company to determine the carrying value oftangible andintangible assets acquired in acquisitionsand the estimated lives of identifiable intangible assets involveinvolves estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based upon changes in economic conditions and other factors. Any changes in the estimates used by the Company to determine the carrying value of its goodwilland identifiable intangible assets, or which otherwise adversely affect their value or estimated lives,may have an adverse effect on the Company's results of operations. The Company’s annual impairment test was performed as of December 31, 2008. Refer to Notes 1 and 7 of the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further details of the Company’s accounting policies and estimates coveringgoodwill and other intangible assets.goodwill.FINANCIAL CONDITION
Asset / Liability Management
In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate, and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Average earning assets represented
96.2%96.8% and95.9%96.2% of total average assets during20072008 and2006,2007, respectively.The Company, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through retail deposit products offered within the markets served, as well as through the prudent use of borrowed and brokered funds.
The Company’s objectives in managing its 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 promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity, under prevailing and forecasted economic conditions, and to maintain an efficient and appropriate mix of core deposits, brokered deposits, and borrowed funds.
Earning Assets
For the year ended December 31,
2007,2008, the Company’s total average earning assets amounted to$808,833,$896,350, compared with$755,945$808,833 in2006,2007, representing an increase of$52,888,$87,515, or7.0%10.8%. The20072008 increase in average earning assets was principally attributed to total averagesecuritiesloan growth of$31,930$52,578 or15.7%9.4%, followed by a$20,583$33,324 or3.8%14.2% increase inaverage loans.the securities portfolio.The tax-equivalent yield on total average earning assets amounted to 6.08% in 2008 compared with 6.49% in 2007,
compared with 6.21% in 2006,representingan increasea decline of2841 basis points. Theincreasedecline in the weighted average earning asset yield was principally attributed to the reduction of short-term interest rates by the Federal Reserve, the impact of which reduced the weighted average yield on the Bank’s variable rate loan portfolios. To a lesser extent, the weighted average loan yields were also impacted by the renegotiation of certain fixed rate loans to variable rate loans with lower prevailing interest rates. The 2008 decline in loan yields wasattributed,partially offset by higher yields from the securities portfolio reflecting, in part,to a 48 basis point increase in the yield on securities, reflectingthe restructuring of a portion of the portfolio in 2007. In addition, because the majority of the securities portfoliocombined with higher available market yields throughout muchis comprised of2007. The yieldfixed rate securities, the decline in short-term interest rates had minimal impact on theloan portfolio increased 22 basis points in 2007, principally reflecting cash flows fromportfolio’s 2008 weighted average yield.For the
portfolio being reinvested into higher-yielding new loan originations, particularly residential mortgage loans.
Totalyear ended December 31, 2008, total tax-equivalent interest and dividend incomeduring 2007amounted to$52,464$54,493 compared with$46,971$52,464 in2006,2007, representing an increase of$5,493,$2,029, or11.7%3.9%. The20072008 increase in interest and dividend income wasprincipallyattributed to earning asset growth,combined with higheras the average earning assetyields.yield declined compared with 2007. Interest income from the securities portfolio contributed $2,609 to the increase in 2008 interest and dividend income, offset in part by a $266 decline in interest income from the loan portfolio.Total Assets
The Company’s assets principally consist of loans and securities, which at December 31,
20072008 represented 65.2% and29.7%29.9% of total assets, compared with67.3%65.2% and25.9%29.7% at December 31,2006,2007, respectively.At December 31,
20072008 the Company’s total assets stood at$889,472$972,288 compared with$824,877$889,472 at December 31,2006,2007, representing an increase of$64,595,$82,816, or7.8%9.3%. The increase in total assets was principally attributed to a$51,365$53,892 or24.1%9.3% increase insecurities,loans, followed byloan growth of $24,612a $25,885 or4.4%. Partially offsetting these increases was an $11,816, or 60.4%, decline9.8% increase incash and cash equivalents.securities.Securities
The securities portfolio represented
29.1%30.0% of the Company’s average earning assets during20072008 and generated25.8%29.6% of its total tax-equivalent interest and dividend income, compared with22.6%29.1% and 25.8% in2006.2007, respectively.Bank management considers securities as a relatively attractive means to effectively leverage the Bank’s strong capital position, as securities are typically assigned a significantly lower risk weighting for the purpose of calculating the Bank’s and the Company’s risk-based capital ratios.
The securities portfolio is primarily comprised of mortgage-backed securities issued by U.S. government agencies, U.S. Government sponsored enterprises, and other corporate issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions, and obligations of other U.S. government-sponsored enterprises.The overall objectives of the Bank’s strategy for the securities portfolio include maintaining appropriate liquidity reserves, diversifying earning assets, managing interest rate risk, leveraging the Bank’s strong capital position, and generating acceptable levels of net interest income. The securities portfolio is managed under the policy guidelines established by the Bank’s Board of Directors.
The securities portfolio is primarily comprised of mortgage-backed securities issued by U.S. government agencies, U.S. government sponsored enterprises, and other non-agency, private-label issuers. The securities portfolio also includes tax-exempt obligations of state and political subdivisions, and obligations of other U.S. government sponsored enterprises. At December 31, 2008, the securities portfolio did not contain any pools of subprime mortgage-backed securities, collateralized debt obligations, or commercial mortgage-backed securities. Additionally, the Bank did not own any equity securities or have any corporate debt exposure in its securities portfolio, nor did it own any perpetual preferred stock in Federal Home Loan Mortgage Corporation ("FHLMC") or Federal National Mortgage Association ("FNMA"), or any interests in pooled trust preferred securities or auction rate securities.
Total Securities: At December 31,
2007,2008, total securities stood at$264,617$290,502 compared with$213,252$264,617 at December 31,2006,2007, representing an increase of$51,365,$25,885, or24.1%9.8%.
Securities Portfolio Restructuring: In April 2007, Company’s Board of Directors approved the restructuring of a portion of the Company’s balance sheet through the sale of $43,337 of its aggregate $227,473 available for sale securities portfolio, the proceeds from which were initially used to pay down short-term borrowings. Since the Company no longer had the intent to hold these securities until a recovery of their amortized cost, which may be at maturity, the Company recorded an adjustment to write down these securities to fair value at March 31, 2007, resulting in an impairment loss of $1,162. The weighted average yield on the securities sold approximated 4.22%, whereas the weighted average cost of the borrowings paid down approximated 5.31%. The Company’s overall objectives were to improve future period earnings, lower the interest rate risk profile of the Company’s balance sheet, and provide a means to more effectively respond to current and future yield curve environments.
During the latter part of the second quarter, market yields climbed to a five-year high, with the benchmark 10-year U.S. Treasury advancing to 5.32% in mid June. The strong increase in market yields presented opportunities for replacing the securities sold, increasing the Bank’s earning assets, and generating higher levels of net interest income.Trading Securities: Trading securities are securities bought and held principally for the purpose of selling them in the near term with the objective of generating profits on short-term differences in price. During the years ended December 31,
20072008 and2006,2007, the Bank did not own any trading securities.Securities Held to Maturity: Securities held to maturity are debt securities for which the Bank has the positive intent and ability to hold until maturity. Held to maturity investments are reported at their aggregate cost, adjusted for amortization of premiums and accretion of discounts. During the years ended December 31,
20072008 and2006,2007, the Bank did not own any securities held to maturity.Securities Available for Sale: Securities available for sale represented 100% of total securities at December 31,
20072008 and2006.2007.The designation of securities available for sale is made at the time of purchase, based upon management’s intent to hold the securities for an indefinite time; however, these securities would be available for sale in response to changes in market interest rates, related changes in the securities’ prepayment risk, needs for liquidity, or changes in the availability of and yield on alternative investments. The securities available for sale portfolio is used for liquidity purposes while simultaneously producing earnings.
Securities classified as available for sale are reported at their fair value with unrealized gains or losses, net of taxes, excluded from earnings but shown separately as a component of shareholders’ equity. Gains and losses on the sale of securities available for sale are determined using the specific-identification method and are shown separately in the consolidated statements of income.
The
balances of securities available for sale are stated on the consolidated balance sheet net of fair value adjustments, reflecting net unrealized gains of $1,812 and net unrealized losses of $1,031 at December 31, 2007 and 2006, respectively. The change in net unrealized gains and losses was principally attributed to changes in the securities portfolio composition and prevailing end of year market interest rates. The change in unrealized gains and losses also reflects the 2007 restructuring of a portion of the securities portfolio. The unrealized loss position at December 31, 2006 reflects prevailing market conditions at that time and the fact that a portion of the securities were purchased during periods of historically low interest rates and available market yields.
Thefollowing table summarizes the securities available for sale portfolio as of December 31,20072008 and2006:2007:
December 31, 2007
Amortized
CostGross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Available for Sale:
Obligations of U.S. Government-sponsored enterprises
$ 17,250
$ 99
$ ---
$ 17,349
Mortgage-backed securities:
U.S. Government-sponsored enterprises
161,057
1,781
120
162,718
U.S. Government agencies
10,848
57
36
10,869
Other mortgage-backed securities
34,879
105
281
34,703
Obligations of State and Political Subdivisions thereof
38,771
493
286
38,978
TOTAL
$262,805
$2,535
$723
$264,617
December 2008 Available for Sale:
Amortized Cost*
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Obligations of US Government-sponsored enterprises
$ 700
$ 1
$ ---
$ 701
Mortgage-backed securities:
US Government-sponsored enterprises
172,661
4,874
10
177,525
US Government agency
32,750
961
26
33,685
Private-label
43,579
172
4,193
39,558
Obligations of states and political subdivisions thereof
42,534
166
3,667
39,033
Total
$292,224
$6,174
$7,896
$290,502
*includes the writedown of securities considered to be other than temporarily impaired at December 31, 2008, with impairment writedowns totaling $1,435.
December 31, 2006
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair
ValueAvailable for Sale:
Obligations of U.S. Government-sponsored enterprises
$ 27,844
$ 8
$ 229
$ 27,623
Mortgage-backed securities:
U.S. Government-sponsored enterprises
116,666
182
1,827
115,021
U.S. Government agencies
9,830
31
56
9,805
Other mortgage-backed securities
29,543
5
507
29,041
Obligations of State and Political Subdivisions thereof
30,400
1,378
16
31,762
TOTAL
$214,283
$1,604
$2,635
$213,252
December 31, 2007
Amortized
CostGross
Unrealized
GainsGross
Unrealized
LossesEstimated
Fair ValueAvailable for Sale:
Obligations of U.S. Government-sponsored enterprises
$ 17,250
$ 99
$ ---
$ 17,349
Mortgage-backed securities:
U.S. Government-sponsored enterprises
161,057
1,781
120
162,718
U.S. Government agencies
10,848
57
36
10,869
Private-label
34,879
105
281
34,703
Obligations of State and Political Subdivisions thereof
38,771
493
286
38,978
Total
$262,805
$2,535
$723
$264,617
Obligations of U.S. Government-sponsored Enterprises: This category of securities represents promissory notes (debt instruments) issued by U.S. Government-sponsored enterprises, such as FNMA, FHLMC, FHLB, etc. All of these securities were credit rated AAA by all of the major credit rating agencies at December 31, 2008 and 2007.
At December 31, 2008, obligations of U.S. Government-sponsored enterprises, at fair value, totaled $701, compared with $17,349 at December 31, 2007, representing a decline of $16,648, or 96.0%. The 2008 decline in these type securities was attributed to the exercise of callable options by the issuers during 2008, reflecting declining interest rates and market yields.
At December 31, 2008, the Bank’s weighted average yield on obligations of U.S. Government-sponsored enterprises amounted to 5.50%, compared with 5.68% at December 31, 2007.
Mortgage-backed Securities Issued by U.S. Government-sponsored Enterprises: This category of securities represents mortgage backed securities issued and guaranteed by U.S. Government-sponsored enterprises, specifically, FNMA and FHLMC. These Government-sponsored enterprises were placed under the conservatorship of the U.S. Government on September 7, 2008. All of these securities were credit rated AAA by the major credit rating agencies at December 31, 2008 and 2007.
At December 31, 2008, mortgage-backed securities issued by U.S. Government-sponsored enterprises, at fair value, totaled $177,525, compared with $162,718 at December 31, 2007, representing an increase of $14,807, or 9.1%.
At December 31, 2008, the Bank’s weighted average yield on mortgage-backed securities issued by U.S. Government-sponsored enterprises amounted to 5.84%, compared with 5.90% at December 31, 2007.
Mortgage-backed Securities Issued by U.S. Government Agencies: This category of securities represents mortgage-backed securities backed by the full faith and credit of the U.S. Government, such as the Government National Mortgage Association ("GNMA"). All of these securities were credit rated AAA at December 31, 2008 and 2007.
At December 31, 2008, mortgage-backed securities issued by U.S. Government agencies, at fair value, totaled $33,685, compared with $10,869 at December 31, 2007, representing an increase of $22,816, or 209.9%.
At December 31, 2008, the Bank’s weighted average yield on mortgage-backed securities issued by U.S. Government agencies amounted to 5.77%, compared with 5.86% at December 31, 2007.
Mortgage-backed Securities Issued by Private-label Issuers: This category of securities represents mortgage-backed securities issued by banks, investment banks, and thrift institutions. Typically these securities are based on so-called jumbo mortgages, which exceed the conforming loan sizes required by agency securities. While private-label mortgage-backed securities are not guaranteed by any U.S. Government agency, they are credit rated by the major rating agencies (Moody’s, Standard & Poor’s and FITCH).
All of the Bank’s mortgage-backed securities issued by private-label issuers carry various amounts of credit enhancement, and none are collateralized with sub-prime loans. These securities were purchased based on the underlying loan characteristics such as loan to value ratios, borrower credit scores, property type and location, and the level of credit enhancement.
At December 31, 2008, mortgage-backed securities issued by private-label issuers, at fair value, totaled $39,558, compared with $34,703 at December 31, 2007, representing an increase of $4,855, or 14.0%.
At December 31, 2008, $26,014 or 65.7% of the fair value of the Bank’s private-label mortgage-backed securities portfolio was rated AAA by the major credit rating agencies, compared with 100% at December 31, 2007. During 2008, in response to the deteriorating mortgage loan collateral in certain of these securities, at least one of the major credit rating agencies down graded $11,342, of the Bank’s private-label mortgage-backed securities. At December 31, 2008, the amount of private-label mortgage-backed securities that had been downgraded by at least one of the major credit rating agencies to below investment grade amounted to $4,204, or 10.6% of the fair value of the Bank’s private-label mortgage-backed securities portfolio at December 31, 2008. As previously reported, in the fourth quarter of 2008, the Bank recorded an other-than-temporary impairment charge of $1,435 related to these below investment grade securities.
At December 31, 2008, the Bank’s weighted average yield on its private-label mortgage-backed securities portfolio amounted to 5.89%, compared with 5.77% at December 31, 2007.
Obligations of States and Political Subdivisions Thereof: Obligations of states and political subdivisions thereof ("municipal bonds") are issued by city, county and state governments, as well as by enterprises with a public purpose, such as certain electric utilities, universities and hospitals. Municipal obligations are supported by the general taxing authority of the municipality and, in the cases of school districts, are supported by state aid. The Bank’s municipal bond portfolio is generally concentrated in school districts across the U.S.A., which historically have been considered among the safest municipal bond investments. One of the primary attractions of municipal bonds is that they are federally tax exempt.
Municipal bonds are frequently supported with insurance, which guarantees that in the event the issuer experiences financial problems, the insurer will step in and assume payment of both principal and interest. Historically, insurance support has strengthened an issuer’s underlying credit rating to AAA or AA status.
During 2008, many of the insurance companies providing municipal bond insurance experienced financial difficulties and, accordingly, were downgraded by at least one of the major credit rating agencies. Consequently, in 2008 a portion of the Bank’s municipal bond portfolio was moderately downgraded by at least one of the major credit rating agencies. Notwithstanding the credit rating downgrades, at December 31, 2008, 100% of the Bank’s municipal bond portfolio was considered investment grade by the major credit rating agencies.
At December 31, 2008, the fully tax-equivalent yield on the Bank’s municipal bond portfolio amounted to 7.16%, compared with 6.82% at December 31, 2007.
Purchase Premiums and Discounts: Securities are typically purchased at premium or discounted prices, depending on the coupon of the security and prevailing market yields. The Bank recognizes the amortization of premiums and accretion of discounts in interest income using the interest method over the estimated life of the security.
Securities Interest Income: The aggregate tax-equivalent yield on the securities portfolio amounted to 6.00% in 2008, compared with 5.74% in
2007, compared with 5.26% in 2006, representing an improvement of 48 basis points.2007. The increase wasprincipallypartially attributed to the restructuring of a portion of the securities portfolio in 2007, combined with the general availability of higher market yields on certain types of securities during certain periods in20072008 compared with prior years.Additionally, most of the 2007 cash flows from the securities portfolio were reinvested into securities with higher yields.The total tax-equivalent interest income from the securities portfolio amounted to $16,125 in 2008, compared with $13,516 in 2007,
compared with $10,695 in 2006,representing an increase of$2,821,$2,609, or26.4%19.3%. The increase in interest income from the securities portfolio was attributed to a4826 basis point increase in portfolio yield,andcombined with a15.7%$33,324 or 14.2% increase in the average20072008 securities portfolio balance.Securities Maturity Distribution and Weighted Average Yields: The following
tables summarizetable summarizes the maturity distribution of the amortized cost of the Bank’s securities portfolio and weighted average yields of such securities on a fully tax-equivalent basis as of December 31,2007.2008. The maturity distribution is based upon the final maturity date of the securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers have the right to prepay.SECURITIES
MATURITY SCHEDULE AND WEIGHTED AVERAGE YIELDS
DECEMBER 31,20072008
(at fair value)
One
Year
Or
LessGreater than One Year to
Five yearsGreater than
Five Years to
Ten yearsGreater
Than Ten
Years
Total
Obligations to U.S. Government-sponsored enterprises
$ ---
$ 5,968
$ 8,701
$ 2,680
$ 17,349
Average Yield
0.00%
5.03%
5.87%
6.51%
5.68%
Mortgage-backed Securities:
U.S. Government-sponsored enterprises
5
269
6,407
156,037
162,718
Average Yield
5.26%
4.45%
4.96%
5.94%
5.90%
U.S. Government agencies
---
22
1,594
9,253
10,869
Average Yield
0.00%
6.69%
6.40%
5.76%
5.86%
Other mortgage-backed securities
30
---
2,196
32,477
34,703
Average Yield
6.72%
0.00%
7.93%
5.62%
5.77%
Obligations of State and Political Subdivisions
---
233
464
38,281
38,978
Average Yield
0.00%
6.64%
6.48%
6.85%
6.82%
TOTAL
$ 35
$ 6,492
$19,362
$238,728
$264,617
One Year or less
Greater than one year to Five years
Greater than Five to ten years
Greater than ten years
TOTAL
Estimated
Fair ValueWeighted average yield
Estimated
Fair ValueWeighted average rate
Estimated
Fair ValueWeighted average yield
Estimated
Fair ValueWeighted average yield
Estimated
Fair ValueWeighted
average
yieldObligations of US
Government-sponsored
enterprises$ ---
---
$ ---
---
$ 701
5.50%
$ ---
---
$ 701
5.50%
Mortgage-backed securities:
US Government-sponsored
enterprises55
3.45%
626
4.83%
6,006
4.85%
170,838
5.88%
177,525
5.84%
US Government agency
1
4.83%
34
3.85%
2,068
2.63%
31,582
5.98%
33,685
5.77%
Private-label
---
0.00%
---
0.00%
3,146
4.68%
36,412
5.99%
39,558
5.89%
Obligations of states and
political subdivisions
thereof---
0.00%
172
7.07%
1,317
6.74%
37,544
7.17%
39,033
7.16%
Total
$56
$832
$13,238
$276,376
$290,502
Securities Concentrations: At December 31,
20072008 and2006,2007, the Bank did not hold any securities for a single issuer, other than U. S. Government agencies and sponsored enterprises, where the aggregate book value of the securities exceeded10%5% of the Company’s shareholders’ equity.Management believes U.S. Government-sponsored enterprises have minimal credit risk, as they play a vital role in the nation’s financial markets. At December 31, 2007 and 2006, all securities issued by Government agencies and sponsored enterprises were credit rated "AAA" by Moody’s and Standard and Poor’s.
Securities Credit Risk: The Bank continuously evaluates and monitors the credit risk of its securities utilizing a variety of resources including external credit rating agencies, predominantly Moody’s and Standard and Poor’s. All of the Bank’s mortgage-backed securities were rated "AAA" as of December 31, 2007. The Bank held no investment securities having a credit rating below "A" as of December 31, 2007. As of December 31, 2007, the Bank did not own any commercial mortgage-backed securities, collateralized debt obligations, or pools of subprime mortgage-backed securities.Impaired Securities: The securities portfolio contains certain securities where amortized cost exceeds fair market value, which at December 31,
20072008 amounted to an excess of$723, compared with $2,635 at$7,896, or 2.7% of the amortized cost of the total securities portfolio. At December 31,2006. Unrealized losses that are considered other-than-temporary are recorded as2007 this amount represented an excess of $723, or 0.28% of the total securities portfolio.As a
loss onpart of the Company’sconsolidated statementsongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired. For further discussion regarding the Company’s other-than-temporary impairment policy, see Other-Than-Temporary Impairments ofincome. InSecurities in Item 8, Note 1, in this Annual Report on Form 10-K.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 net realized securities losses equal to the difference between the fair value and cost or amortized cost basis of the security.
The Company’s evaluation of securities for impairments is a quantitative and qualitative process intended to determine whether declines in the fair value of investment securities should be recognized in current period earnings. The primary factors considered in evaluating whether
impairmenta decline in the fair value of securities is other-than-temporarymanagement considers a varietyinclude: (a) the length offactors includingtime and extent to which thenaturefair value has been less than cost or amortized cost and the expected recovery period of theinvestmentsecurity, (b) thecausefinancial condition, credit rating and future prospects of theimpairment,issuer, (c) whether theseveritydebtor is current on contractually obligated interest andduration ofprincipal payments (d) theimpairment, and the Bank’s ability and intent to hold the security to maturity. Other data considered by management includes, for example, sector credit ratings,volatility of thesecurity’ssecurities market price (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity, and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred.
At December 31, 2007For securitized financial assets with contractual cash flows, such as the Bank’s private-label mortgage-backed securities, the Company regularly monitors the current characteristics of each security such as delinquency and2006, management determined thereforeclosure levels, credit enhancement, and coverage ratios. When the level of credit loss coverage for an individual security deteriorates below a specified level, the Company expands it analysis of the security to include detailed cash flow projections based on loan level credit characteristics and prepayment assumptions. The Company reviews the resulting cash flows to determine whether it will receive all of the originally scheduled cash flows. The resulting projected credit losses are compared to the current level of credit enhancement to determine whether the security is expected to experience losses during any future period.The Company’s best estimate of cash flows uses severe economic recession assumptions due to market uncertainty. The Company’s assumptions include but are not limited to delinquencies, foreclosure levels and constant default rates on the underlying collateral, loss severity ratios, and constant prepayment rates. If the Company does not expect to receive 100% of future contractual principal and interest, an other-than-temporary impairment charge is recognized. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third party sources along with certain internal assumptions and judgments regarding the future performance of the underlying collateral.
As previously reported, based on the foregoing evaluation criteria, during the fourth quarter of 2008, the Company concluded that unrealized losses on available-for-sale, private-label mortgage-backed securities with an amortized cost of $4,255 were other-than-temporarily impaired, because the Company could no
unrealizedlonger conclude that it is probable that it will recover 100% of these investments. Accordingly, in the fourth quarter, the Company recorded an other-than-temporary impairment charge of $1,435. This charge was recorded as securities losses in the Company’s consolidated statement of income. Management believes these losses were attributable to unprecedented market stresses affecting private-label mortgage-backed securities,portfolioa rapidly declining U.S. economy in general and the national housing market in particular, which deteriorated rapidly in recent months. While recording this impairment charge is required by current U.S. GAAP accounting standards, Company management estimates that the ultimate economic losses that may be realized for these securities will be meaningfully less than the current "mark-to-market" losses. Company management believes that the difference between the expected losses and current the "mark-to-market" losses are largely attributed to current market illiquidity conditions, massive de-leveraging, and the historical disruption in the financial markets in general.The Company also concluded that as of December 31, 2008, the unrealized losses of $7,896 on available-for-sale securities with an amortized cost of $76,323 and a fair value of $68,427, as identified in the table below, were
other-than-temporary.temporarily impaired. This conclusion was based on the issuer’s continued satisfaction of the securities obligations in accordance with their contractual terms and the expectation that they will continue to do so, management’s intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value which may be at maturity, the expectation that the Company will receive 100% of future contractual cash flows, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence.The following table summarizes temporarily impaired securities and their approximate fair values at December 31,
2007.2008. All securities referenced are debt securities. At December 31,2007,2008, the Bank did not hold any common stock or equity securities in its securities portfolio.TEMPORARILY IMPAIRED SECURITIES
DECEMBER 31,20072008
Less Than 12 Months
12 Months or Longer
Total
Description of Securities:
Fair Value
Number of Investments
Unrealized Losses
Fair Value
Number of Investments
Unrealized
LossesFair
ValueNumber of Investments
Unrealized Losses
Obligations of U.S. Government
–sponsored enterprises$ ---
--- $ ---
$ ---
--- $ ---
$ ---
--- $ ---
Mortgage-backed securities:
U.S. Government-sponsored
enterprises7,948
9
19
13,321
41
101
21,269
50
120
U.S. Government agencies
3,474
12
22
1,109
10
14
4,583
22
36
Other mortgage-backed securities
13,841
15
118
9,297
27
163
23,138
42
281
Obligations of states of the U.S.
and political subdivisions thereof12,796
46
216
760
4
70
13,556
50
286
Total temporarily impaired securities
$38,059
82
$375
$24,487
82
$348
$62,546
164
$723
Less than 12 months
12 months or longer
Total
Description of Securities:
Estimated
Fair ValueNumber of
InvestmentsUnrealized
LossesEstimated
Fair ValueNumber of
InvestmentsUnrealized
LossesEstimated
Fair ValueNumber of
InvestmentsUnrealized
LossesMortgage-backed securities:
US Government-sponsored
enterprises$ 2,423
3
$ 7
$ 451
3
$ 3
$ 2,874
6
$ 10
US Government agency
1,660
16
19
230
7
7
1,890
23
26
Private-label
27,140
37
3,560
6,620
23
633
33,760
60
4,193
Obligations of states of the U. S.
and political subdivisions thereof25,975
79
2,330
3,928
18
1,337
29,903
97
3,667
Total
$57,198
135
$5,916
$11,229
51
$1,980
$68,427
186
$7,896
At December 31, 2007, the total unrealized losses on temporarily impaired securities amounted to $723, representing 1.1% of their amortized cost.As of December 31,
2007,2008, unrealized losses on securities in a continuous unrealized loss position more than twelve-months amounted to $1,980, compared with $348or 1.4% of their amortized cost.at December 31, 2007.For securities with unrealized losses, the following information was considered in determining that the impairments were not other-than-temporary:
Securities backedMortgage-backed securities issued by U.S. Government-sponsoredenterprises, allenterprises: As ofwhichDecember 31, 2008, the total unrealized losses on these securities amounted to $10. All of these securities were credit rated "AAA",by the major credit rating agencies. Company management believes these securities have minimal credit risk, as these enterprises play a vital role in the nation’s financial markets.Mortgage-backed securities issued by U.S. Government agencies all of which were credit rated "AAA", are backed byCompany management believes that thefull faith and credit of the United States and therefore bear no credit risk.Other mortgage-backed securities, all of which were corporate mortgage-backed securities, were all credit rated "AAA". These securities were additionally evaluated for credit risk based on the strength and performance of the underlying borrowers and collateral, and the extent of the current underlying credit support within the structure of each security.Obligations of states of the U.S. and political subdivisions thereof, none of which were credit rated below "A", were additionally evaluated for credit risk based on the underlying credit ratings and strength of the issuers and bond insurers, as well as the defined sources of repayment (e.g. local property taxes, tax revenue, etc).
Theunrealized lossesin the securities portfolioat December 31,2007 and 20062008 were attributed to changes in current marketinterest rate increases, reflectingyields and spreads since thevolatile movements indate theU.S. Treasury yield curve over the past several years. Specifically, certain debtunderlying securities were purchased,when market interest rates were lower than the rates prevailingand does not consider these securities to be other-than-temporarily impaired at December 31,2007 and 2006. Because the decline in market value was attributable to changes in interest rates and not credit quality or other factors, and because the Bank2008. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be atmaturity,maturity.Mortgage-backed securities issued by U.S. Government agencies: As of December 31, 2008, the total unrealized losses on these securities amounted to $26. All of these securities were credit rated "AAA" by the major credit rating agencies. Company management believes these securities bear no credit risk because they are backed by the full faith and credit of the United States. The Company attributes the unrealized losses at December 31, 2008 to changes in current market yields and spreads for similar securities since the date the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at December 31, 2008. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity. Private-label mortgage-backed securities: As of December 31, 2008, the total unrealized losses on the Bank’s private-label mortgage-backed securities amounted to $4,193, of which $633 had been in an unrealized loss position twelve months or longer. The Company attributes the unrealized losses at December 31, 2008 to current market liquidity conditions, massive de-leveraging, risk related market pricing discounts for non-agency mortgage-backed securities, and the historical disruption in the financial markets in general. Based upon the foregoing considerations and the expectation that the Company will receive all of the future contractual cash flows on these securities, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 20072008. The Company also has the ability and2006.
Management believesintent to hold these securities until a recovery of their amortized cost, which may be at maturity.Obligations of states of the extentU.S. and political subdivisions thereof: As of December 31, 2008, the total unrealized losses on the Bank’s municipal securities amounted to $3,667, of which $1,337 had been in an unrealized loss position twelve months or longer. The Bank’s municipal securities are largely insured and are supported by the general taxing authority of the municipality and in the cases of school districts, are supported by state aid. At December 31, 2008 all municipal bond issuers were current on contractually obligated interest and principal payments. The Company attributes the unrealized losses at December 31, 2008 to changes in prevailing market yields and pricing spreads since the date the underlying securities were purchased, combined with current market liquidity conditions and the disruption in the financial markets in general. Accordingly, The Company does not consider these municipal securities to be other-than-temporarily impaired at December 31, 2008. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity.Federal Home Loan Bank Stock
The Bank is a member of the Federal Home Loan Bank ("FHLB") of Boston. The FHLB of Boston is a cooperatively owned wholesale bank for housing and finance in the six New England States. Its mission is to support the residential mortgage and community-development lending activities of its members, which include over 450 financial institutions across New England. As a requirement of membership in the FHLB of Boston, the Bank must own a minimum required amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB. The Bank uses the FHLB of Boston for most of its wholesale funding needs.
At December 31, 2008 the Bank’s investment in FHLB stock totaled $14,796, compared with $13,156 at December 31, 2007, representing an increase of $1,640, or 12.5%.
FHLB stock is a non-marketable equity security and therefore is reported at cost, which equals par value. Shares held in excess of the minimum required amount are generally redeemable at par value; however, the FHLB recently announced a moratorium on such redemptions in order to preserve its capital in response to current market conditions. The minimum required shares are redeemable, subject to certain limitations, five years following termination of FHLB membership. The Bank has no intention of terminating its FHLB membership. The investment in FHLB stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB of Boston and its overall financial condition. No impairment losses have been recorded through December 31, 2008.
In February 2009 the FHLB of Boston announced a fourth quarter other-than-temporary impairment charge of $339.1 million on its private-label mortgage backed securities. The FHLB of Boston has advised its members that it is focusing on preserving capital in response to ongoing market volatility and, accordingly, dividend payments for the first quarter of 2009 have been suspended, and it is unlikely that dividends will be paid in 2009. As of September 30, 2008, the estimated fair value of private-label mortgage-backed securities
will steadily diminish over time as principal paymentsit owned was approximately $1.3 billion less than the $4.4 billion carrying value of the securities at that date. If this unrealized loss were deemed to be an other-than-temporary loss in the future, it could exceed the FHLB of Boston’s current level of retained earnings andpre-payments are receivedpossibly put into question whether the fair value of the FHLB of Boston stock owned by the Bank was less than par value. The FHLB of Boston has stated that it expects anddurationsintends to hold its private-label mortgage-backed securities to maturity. The Bank will continue toshorten. In the casemonitor its investment in FHLB ofdebt securities, management believes unrealized losses will diminish over time as the periods remaining to maturity continue to shorten. Management also believes that any declines in the U.S. Treasury yield curve will further diminish the extent of unrealized losses in the securities portfolio, as market values typically increase in a declining interest rate environment. Conversely, management believes that upward movements in the U.S. Treasury yield curve will increase the extent of unrealized losses in the securities portfolio over the near term.Boston stock.Loans
Total Loans: At December 31,
2007,2008, total loans amounted to$579,711,$633,603, compared with$555,099$579,711 at December 31,2006,2007, representing an increase of$24,612,$53,892, or4.4%9.3%. Commercial loansaccounted for $25,647 or 104.2%led the overall growth of the2007loangrowth, offsetportfolio inpart by small declines in consumer loans and tax-exempt loans to municipalities and not-for-profit organizations.2008, as residential mortgage loan originations slowed. In general, business loan origination activity benefited from astill-favorablefavorable market interest rate environment, a relatively stable local economy, and initiatives designed to expand the Bank’s product offerings and attract new customers while continuing to leverage its existing customer base.The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington and Knox, Maine. The following table summarizes the major components of the Bank’s loan portfolio, net of deferred loan origination fees and costs, as of December 31 over the past five years.
SUMMARY OF LOAN PORTFOLIO AT DECEMBER 31
2008
2007
2006
2005
2004
2007
2006
2005
2004
2003
Commercial real estate mortgages
$183,663
$159,330
$135,269
$104,446
$ 77,518
$236,674
$183,663
$159,330
$135,269
$104,446
Commercial and industrial loans
65,238
61,634
58,542
43,967
38,664
65,717
65,238
61,634
58,542
43,967
Agricultural and other loans to farmers
15,989
17,706
18,962
15,077
11,719
19,390
15,989
17,706
18,962
15,077
Total commercial loans
264,890
238,670
212,773
163,490
127,901
321,781
264,890
238,670
212,773
163,490
Residential real estate mortgages
251,625
253,114
236,712
222,110
203,077
249,543
251,625
253,114
236,712
222,110
Consumer loans
10,267
10,889
12,565
13,534
13,126
4,773
10,267
10,889
12,565
13,534
Home equity loans
45,783
45,062
49,221
47,189
35,941
51,095
45,783
45,062
49,221
47,189
Total consumer loans
307,675
309,065
298,498
282,833
252,144
305,411
307,675
309,065
298,498
282,833
Tax exempt loans
6,001
6,213
2,732
1,950
3,652
5,358
6,001
6,213
2,732
1,950
Deferred origination costs (fees), net
1,145
1,151
863
205
(289)
Deferred origination costs, net
1,053
1,145
1,151
863
205
Total loans
579,711
555,099
514,866
448,478
383,408
633,603
579,711
555,099
514,866
448,478
Allowance for loan losses
(4,743)
(4,525)
(4,647)
(4,829)
(5,278)
(5,446)
(4,743)
(4,525)
(4,647)
(4,829)
Total loans net of allowance for loan losses
$574,968
$550,574
$510,219
$443,649
$378,130
$628,157
$574,968
$550,574
$510,219
$443,649
At December 31,
2007,2008, consumer loans comprised53.1%48.2% of the total loan portfolio while commercial loans comprised45.7%50.1%, compared with55.7%53.1% and43.0%45.7% at December 31,2006,2007, respectively.Factors contributing to the changes in the loan portfolio are enumerated in the following discussion and analysis.
Commercial Loans: At December 31,
2007,2008, total commercial loans stood at$264,890,$321,781, compared with$238,670$264,890 at December 31,2006,2007, representing an increase of$26,220,$56,891, or11.0%21.5%. Commercial loan growth was principally driven by commercial real estate mortgage loans, which posted an increase of$24,333,$53,011, or15.3%28.9%. At December 31,20072008 commercial real estate mortgageloanloans totaled$183,663$236,674 and represented31.7%37.4% of the loan portfolio, compared with28.7%31.7% at December 31,2006.2007.At December 31,
2007,2008, commercial and industrial loans totaled$65,238,$65,717, compared with$61,634$65,238 at December 31,2006,2007, representing an increase of$3,604,$479, or5.8%0.7%. This category of loans represented11.2%10.4% of the loan portfolio at December 31, 2008, compared with 11.3% at December 31, 2007. The Bank’s market area demographics have historically limited the opportunity and growth potential in this particular category of loans.Loans to finance agricultural production and other loans to farmers totaled
$15,989$19,390 as of December 31,2007,2008, compared with$17,706$15,989 at December 31,2006,2007, representinga declinean increase of$1,717,$3,401, or9.7%21.3%. This category of loans represented2.8%3.1% of the loan portfolio at December 31,2007,2008, compared with3.2%2.8% at December 31,2006. The decline was principally attributed to pay-downs on loan balances during2007. The communities served by the Bank generally offer limited opportunities for lending in this industry sector. This category of loans includes loans related to Maine’s wild blueberry industry.Bank management attributes the overall
20072008 growth in the commercial loan portfolio, in part, to an effective business banking team, a variety of new business development initiatives, focused incentive compensation plans and a relatively stable local economy. Given the recent economic downturns in the markets served by the Bank and the prospect for further declines in the future, Company management anticipates commercial loan origination activity will experience a moderate slowdown in 2009.Consumer Loans: At December 31,
2007,2008, total consumer loans, which principally consisted of residential real estate mortgage loans, stood at$307,675$305,411 compared with$309,065$307,675 at December 31,2006,2007, representing a decline$1,390,$2,264, or0.5%0.7%.Residential real estate mortgage loans totaled at
$251,625$249,543 as of December 31,2007,2008, compared with$253,114$251,625 at December 31,2006,2007, representing a decline of$1,489,$2,082, or0.6%0.8%. This category of loans represented43.4%39.4% of the Bank’s loan portfolio at December 31,2007,2008, compared with45.6%43.4% at December 31,2006.2007.
Principally reflecting a softening real estate market, residential real estate mortgage loan originations started slowing in the latter part of 2006 and this trend continued throughout 2007. In 2007, the Bank originated and closed $46,450The decline in residential real estate mortgage loanscomparedin 2008 principally reflected a continued softening of the real estate markets in many of the communities served by the Bank, combined with$58,364market interest rates that continued at elevated levels. While the Bank originated and closed $37,246 in2006, representing a decline of $11,914, or 20.4%. The new loan originationsresidential real estate mortgage loans in2007 replaced a significant2008, this amountofwas more than offset by $39,328 in principalcash flowspaydowns from the existing residential real estate loanportfolio which, givenportfolio. With the recent and significant decline in residential mortgage loan interestrate environment compared with prior years, increased the overall yield on this portfolio and generated anrates, Bank management anticipates a meaningful increase ininterest income of $809, or 5.7%, compared with 2006.
Home equity loans totaled $45,783 at December 31, 2007, compared with $45,062 at December 31, 2006, representing an increase of $721, or 1.6%. The relatively small increaseresidential mortgage loan origination activity inhome equity loans was in part attributed to mortgage refinancing activity, which was driven by the higher cost of Prime interest rate based home equity loans, prompting borrowers to consolidate their debt into lower cost fixed rate mortgages.2009.Loans to individuals for household, family and other personal expenditures ("consumer loans"), which also include credit card loans,
and student loans,totaled $4,773 at December 31, 2008 compared with $10,267 at December 31, 2007,compared with $10,889 at December 31, 2006,representing a decline of$622,$5,494, or5.7%53.5%. Theoveralldecline in this category of loans wasprincipallyattributed, in part, to the sale of the Bank’s$2,539 student$2,070 credit card loan portfolio in2007.the fourth quarter of 2008. Given strong competition from the financing affiliates of consumer durable goods manufacturers, among other considerations, the Bank has not campaigned aggressively for consumer installment loans over the past
severalfive years.However,Home equity loans totaled $51,095 at December 31, 2008, compared with $45,783 at December 31, 2007, representing an increase of $5,312, or 11.6%. Approximately 86% of the
Bank continues to be one of relatively few community banks with its own credit cardBank’s home equity loan portfolioas large credit card processing companies continueis represented by variable rate loans indexed toacquire credit card portfoliosthe Prime interest rate. Bank management believes the 2008 increase in home equity loans was principally attributed to the significant decline in the Prime interest rate, providing borrowers with an attractive andassociated sourcesreadily available source ofnon-interest income from smaller financial institutions.low cost borrowings, compared with other borrowing alternatives.Tax Exempt Loans: Tax-exempt loans totaled $5,358 at December 31, 2008, compared with $6,001 at December 31, 2007,
compared with $6,213 at December 31, 2006,representing a decline of$212,$643, or3.4%10.7%. Tax-exempt loans represented1.0%0.8% of the loan portfolio at December 31,2007,2008, compared with1.1%1.0% at December 31,2006.2007.Tax-exempt loans principally include loans to local government municipalities and, to a lesser extent, not-for-profit organizations. Government municipality loans typically have short maturities (e.g., tax anticipation notes). Government municipality loans are normally originated through a bid process among local financial institutions and are typically priced aggressively, thus generating narrow net interest margins.
Subprime Mortgage Lending: Subprime mortgage lending, which has been the riskiest sector of the residential housing market, is not a market that bank management has ever actively pursued. In general, the industry does not apply a uniform definition of what actually constitutes "subprime" lending. In referencing subprime lending activities, Bank management relies upon several sources, including Maine’s predatory lending law enacted January 1, 2008, and the "statement of subprime mortgage lending" issued by the federal bank regulatory agencies (the "agencies") on June 29, 2007, which further references the expanded guidance for subprime lending programs (the "expanded guidance"), issued by the agencies by press release dated January 31, 2001.
In the expanded guidance, the agencies indicated that subprime lending does not refer to individual subprime loans originated and managed, in the ordinary course of business, as exceptions to prime risk selection standards. The Agencies recognize that many Prime loan portfolios will contain such accounts. The Agencies also excluded Prime loans that develop credit problems after origination and community development loans from the subprime arena. According to the expanded guidance, subprime loans are other loans to borrowers that display one or more characteristics of reduced payment capacity. Five specific criteria, which are not intended to be exhaustive and are not meant to define specific parameters for all subprime borrowers and may not match all markets’ or institutions’ specific subprime definitions, are set forth, including having a FICO (credit) score of 660 or lower. Based on the definitions and exclusions described above, Bank management considers the Bank as a Prime lender. Within the Bank’s residential mortgage loan portfolio there are loans that, at the time of origination, had FICO scores of 660 or below. However, as a portfolio lender, the Bank reviews all credit underwriting data including all data included in borrower credit reports and does not base its underwriting decisions solely on FICO scores. Bank management believes the aforementioned loans, when made, were amply collateralized and documented, and otherwise conformed to the Bank’s lending standards.
Real Estate Loans Under Foreclosure: At December 31,
2007,2008, real estate loans under foreclosure totaled$1,476$2,463 compared with$495$1,476 at December 31,2006,2007, representing an increase of$981.$987, or 66.9%. At December 31, 2008, real estate loans under foreclosure were represented by six residential mortgage loans totaling $1,103 and six commercial real estate loans totaling $1,360. At December 31, 2007, real estate loans under foreclosure were represented by fiveconsumerresidential mortgage loans totaling $332and one commercial real estate loan totaling $1,144. At December 31, 2006, real estate loans under foreclosure were represented by four consumer mortgage loans amounting to $345and one commercial real estateloansloan totaling$150.$1,144. During2007,2008, foreclosure proceedings were completed or otherwise resolved on allfivesix of these loans, and any resulting charge-offs were recognized.Loan Concentrations: Because of the Company’s proximity to Acadia National Park, a large part of the economic activity in the area is generated from the hospitality business associated with tourism. At December 31,
2007,2008, approximately$50,282$54,855 or 8.7% of the Bank’s loan portfolio was represented by loans to the lodging industry, compared with$30,210$50,282 or5.4%8.7% at December 31,2006.2007. Loan concentrations continued to principally reflect the Bank’s business region.
Loans Secured by Real Estate: At December 31, 2007, consumer and commercial loans secured by real estate comprised 86.2% of the loan portfolio, compared with 86.5% at December 31, 2006. Over the past few years the strength in the local real estate markets, both residential and commercial, has led to historically high property values in the Bank’s market area. However, during the latter part of 2006 this trend began to soften and during 2007 property values began to decline. Recognizing the impact declining real estate values may have on the loan portfolio and origination pipeline, the Bank periodically reviews its underwriting standards in an effort to ensure that the quality of the loan portfolio is not jeopardized by unrealistic loan to value ratios or debt service levels. There was no significant deterioration in the performance or risk characteristics of the real estate loan portfolio through the reporting period.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
marketfair value below the carrying value are charged to other operating expenses.At December 31,
20072008 total OREO amounted to$340,$83, compared withnone$340 as of December 31,2006.2007. Onecommercialresidential property comprised the December 31,20072008 balance of OREO.Mortgage Loan Servicing: The Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31,
2007,2008, the unpaid balance of mortgage loans serviced for others totaled$5,609$4,575 compared with$6,566$5,609 at December 31,2006,2007, representing a decline of$957,$1,034, or14.6%18.4%. The decline in20072008 balances was attributed to serviced mortgage loan principal payments, as well as prepayments resulting from loan refinancing activity. Pursuant to the Bank’s asset and liability management strategy, its need for interest earning assets and its strong capital position, loans originated during20062008 and 2007 were held in the Bank’s loan portfolio.Loan Portfolio Interest Rate Composition: The following table summarizes the commercial, tax-exempt and consumer components of the loan portfolio by fixed and variable interest rate composition, as of December 31,
20072008 and2006:2007:
2007
2006
2008
2007
Commercial:
Fixed
$ 49,393
$ 43,329
$ 49,172
$ 49,393
Variable
216,070
195,917
273,135
216,070
Total
$265,463
$239,246
$322,307
$265,463
Tax exempt:
Fixed
$ 6,001
$ 6,213
$ 5,358
$ 6,001
Variable
---
---
---
---
Total
$ 6,001
$ 6,213
$ 5,358
$ 6,001
Consumer:
Fixed
$169,609
$172,874
$177,825
$169,609
Variable
138,638
136,766
128,113
138,638
Total
$308,247
$309,640
$305,938
$308,247
Total Loans:
Total loans:
Fixed
$225,003
$222,416
$232,355
$225,003
Variable
354,708
332,683
401,248
354,708
Total loans
$579,711
$555,099
Total
$633,603
$579,711
At December 31,
20072008, fixed and variable rate loans comprised38.8%36.7% and61.2%63.3% of the loan portfolio, compared with40.1%38.8% and59.9%61.2% at December 31,2006,2007, respectively. The 2008 increase in variable rate loans in was principally driven by sharp declines in the Prime interest rate, which is the index used for most of the Bank’s variable rate commercial loans. Most new borrowers elected Prime based loan pricing in 2008, while some existing borrowers renegotiated their higher cost fixed rate borrowings to lower cost Prime based borrowings.Loan Maturities and Re-pricing Distribution: The following table summarizes fixed rate loans reported by remaining maturity, and floating rate loans by next re-pricing date, as of December 31,
20072008 and2006.2007. Actual maturity dates may differ from contractual maturity dates due to prepayments,or loanmodifications and re-financings.
Maturities
2007
2006
2008
2007
One year or less
$158,251
$ 213,741
$235,261
$158,251
Over 1-5 years
189,567
128,589
179,359
189,567
Over 5 years
231,893
212,769
218,983
231,893
Total loans
$579,711
$555,099
$633,603
$579,711
Credit Risk: Credit risk is managed through loan officer authorities, loan policies, and oversight from the Bank's 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 function, which reports to the Audit Committee of the Board of Directors.
Management recognizes that early and accurate recognition of risk is the best means to reduce credit losses and maximize earnings. The Bank employs a comprehensive risk management structure to identify and manage the risk of loss. For consumer loans, the Bank identifies loan delinquency beginning at 10-day delinquency and provides appropriate follow-up by written correspondence or personal contact. Non-residential mortgage loan losses are recognized no later than the point at which a loan is 120 days past due. Residential mortgage loan losses are recognized during the foreclosure process, or sooner, when that loss is quantifiable and reasonably assured. For commercial loans the Bank applies a risk grading system, which stratifies the portfolio and allows management to focus appropriate efforts on the highest risk components of the portfolio. The risk grades include ratings that correlate with regulatory definitions of
"Pass","Pass," "Other Assets EspeciallyMentioned", "Substandard", "Doubtful",Mentioned," "Substandard," "Doubtful," and"Loss"."Loss."As a result of management’s ongoing review of the loan portfolio, loans are placed on non-accrual status, either due to the delinquent status of principal
andand/or interest, or a judgment by management that, although payments of principal and/or interest are current, such action is prudent because collection in full of all outstanding principal and interest is in doubt. Loans are generally placed on non-accrual status when principal and or interest is 90 days overdue, or sooner if judged appropriate by management. Consumer loans are generally charged-off when principal and or interest payments are 120 days overdue, or sooner if judged appropriate by management.Non-performing Loans: Non-performing loans include loans on non-accrual status, loans that have been treated as troubled debt restructurings, and loans past due 90 days or more and still accruing interest. There were no troubled debt restructurings in the loan portfolio during the
lastpast five years.The following table sets forth the details of non-performing loans over the
lastpast five years.TOTAL NON-PERFORMING LOANS
AT DECEMBER 31
2007
2006
2005
2004
2003
2008
2007
2006
2005
2004
Loans accounted for on a non-accrual basis:
Real Estate:
Construction and development
$ ---
$ ---
$ ---
$ ---
$ 114
$ 25
$ ---
$ ---
Residential mortgage
450
111
267
453
1,113
1,722
450
111
267
453
Commercial and industrial, and agricultural
1,598
456
593
93
31
2,138
1,598
456
593
93
Consumer
5
3
5
26
37
16
5
3
5
26
Total non-accrual loans
2,053
570
865
572
1,295
3,901
2,053
570
865
572
Accruing loans contractually past due 90 days or more 9
58
3
151
199
Accruing loans contractually past due 90 days
or more
503
9
58
3
151
Total non-performing loans
$2,062
$628
$868
$723
$1,494
$4,404
$2,062
$628
$868
$723
Allowance for loan losses to non-performing loans
230%
721%
535%
668%
353%
124%
230%
721%
535%
668%
Non-performing loans to total loans
0.36%
0.11%
0.17%
0.16%
0.39%
0.70%
0.36%
0.11%
0.17%
0.16%
Allowance to total loans
0.82%
0.82%
0.90%
1.08%
1.38%
0.86%
0.82%
0.90%
1.08%
During the year ended December 31,
2007,2008, non-performing loans increased, but remained at relatively low levels. The Bank attributesthisthe stability of the loan portfolio to mature credit administration processes and disciplined underwriting standards, aided by a relatively stable local economy. The Bank maintains a centralized loan collection and managed asset department, providing timely and effective collection efforts for problem loans.At December 31,
2007,2008, total non-performing loans amounted to$2,062,$4,404, or0.36%0.70% of total loans, compared with$628$2,062 or0.11%0.36% of total loans as of December 31,2006.2007. The increase in non-performing loans was largely attributed to the migration of onecommercialresidential real estate mortgage loan of$1,144,$907 that became non-performing in the fourth quarter. The increase in accruing loans contractually past due 90 days or55.5%, of total non-performing loansmore to $503 at December 31,2007.2008, was due to one agency guaranteed small business loan which the Company believes it will receive 100% of future principal and interest.While the level of non-performing loan ratios continued to reflect the overall favorable quality of the loan portfolio at December 31,
2007,2008, Bank management is cognizant of theslowingcontinued softening of the real estate market andsofteningdeteriorating economic conditions overall, and believes it is managing credit risk accordingly. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Bank's customers, includinginterest rates anddebt service levels,oil and gas prices,declining collateral values, tourism activity, and other factors existing at the time. Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Company’s results of operations and financial condition.Potential Problem Loans: In addition to the non-performing loans discussed above, the Bank also has loans that are 30 to 89 days delinquent. These loans amounted to
$2,865$3,591 and$2,238$2,865 at December 31, 2008 and 2007, or 0.57% and2006, or0.49%and 0.40%of total loans,respectively.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 loanlosses.losses
Subprime Mortgage Lending: Subprime mortgage lending, which has beenOn at least a quarterly basis, theriskiest sector of the residential housing market, is not a market thatBankmanagement has ever actively pursued. In general, the industry does not apply a uniform definition of what actually constitutes "subprime" lending. In referencing subprime lending activities, Bank management relies upon the "Statement of Subprime Mortgage Lending" issued by the federal bank regulatory agencies (the "Agencies") on June 29, 2007, which further references the Expanded Guidance for Subprime Lending Programs (the "Expanded Guidance"), issued by the Agencies by press release dated January 31, 2001. In the Expanded Guidance, the Agencies indicated that subprime lending does not referapplies an internal credit quality rating system toindividual subprime loans originated and managed, in the ordinary course of business, as exceptions to prime risk selection standards. The Agencies recognize that many prime loan portfolios will contain such accounts. The Agencies also excluded primecommercial loans thatdevelop credit problems after originationare either past due or fully performing but exhibit certain characteristics that could reflect a potential weakness. Loans are placed on nonaccrual status when the likely amount of future principal andcommunity development loans frominterest payments are expected to be less than thesubprime arena. According to the Expanded Guidance, subprimecontractual amounts, even if such loans areother loans to borrowers that display one or more characteristics of reduced payment capacity. Five specific criteria, which arenotintended to be exhaustive and are not meant to define specific parameters for all subprime borrowers and may not match all markets’ or institutions’ specific subprime definitions, are set forth, including having a FICO (credit) score of 660 or lower. Based on the definitions and exclusions described above, Bank management considers90 days past due.Periodically the Bank
as a prime lender. Withinreviews theBank’s residential mortgageloan portfoliotherefor 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 nonperforming at some time in thetime of origination, had FICO scores of 660 or below. However,future. Through the Bank’s on-going credit monitoring, it considers loans which, in its internal classification system, are classified asa portfolio lender,substandard but continue to accrue interest to be potential problem loans. At December 31, 2008, the Bankreviews all credit underwriting data including all data includedidentified 10 commercial relationships totaling $1,733 as potential problem loans. At December 31, 2007, the Bank identified 11 commercial relationships totaling $1,771 as potential problem loans. Factors such as payment history, value of supporting collateral, and personal or government guarantees led us to conclude that the current risk exposure on these loans did not warrant accounting for the loans as nonperforming. Although inborrower credit reports and does not base its underwriting decisions solely on FICO scores. Bank management believesa performing status as of year-end, these loans exhibited certain risk factors, which have theaforementioned loans, when made, were amply collateralized and documented, and otherwise conformedpotential to cause them to become nonperforming at some point in theBank’s prime lending standards.future.Allowance
Forfor Loan Losses: At December 31,2007,2008, the allowance for loan losses (the "allowance") stood at$4,743,$5,446, compared with$4,525$4,743 at December 31,2006,2007, representing an increase of$218,$703, or4.8%14.8%. At December 31, 2008, the allowance expressed as a percentage of total loans stood at 86 basis points, up from 82 basis points at December 31, 2007. The increase in the allowance principally reflects the growth of the loan portfolio in2007.2008, a higher level of non-performing loans, generally declining real estate values in much of the Bank’s market area, and other qualitative and environmental considerations.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 management’s judgment, is appropriate for the amount of risk inherent in the current loan portfolio, and adequate to provide for estimated, probable losses.
ReservesAllowances are established for specificloans includingimpaired loans, a pool of reserves based on historical charge-offs by loan types, and supplemental reserves that adjust historical loss experience to reflect current economic conditions, industry specific risks, and otherobservable data.qualitative and environmental considerations impacting the inherent risk of loss in the current loan portfolio.Specific allowances for impaired loans are determined in accordance with SFAS No. 114, "Accounting by Creditors For Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." The amount of loans considered to be impaired totaled $2,138 as of December 31, 2008, compared with $1,598 as of December 31, 2007. The related allowances for loan losses on these impaired loans amounted to $176 and $280 as of December 31, 2008 and 2007, respectively.
Management reviews impaired loans to ensure such loans are transferred to interest non-accrual status, and written down when necessary. The amount of interest income not recorded on impaired loans amounted to $263 and $111 for the years ended December 31, 2008 and 2007, respectively.
General allowances for loan losses account for the risk and estimated loss
provisions are recorded basedinherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There were no major changes in loan concentrations during 2008.Based upon
overall aggregate data,the process employed and giving recognition to all attendant factors associated with the loan portfolio, management believes the allowance for loan losses at December 31, 2008 isincreased when, on an aggregate basis, additional estimated losses are identified and deemed by management as being likely. No portion ofappropriate for theallowance is restricted to anyrisks inherent in the loanor group of loans, and the entire allowance is available to absorb realized losses. The amount and timing of realized losses and future allowance allocations could vary from current estimates.portfolio.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 Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.
The following table details changes in the allowance for loan losses and summarizes loan loss experience by loan type over the past five years.
ALLOWANCE FOR LOAN LOSSES
SUMMARY OF LOAN LOSS EXPERIENCE
2007
2006
2005
2004
2003
2008
2007
2006
2005
2004
Balance at beginning of period
$ 4,525
$ 4,647
$ 4,829
$ 5,278
$ 4,975
$ 4,743
$ 4,525
$ 4,647
$ 4,829
$ 5,278
Charge offs:
Commercial, financial, agricultural, and
other loans to farmers98
14
94
476
75
Real estate:
Construction and development
---
34
4
Mortgage
101
216
19
66
207
Installments and other loans to individuals
104
119
125
275
141
Commercial real estate mortgages
280
60
193
19
45
Commercial and industrial loans
858
29
4
92
456
Agricultural and other loans to farmers
3
69
10
2
20
Residential real estate mortgages
86
8
23
125
55
Consumer loans
106
104
119
---
275
Home equity loans
3
33
---
---
---
Total charge-offs
303
349
238
851
427
1,336
303
349
238
851
Recoveries:
Commercial, financial, agricultural, and
other loans to farmers25
4
14
66
24
Real estate:
Construction and development
---
4
---
---
Mortgage
4
39
1
51
106
Installments and other loans to individuals
36
53
37
105
60
Commercial real estate mortgages
1
4
7
---
49
Commercial and industrial loans
---
22
4
13
54
Agricultural and other loans to farmers
1
3
---
1
12
Residential real estate mortgages
18
---
32
5
2
Consumer loans
24
36
53
37
105
Total recoveries
65
96
56
222
190
44
65
96
56
222
Net charge-offs
238
253
182
629
237
1,292
238
253
182
629
Provision charged to operations
456
131
---
180
540
1,995
456
131
---
180
Balance at end of period
$ 4,743
$ 4,525
$ 4,647
$ 4,829
$ 5,278
$ 5,446
$ �� 4,743
$ 4,525
$ 4,647
$ 4,829
Average loans outstanding during period
$558,795
$538,212
$479,974
$416,956
$367,701
$611,373
$558,795
$538,212
$479,974
$416,956
Net charge-offs to average loans outstanding
0.04%
0.05%
0.04%
0.15%
0.06%
0.21%
0.04%
0.05%
0.04%
0.15%
The Bank's loan loss experience
continued at low levelsincreased during2007,2008, with net loan charge-offs amounting to$238,$1,292, or net charge-offs to average loans outstanding of0.04%0.21%, compared with$253,$238, or net loan charge-offs to average loans outstanding of0.05%0.04% in2006. The provision2007. Two problem loans accounted for $1,094, or 84.7%, of total net loanlosses totaled $456charge-offs in2007, compared with $131 in 2006, principally reflecting the growth of the total loan portfolio and, to a lesser extent, the increase in non-performing loans.2008.The following table presents the five-year summary of the allowance by loan type at each respective year-end.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
(at December 31)
2007
2006
2005
2004
2003
Amount
Percent of Loans in Each Category to Total loans
Amount
Percent of
Loans in Each Category to Total loansAmount
Percent of Loans in Each Category to Total loans
Amount
Percent of Loans in Each Category to Total loans
Amount
Percent of Loans in Each Category to Total loans
Commercial, financial,
and agricultural$1,093
9.99%
$1,435
9.83%
$1,407
11.70%
$1,886
11.29%
$2,281
8.06%
Real estate mortgages:
Real estate-construction
168
4.25%
205
6.26%
186
5.37%
135
4.76%
67
3.30%
Real estate-mortgage
3,247
82.24%
2,628
80.30%
2,768
80.00%
2,305
80.98%
1,708
84.39%
Installments and other loans
to individuals235
1.38%
257
1.92%
230
2.07%
249
2.49%
342
3.07%
Other
---
2.14%
---
1.69%
---
0.87%
---
0.48%
---
1.18%
Unallocated
---
0.00%
---
0.00%
56
0.00%
254
0.00%
880
0.00%
TOTAL
$4,743
100.00%
$4,525
100.00%
$4,647
100.00%
$4,829
100.00%
$5,278
100.00%
Specific allowances for impaired loans are determined in accordance with SFAS No. 114, "Accounting by Creditors For Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." The amount of loans considered to be impaired totaled $1,598 as of December 31, 2007, compared with $456 as of December 31, 2006.The related allowances for loan losses on these impaired loans amounted to $280 and $130 as of December 31, 2007 and 2006, respectively. At December 31, 2007 and 2006, all impaired loans had specific allowances. The Bank had no troubled debt restructurings at December 31, 2007 and 2006, and all of its impaired loans were considered collateral dependent.
Management reviews impaired loans to ensure such loans are transferred to interest non-accrual status, and written down when necessary. The amount of interest income not recorded on impaired loans amounted to $71 and $93 for the years ended December 31, 2007 and 2006, respectively.
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 major changes in loan concentrations during 2007.
Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, management believes the allowance for loan losses at December 31, 2007 to be appropriate for the risks inherent in the loan portfolio, and resident in the local and regional economy as of that date.
2008
2007
2006
2005
2004
Amount
Percent of
Loans in
Each
Category
to
Total
loansAmount
Percent of
Loans in
Each
Category
to
Total
loansAmount
Percent of
Loans in
Each
Category
to
Total
loansAmount
Percent of
Loans in
Each
Category
to
Total
loansAmount
Percent of
Loans in
Each
Category
to
Total
loansCommercial, financial,
and agricultural$1,612
9.36%
$1,093
9.99%
$1,435
9.83%
$1,407
11.70%
$1,886
11.29%
Real estate mortgages:
Real estate-construction
251
6.04%
168
4.25%
205
6.26%
186
5.37%
135
4.76%
Real estate-mortgage
3,414
82.58%
3,247
82.24%
2,628
80.30%
2,768
80.00%
2,305
80.98%
Installments and other loans
to individuals169
0.77%
235
1.38%
257
1.92%
230
2.07%
249
2.49%
Other
---
1.33%
---
2.14%
---
1.69%
---
0.87%
---
0.48%
Unallocated
---
0.00%
---
0.00%
---
0.00%
56
0.00%
254
0.00%
TOTAL
$5,446
100.00%
$4,743
100.00%
$4,525
100.00%
$4,647
100.00%
$4,829
100.00%
Funding Sources
The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Funding sources principally consist of retail deposits and, to a lesser extent, borrowings from the Federal Home Loan Bank of Boston ("FHLB") of which it is a member, and certificates of deposit obtained from the national market.
Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring and higher deposits in the 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 Bank’s strong liquidity position, including borrowing
linescapacity from the FHLB, brokered certificates of deposit obtained from the national market and cash flows from the securities portfolio.According to a January
20082009 report prepared bythe Maine Bureau of Financial Institutions, during the first half of 2007, Maine banks experienced strong growth in core deposits, positively impacting liquidity for Maine Banks and lessening their reliance on non-core funding. As a consequence, among Maine banks, the loan-to-core deposit ratio declined to 123% at June 30, 2007, down from 134% one year earlier, but still well above the national average of 102%, which was up from 100% one year earlier. At December 31, 2007, the Bank’s loan-to-core-deposit ratio amounted to 133%, compared with 134% at December 31, 2006.
According tothe Maine Bureau of Financial Institutions, Maine banks rely on borrowings and other types of non-core funding to a much greater degree than the national average, as Mainebanksbanks’ historical core deposit growth has not kept pace with asset growth. AtJuneSeptember 30,2007,2008, borrowings and other types of non-core funding supported31%32.5% of Maine bank assets,downup from33% one year earlier, but still31.3% at December 31, 2007, and well above the national average of13%, which was down from18%one year earlier.. At December 31,20072008 the Bank’s non-core funding represented43%49.4% of total assets, compared with39%43.0% at December 31,2006.2007.While the foregoing ratios compare unfavorably to both Maine banks and the national average of all federally insured banks, the Bank has had a long and successful track record in managing its liquidity and funding its earning asset portfolios. Nevertheless,
Managementmanagement believes that the Bank’s future success in growing core deposits will be a determinant factor in its ability to meaningfully grow earning assets and leverage its strong capital position.Deposits
During
2007,2008, the most significant source of funding for the Bank’s earning assets continued to be retail deposits, gathered throughout its network of twelve (12) banking offices throughout downeast and midcoast Maine. Total average retail deposits accounted for49.2%53.3% of the funding required in supporting the Bank’s earning asset portfolios during2007,2008, compared with51.0%49.2% in2006.2007.Total Deposits: At December 31,
20072008 total deposits amounted to$539,116$578,193 compared with$496,319$539,116 at December 31,2006,2007, representing an increase of$42,797,$39,077, or8.6%7.2%.The Bank’s 2007 depositRetail deposits led the overall growthincluded $21,331incertificates of deposittotal deposits, with brokered time deposits obtained from the national market ("brokered deposits"), as the Bank’s 2007 earning asset growth outpaced retail deposit growth, thus and necessitating the use of an additional funding source.posting a meaningful decline.
TotalRetail Deposits: At December 31,2007,2008, total retail deposits amounted to$435,424,$489,687, compared with$413,958$435,424 at December 31,2006,2007, representing an increase of$21,466$54,263 or5.2%12.5%.DemandRetail time deposits led the overallgrowthincrease in retail deposits.Demand Deposits: The Bank’s demand deposits
posting an increase of $11,289 or 21.0% compared withare principally business accounts. At December 31,2006. NOW accounts and retail certificates of deposits also contributed to retail deposit growth, posting increases of $3,462 and $7,919, or 5.4% and 6.0%, compared with December 31, 2006, respectively.
Total Average Deposits: Total average2008, total demand deposits amounted to$513,109 in 2007,$57,954, compared with$482,932 in 2006, representing an increase of $30,177, or 6.2%. Total average retail deposits amounted to $397,982 in$65,161 at December 31, 2007,compared with $402,042 in 2006,representing a decline of$4,060,$7,207, or1.0%11.1%.The decline in average retail deposits was principally attributed to a $15,725 decline in money market accounts offered to clients of Trust Services, reflecting a reallocation of cash within certain managed asset portfolios in the course of normal operations. Excluding the deposit accounts offered to clients of Trust Services, total average retail deposits increased by $11,665, or 3.1%, compared with 2006.
In general, without considering the declines in money market accounts offered to clients of Trust Services,As discussed above, the Bank’soverall retail deposit growth in 2007 moderately lagged historical norms. Management believes that competition from banks and non-banks intensified during 2007, as savers and investors sought higher returns, and that financial institutions in particular have been aggressively pricing their deposits in order to fund earning asset growth. Management also believes that during 2007 investors may have reallocated a portion of their cash positions, believing the equity markets became more attractive from a total return perspective.
Bank management believes it has exercised restraint with respect to overly aggressive deposit pricing strategies, and has sought to achieve an appropriate balance between retail deposit growth and wholesale funding levels, while protecting the Bank’s net interest margin and liquidity position.
The following table summarizes the changes in the average balances of deposits during the periods indicated, including the weighted average interest rates paid for each category of deposits:
AVERAGE DEPOSIT BALANCES BY CATEGORY OF DEPOSIT
2007
2006
Average
BalanceAverage
RateAverage
BalanceAverage
RateDemand deposits
$ 55,634
---
$ 54,308
---
NOW accounts
64,404
0.58%
64,785
0.43%
Savings and money market deposits
146,792
3.05%
151,943
2.83%
Time deposits
131,152
4.06%
131,006
3.49%
Brokered time deposits
115,127
5.25%
80,890
4.81%
Total deposits
$513,109
$482,932
Demand Deposits: Total demand deposits, which are principally business in nature, averaged $55,634 in 2007, compared with $54,308 in 2006, representing an increase of $1,326, or 2.4%. Demand deposits represented 14.0% of total average retail deposits in 2007, compared with 13.5% in 2006.
Consistent with the Bank’s market area demographics, a significant portion of its demanddeposits arehighlyseasonal in naturewith balances peaking inand thesummertiming andautumn while declining in winter and spring. While the exact timingextent oftheseseasonal swingsmayvary from year to year. This is particularly the case with transactions accounts versus certificates of deposit. For the yearbased on historical trends, Bank management anticipates that this categoryended December 31, 2008, average demand deposits amounted to $54,664, compared with $55,634 in 2007, representing a decline of $970, or 1.7%. Management believes the decline in demand depositswill show meaningful declines duringwas due in part to thefirst quarter of 2008, but will begin their seasonal upward trendslowing economy in thelatter part ofmarkets served by thesecond quarter of 2008.
The rate of average demand deposit growth moderately lagged historical norms during 2007. Management believes that competition for demand deposits has intensified, with more financial institutions offering no fee checking accounts, aggressive relationship pricing, and other highly competitive promotional offerings.Bank.The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis. The Bank’s business checking account offerings include Small BusinessPlus, BusinessPlus, and Free Small Business, each designed to help business owners manage the varying financial aspects of their business. The Bank also offers its business customers a variety of cash management products including a Cash Management Sweep Account. Customers are able to automatically transfer their excess demand deposit balances, over certain thresholds established with an earnings credit rate, to interest bearing, overnight securities repurchase agreements. Business demand deposits are also generated by way of the Bank’s Merchant Credit Card Processing Program.
NOW
Account Deposits: TheAccounts: Bank offers interest bearing NOW accounts to individuals, not-for-profit organizations and sole proprietor businesses.TotalAt December 31, 2008, total NOW accountsaveragedamounted to $67,747, compared with $67,050 at December 31, 2007, representing an increase of $697, or 1.0%. For the year ended December 31, 2008, average NOW accounts amounted to $67,240, compared with $64,404 in 2007,compared with $64,785 in 2006,representinga declinean increase of$381$2,836, or0.6%4.4%.In 2007, total average NOW represented 16.2% of total average retail deposits, compared with 16.1% in 2006.
Bank management principally attributed the 2007 decline in NOW account deposit balances to the interest rate environment and an atmosphere of well-publicized and more attractive short-term interest rates provided by alternative deposit products, such as the Bank’s high yielding money market account.During
2007,2008, the Bank’s most successful NOW account product continued to be Gold Wave Checking, a relationship product designed for its customers age 50 andabove customers.above.Savings and Money Market Deposits:
TotalAt December 31, 2008, total savings and money market accountsaveraged $146,792 in 2007,amounted to $163,780, compared with$151,943 in 2006,$163,009 at December 31, 2007, representinga declinean increase of$5,151,$771, or3.4%0.5%.Savings and money market accounts represented 36.9% of total average retail deposits during 2007, compared with 37.8% in 2006.
The $5,151 decline inFor the year ended December 31, 2008, average savings and money marketdepositsaccounts amounted to $167,739, compared with $146,792 in 2007, representing an increase of $20,947, or 14.3%. This increase was principally attributed tothe $15,725 declinea $17,102 increase in money market accounts offered to clients of Trust Services,as discussed above.reflecting a reallocation of cash within certain managed asset portfolios in the course of normal operations. Excluding the money market accounts offered to clients of Trust Services, total average savings and money marketaccountsdeposits increased by$10,574,$3,845, or8.8%2.6%, compared with2006.2007.
In responseTime Deposits: At December 31, 2008, total time deposits amounted tocompetitive pricing pressures and$200,206, compared with $140,204 at December 31, 2007, representing an increase of $60,002, or 42.8%. For the year ended December 31, 2008, average time deposits amounted to $188,044, compared with $131,152 in 2007, representing an increase of $56,892, or 43.3%. The increase in retail time deposits was largely attributed to the successful gathering of approximately $35,000 of out of marketdemand duringretail certificates of deposit, all of which were within FDIC insurance limitations at the time of origination.Brokered Time Deposits: At December 31, 2008, total brokered time deposits amounted to $88,506, compared with $103,692 at December 31, 2007, representing a
perioddecline ofrising short-term interest rates,$15,186, or 14.6%. For the year ended December 31, 2008, average brokered time deposits amounted to $95,679, compared with $115,127 in2006 the Bank introduced its new Prime-basedHorizon Money Market Account,which management believes is highly competitive and designed to satisfy the needs2007, representing a decline ofboth small and large investors alike.$19,448, or 16.9%. At December 31, 2008, total brokered deposits represented 15.3% of total deposits, compared with 19.2% of total deposits at December 31, 2007. The2007 growthdecline insavings and money market accountsbrokered deposits was principally attributed tothis new product.
The Bank also offers statement savings accounts and, as a community-oriented financial institution, continues to supportstrong retail deposit growth. In addition, during most of 2008, prevailing market conditions kept themore traditional passbook savings accounts.
Time Deposits: Total timecost of brokered depositsaveraged $131,152 in 2007,at historically wide spreads compared with$131,006 in 2006, representing an increase of $146, or 0.1%. Time deposits represented 33.0% of total average retail deposits during 2007, compared with 32.6% in 2006.
The 2007 growth in time deposits lagged historical norms. Given the strength of short-term interest rates during 2007, management believes investors and savers were attracted to relatively high yielding and liquid money market accounts. Additionally, in pricing time deposits, particularly non-relationship time deposits, Bank management will considerother wholesale sources of funding,which may be offered at more attractive termsprompting management to re-balance a portion of the Bank’s wholesale funding base.Bank management believes it has exercised restraint with respect to overly aggressive deposit pricing strategies, and
prices, including borrowed fundshas sought to achieve an appropriate balance between retail deposit growth and wholesale funding levels, while considering the associated impacts on the Bank’s net interest margin and liquidity position. In offering retail time deposits,availablethe Bank generally prices these deposits on a relationship basis. At December 31, 2008, the weighted average cost of retail time deposits was 3.21% compared with 4.15% at December 31, 2007, representing a decline of 94 basis points. At December 31, 2008 the weighted average cost of brokered time deposits was 3.55%, compared with 5.01% at December 31, 2007, representing a decline of 146 basis points. Given the current interest rate environment and continuing time deposit maturities, Bank management anticipates that the weighted average cost of time deposits will continue to show declines in 2009.The following table summarizes the changes in the
national market ("brokered time deposits")average balances of deposits during the periods indicated, including the weighted average interest rates paid for each category of deposits:AVERAGE DEPOSIT BALANCES BY CATEGORY OF DEPOSIT
2008 2007
Average
BalanceAverage
RateAverage
BalanceAverage
RateDemand deposits
$ 54,664
---
$ 55,634
---
NOW accounts
67,240
0.54%
64,404
0.58%
Savings and money market deposits
167,739
1.98%
146,792
3.05%
Time deposits
188,044
3.67%
131,152
4.06%
Brokered time deposits
95,679
4.60%
115,127
5.25%
Total deposits
$573,366
$513,109
Time deposits in denominations of $100 or greater totaled $65,437 at December 31, 2008, compared with $36,142 at December 31,
2007, compared with $29,118 at December 31, 2006, representing an2007. In October 2008, the Emergency Economic Stabilization Act raised the basic limit on federal deposit insurance coverage from $100 to $250 per depositor. In the fourth quarter of 2008, the Bank experienced a moderate increaseof $7,024, or 24.1%.in time deposits exceeding $100. The following table summarizes the maturity distribution of time deposits of $100 or greater:
MATURITY SCHEDULE
TIME DEPOSITS $100THOUSANDOR GREATER
DECEMBER 31,20072008
MaturityThree months or less
$ 8,065$27,996Over three to six months
13,42115,580Over six to twelve months
4,23113,046Over twelve months
10,4258,815
Total
$36,142$65,437
Brokered Time Deposits: Total brokered time deposits averaged $115,127 in 2007, compared with $80,890 in 2006, representing an increase of $34,237, or 42.3%. Brokered time deposits represented 22.4% of total average deposits during 2007, compared with 16.7% in 2006.
The increase in brokered time deposits was primarily attributed to the funding needs associated with the Bank’s earning asset growth, principally loans, which outpaced retail deposit growth during 2007. The rates of interest paid on brokered time deposits were generally comparable with collateralized advances from the Federal Home Loan Bank, the primary source of wholesale funding used by the Bank.Borrowed Funds
Borrowed funds principally consist of advances from the Federal Home Loan Bank of Boston (the "FHLB") and, to a lesser extent, securities sold under agreements to repurchase. Advances from the FHLB are principally secured by stock in the FHLB, investment securities, and blanket liens on qualifying mortgage loans and home equity loans.
The Bank utilizes borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Borrowed funds are principally utilized to support the Bank’s 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 Bank’s ability to select desired amounts, terms and maturities on a daily basis.
Total Borrowings: At December 31,
2007,2008, total borrowings amounted to$278,853,$323,903, compared with$260,712$278,853 at December 31,2006,2007, representing an increase of$18,141,$45,050, or7.0%16.2%. Total borrowings averaged $282,954 in 2008, compared with $260,640 in 2007,compared with $241,870 in 2006,representing an increase of$18,770,$22,314, or7.8%8.6%. The increase in borrowings was principally utilized to support the growth of the Bank’s securities portfolio and, to a lesser extent, reduce the Bank’s reliance on higher cost and more volatile brokered time deposits.Borrowings From the Federal Home Loan Bank: At December 31,
2007,2008, borrowings from the FHLB totaled$256,307$297,534 compared with$245,785$256,307 at December 31,2006,2007, representing an increase of$10,522,$41,227, or4.3%16.1%.During 2007, borrowings from the FHLB averaged $244,424, compared with $227,473 in 2006, representing an increase of $16,951, or 7.5%.The increase in borrowings from the FHLB was principally utilized to fund
2007 earning assetthe growthprincipally investment securities.of the Bank’s securities portfolio and, to a lesser extent, reduce the Bank’s reliance on Brokered time deposits.
Total averageAt December 31, 2008, borrowings from the FHLB expressed as a percentage of totalaverageassets amounted to29.1% during 2007,30.6%, compared with28.8% in 2006.29.1% at December 31, 2007.Securities Sold Under Agreements to Repurchase: At December 31,
2007,2008, securities sold under agreements to repurchase amounted to$22,546,$21,369, compared with$14,927$22,546 at December 31,2006,2007, representingan increasea decline of$7,619,$1,177, or51.0%. During 2007, securities sold under agreement to repurchase averaged $16,216, compared with $14,397 in 2006, representing an increase of $1,819, or 12.6%5.2%.Securities sold under agreements to repurchase were collateralized by U.S. Government-sponsored agency obligations, held in safekeeping by nonaffiliated financial institutions.
Junior Subordinated Debentures: In the second quarter of 2008, the Company’s wholly-owned subsidiary, Bar Harbor Bank & Trust (the "Bank"), issued $5,000 aggregate principal amount of subordinated debt securities. These securities qualify as Tier 2 capital for the Bank and the Company and were issued to help support future earning asset growth without jeopardizing the Bank’s historically strong capital position. The subordinated debt securities are due in 2023, but are callable by the Bank after five years without penalty. The rate of interest on these securities is three month Libor plus 345 basis points. The subordinated debt securities are classified as borrowings on the Company’s consolidated balance sheet.
Borrowing Maturities: Borrowing maturities are managed in concert with the Bank’s asset and liability management strategy and are closely aligned with the ongoing management of balance sheet interest rate risk.
During 2008, the Bank extended the maturities on a portion of its FHLB borrowings. These actions were taken during periods of favorable market interest rates, and were consistent with the Bank’s asset and liability management strategy of lessening its exposure to rising interest rates over a five year horizon.
As of December 31,
2007,2008, total short-term borrowings, comprised ofcertainFHLB advances and all securities sold under repurchase agreements, amounted to$148,246,$121,672, compared with$175,246$148,246 at December 31,2006,2007, representing a decline of $26,574, or53.2% and 67.2%17.9%. At December 31 2008, total short-term borrowings represented 37.6% of total borrowings,respectively. Conversely,compared with 53.2% at December 31, 2007.As of December 31, 2008, total long-term borrowings (FHLB advances with a remaining term greater than one year) totaled $197,231, compared with $130,607 at December 31, 2007,
totaled $130,607, compared with $85,466 atrepresenting an increase of $66,624, or 51.0%. At December 31,2006, or 46.8% and 32.8%2008, total long-term advances represented 60.9% of total borrowings,respectively.
Given the uncertainty about the future direction of interest rates throughout most of 2007, and in light of its liability sensitive balance sheet, the Bank modified the maturity mix of borrowing maturities to moderately reduce its exposure to rising interest rates over the longer term horizon. This was accomplished by extending the maturities on a portion of new borrowings as well as the replacement certain short-term borrowings that matured duringcompared with 46.8% at December 31, 2007.Capital Resources
Consistent with its long-term goal of operating a sound and profitable organization, during
20072008 the Company maintained its strong capital position and continued to be a"well capitalized""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. Historically, most of the Company’s capital requirements have been provided through retained earnings and this continued to be the case during the year ended December 31,2007.
Stock Repurchase Plan: In February 2004, the Company’s Board of Directors approved a program to repurchase up to 10% of the Company’s outstanding shares of common stock, or approximately 310,000 shares. Purchases began on March 4, 2004 and were continued through December 2007. In December of 2007 the Company’s Board of Directors authorized the continuance of this program through December 31,2008.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 December 31, 2007, the Company had repurchased 211,601 shares of stock under this plan, at a total cost of $6,121 and an average price of $28.93 per share. The Company recorded the repurchased shares as treasury stock.
The Company believes that a stock repurchase plan is a prudent use of its capital at this time. Management anticipates the stock repurchase plan will be accretive to the return on average shareholders’ equity and earnings per share. Management also believes that the stock repurchase plan helps facilitate an orderly market for the disposition of large blocks of stock, and lessens the price volatility associated with the Company’s thinly traded stock.
Cash Dividends: The Company has historically paid regular quarterly cash dividends on its common stock. Each quarter the Board of Directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook, the strength of the balance sheet, its need for funds, and other relevant factors. There can be no assurance that dividends on the Company’s common stock will be paid in the future.
The Company’s principal source of funds to pay cash dividends and support its commitments is derived from Bank operations. During 2007, the Company declared and distributed cash dividends in the aggregate amount of $2,899, compared with $2,761 in 2006. The Company’s 2007 dividend payout ratio amounted to 40.5%, compared with 40.1% in 2006. The total dividends paid in 2007 amounted to $0.955 per common share of stock, compared with $0.905 in 2006, representing an increase of $0.05, or 5.5%.
Inthe first quarter of 2008, the Company increased its quarterly cash dividend by $0.005 to $0.25 per common share, representing an increase of $0.015 or 6.4% compared with the dividend paid for the same quarter in 2007. The dividend will be paid March 15, 2008 to shareholders of record as of the close of business on February 15, 2008.Capital Ratios: The Company and the Bank are subject to the risk-based capital guidelines administered by the Company’s and the Bank's principal regulators. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of risk-weighted assets and off-balance sheet items. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk-based capital to risk-weighted assets of 8%, including a minimum ratio of Tier I capital to total risk-weighted assets of 4% and a Tier I capital to average assets of 4% ("Leverage Ratio"). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the Company's financial statements.
As of December 31,
20072008 and2006,2007, the Company and the Bank were considered well-capitalized under the regulatory framework for prompt corrective action. Under the capital adequacy guidelines, a well-capitalized institution must maintain a minimum total risk-based capital to total risk-weighted assets ratio of at least 10.0%, 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 December 31,
2007,2008, the Company’s total risk-based capital was$66,307$73,191 or11.59%11.60% of risk-weighted assets, compared with$63,325,$66,307, or11.65%11.59% of total risk-weighted assets at December 31,2006.2007.At December 31,
2007,2008, the Company’s Tier I capital totaled$61,564$62,745 or10.76%9.95% of risk-weighted assets, compared with$58,800,$61,564, or10.82%10.76% of total risk-weighted assets at December 31,2006.2007.The ratio of Tier I capital to average assets, or Leverage Ratio, at December 31,
20072008 was7.10%6.61%, compared with7.34%7.10% at December 31,2006.2008.The following table sets forth the Company's regulatory capital at December 31,
20072008 and2006,2007, under the rules applicable at that date.
December 31, 2007
December 31, 2006
December 31, 2008
December 31, 2007
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total Capital to Risk Weighted Assets
$66,307
11.59%
$63,325
11.65%
$73,191
11.60%
$66,307
11.59%
Regulatory Requirement
45,774
8.00%
43,491
8.00%
50,458
8.00%
45,774
8.00%
Excess over "adequately capitalized"
$20,533
3.59%
$19,834
3.65%
$22,733
3.60%
$20,533
3.59%
Tier 1 Capital to Risk Weighted Assets
$61,564
10.76%
$58,800
10.82%
$62,745
9.95%
$61,564
10.76%
Regulatory Requirement
22,887
4.00%
21,745
4.00%
25,229
4.00%
22,887
4.00%
Excess over "adequately capitalized"
$38,677
6.76%
$37,055
6.82%
$37,516
5.95%
$38,677
6.76%
Tier 1 Capital to Average Assets
$61,564
7.10%
$58,800
7.34%
$62,745
6.61%
$61,564
7.10%
Regulatory Requirement
34,674
4.00%
32,040
4.00%
37,977
4.00%
34,674
4.00%
Excess over "adequately capitalized"
$26,890
3.10%
$26,760
3.34%
$24,768
2.61%
$26,890
3.10%
As more fully disclosed in Note 12 of the Consolidated Financial Statements in this Annual Report on Form 10-K, the Bank also maintained its standing as a
well capitalizedwell-capitalized institution as defined by applicable regulatory standards. At December 31,2007,2008, the Bank’s Tier I Leverage, Tier I Risk-based and Total Risk-based capital ratios stood at7.44%6.65%,11.25%10.03% and11.64%11.69%, respectively.Series A Fixed Rate Cumulative Perpetual Preferred Stock and Warrant: On January 16, 2009, as part of the CPP established by the Treasury under the EESA, the Company entered into a Letter Agreement (including the Securities Purchase Agreement – Standard Terms incorporated by reference therein, the "Purchase Agreement") with Treasury pursuant to which the Company issued and sold to Treasury (i) 18,751 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value, having a liquidation preference of $1,000 per share (the "CPP Shares") and (ii) a ten-year warrant to purchase up to 104,910 shares of the Company’s common stock, par value $2.00 per share at an initial exercise price of $26.81 per share (the "CPP Warrant"), for an aggregate purchase price of $18,751 in cash. All of the proceeds from the sale of the CPP Shares and CPP Warrant are treated as Tier 1 capital for regulatory purposes. The investment in the company by Treasury through the CPP increased the Company’s already strong Tier 1 Leverage, Tier 1 Risk-based and Total Risk-based capital ratios by approximately 200, 300, and 300 basis points, respectively.
Cumulative dividends on the CPP Shares will accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter, but will be paid only when declared by the Company’s Board of Directors. The CPP Shares have no maturity date and rank senior to the Common Stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The CPP Shares are generally non-voting, other than class voting on certain matters that could adversely affect the CPP Shares. If dividends on the CPP Shares have not been paid for an aggregate of six quarterly dividend periods or more, whether consecutive or not, the Company’s authorized number of directors will be automatically increased by two and the holders of the CPP Shares, voting together with the holders of any then outstanding voting parity stock, will have the right to elect those directors at the Company’s next annual meeting of shareholders or at a special meeting of shareholders called for that purpose. These two directors will be elected annually and will serve until all accrued and unpaid dividends on the CPP Shares have been paid.
The Company may redeem the CPP Shares after February 15, 2012. Prior to this date, the Company may redeem the CPP Shares if (i) the Company has raised aggregate gross proceeds in one or more Qualified Equity Offerings (as defined in the Purchase Agreement) in excess of $4,687,750 and (ii) the aggregate redemption price does not exceed the aggregate net cash proceeds from such Qualified Equity Offerings. Any redemption is subject to the consent of the Board of Governors of the Federal Reserve System. The Purchase Agreement defines a "Qualified Equity Offering" to mean the sale and issuance for cash by the Company, to persons other than the Company or any Company subsidiary after the closing, of shares of perpetual preferred stock, Common Stock or any combination of such stock, that, in each case, qualify as and may be included in Tier 1 capital of the Company at the time of issuance under the applicable risk-based capital guidelines of the Board of Governors of the Federal Reserve System (other than any such sales and issuances made pursuant to agreements or arrangements entered into, or pursuant to financing plans which were publicly announced, on or prior to October 13, 2008).
Prior to January 16, 2012, unless the Company has redeemed the CPP Shares or Treasury has transferred the CPP Shares to a third party, the consent of Treasury will be required for the Company to (1) increase its Common Stock dividend in excess of $0.26 per share, which was the amount of the last regular dividend declared by the Company prior to October 14, 2008, or (2) redeem, purchase or acquire any shares of the Company’s Common Stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.
The CPP Warrant is immediately exercisable. In the event the Company completes one or more Qualified Equity Offerings on or prior to December 31, 2009, that result in the Company receiving aggregate gross proceeds of not less than $18.751 million, the number of the shares of Common Stock underlying the portion of the Warrant then held by Treasury will be reduced by one-half of the shares of Common Stock originally covered by the Warrant. Pursuant to the Purchase Agreement, Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant.
The CPP Shares and the CPP Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company agreed to register the resale or secondary offering of the CPP Shares, the CPP Warrant and the shares of Common Stock issuable upon exercise of the CPP Warrant (the "Warrant Shares"). Neither the CPP Shares nor the CPP Warrant are subject to any contractual restrictions on transfer, except that Treasury may only transfer or exercise an aggregate of one-half of the Warrant Shares prior to the earlier of (i) the date on which the Company has received aggregate gross proceeds of not less than $18.751 million from one or more Qualified Equity Offerings and (ii) December 31, 2009.
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 Company’s capital resources, liquidity, or financial condition.
Stock Repurchase Plan: In August 2008, the Company’s Board of Directors approved a program to repurchase of up to 300,000 shares of the Company’s common stock, or approximately 10.2% of the shares currently outstanding. The new stock repurchase program became effective as of August 21, 2008 and is authorized to continue for a period of up to twenty-four consecutive months. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time to time, without prior notice and may be made in the open market or through privately negotiated transactions. As of December 31, 2008, the Company had repurchased 61,211 shares of stock under this plan, at a total cost of $1,688 and an average price of $27.58 per share. The Company recorded the repurchased shares as treasury stock. Under the terms of the Purchase Agreement with Treasury in connection with the Company’s participation in the CPP, the Company must have the consent of Treasury to redeem, repurchase, or acquire any shares of Company common stock or other equity or capital securities, other than in connection with employee benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement. In January 2009 the Company suspended purchases under the Plan as required under the Purchase Agreement with Treasury in connection with the Company’s participation in the CPP.
The new stock repurchase program replaced the Company’s stock repurchase program that had been in place since February 2004, which had authorized the repurchase of up to 310,000 or approximately 10% of the Company’s outstanding shares of common stock. As of August 19, 2008, the date this program was terminated, the Company had repurchased 288,799 shares at a total cost of $8,441,454 and an average price of $29.23 per share.
Cash Dividends: The Company has historically paid regular quarterly cash dividends on its common stock. Each quarter the Board of Directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook, the strength of the balance sheet, its need for funds, and other relevant factors. There can be no assurance that dividends on the Company’s common stock will be paid in the future.
The Company’s principal source of funds to pay cash dividends and support its commitments is derived from Bank operations. During 2008, the Company declared and distributed cash dividends in the aggregate amount of $3,004, compared with $2,899 in 2007. The Company’s 2008 dividend payout ratio amounted to 38.8%, compared with 40.5% in 2007. The total dividends paid in 2008 amounted to $1.02 per common share of stock, compared with $0.955 in 2007, representing an increase of $0.065 per share, or 6.8%.
In the first quarter of 2009, the Company declared a regular cash dividend of $0.26 per share of common stock, unchanged from the prior quarter, but representing an increase of $0.01 or 4.0% compared with the dividend paid for the same quarter in 2008. The dividend will be paid March 13, 2009 to shareholders of record as of the close of business on February 17, 2009. Prior to January 16, 2012, unless the Company has redeemed the CPP Shares or the Treasury has transferred the CPP Shares to a third party, the consent of Treasury will be required for the Company to increase its Common Stock dividend in excess of $0.26 per share, which was the amount of the last regular dividend declared by the Company prior to October 14, 2008.
Contractual Obligations
The Company is a party to certain contractual obligations under which it is obligated to make future payments. These principally include borrowings from the FHLB, consisting of short and long-term fixed rate borrowings, and collateralized by all stock in the FHLB, a blanket lien on qualified collateral consisting primarily of loans with first and second mortgages secured by one-to-four family properties, and certain pledged investment securities. The Company has an obligation to repay all borrowings from the FHLB.
The Company is also obligated to make payments on operating leases for its branch office in Somesville and its office in Bangor, Maine.
The following table summarizes the Company’s contractual obligations at December 31,
2007.2008. Borrowings are stated at their contractual maturity due dates and do not reflect call features, or principal amortization features, on certain borrowings.CONTRACTUAL OBLIGATIONS
Payments Due By Period
Payments Due By Period
Description
Total Amount of Obligations
< 1 Year
> 1-3 Years
> 3-5 Years
> 5 Years
Total
Amount of
Obligations< 1 Year
> 1-3 Years
> 3-5 Years
> 5 Years
Operating leases
$ 265
$ 85
$ 180
$ ---
$ ---
Borrowings from Federal Home Loan Bank
256,307
125,700
81,642
22,965
26,000
$297,534
$100,303
$128,251
$49,980
$19,000
Securities sold under agreements to repurchase
22,546
22,546
---
---
21,369
21,369
---
---
---
Junior subordinated debentures
5,000
---
---
--- 5,000
Operating Leases
199
88
111
--- ---
Total
$279,118
$148,331
$81,822
$22,965
$26,000
$324,102
$121,760
$128,362
$49,980
$24,000
All FHLB advances are fixed-rate instruments. Advances are payable at their call dates or final maturity dates. At December 31,
2007,2008, the Bank had$92,500$82,000 in callable advances.In the normal course of its banking and financial services business, and in connection with providing products and services to its customers, the Company has entered into a variety of traditional third party contracts for support services. Examples of such contractual agreements would include services providing ATM, Visa Debit
and CreditCard processing, trust services accounting support, check printing, and the leasing of T-1 telecommunication lines supporting the Company’s wide area technology network.The majority of the Company’s core operating systems and software applications are maintained "in-house" with traditional third party maintenance agreements of one year or less.
Off-Balance Sheet Arrangements
The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors.
At December 31,
20072008 and2006,2007, the Company’s off-balance sheet arrangements were limited to standby letters of credit.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 December 31,
2007,2008, commitments under existing standby letters of credit totaled$506,$262, compared with$442$506 at December 31,2006.2007. The fair value of the standby letters of credit was not significant as of the foregoing dates.Off-Balance Sheet Risk
The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and certain financial derivative instruments; namely, interest rate swap agreements and interest rate floor agreements.
Commitments to Extend Credit: Commitments to extend credit represent agreements by the Bank to lend to a customer provided there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.
Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis using the same credit policies as it does for its balance sheet instruments, such as loans. The amount of collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is based on management's credit evaluation of the customer.
The following table summarizes the Bank’s commitments to extend credit as of December 31:
COMMITMENTS TO EXTEND CREDIT
December 31,
2007December 31,
2006December 31,
2008December 31,
2007Commitments to originate loans
$ 15,075
$ 13,340
$ 31,584
$ 15,075
Unused lines of credit
85,530
81,800
70,610
85,530
Un-advanced portions of construction loans
19,752
7,638
4,284
19,752
Total
$120,357
$102,778
$106,478
$120,357
Financial Derivative Instruments: As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank's interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant adverse effect on net interest income. Derivative instruments that management periodically uses as part of its interest rate risk management strategy include interest rate swap agreements and interest rate floor agreements. A policy statement, approved by the Board of Directors of the Bank, governs use of derivative instruments.
At December 31,
2007,2008, the Bank had three outstanding derivative instruments with notional amounts totaling $40,000. The notional amounts of the financial derivative instruments do not represent exposure to credit loss. The Bank is exposed to credit loss only to the extent the counter-party defaults in its responsibility to pay interest under the terms of the agreements. Management does not anticipate non-performance by the counter-parties to the agreements, and regularly reviews the credit quality of the counter-parties from which the instruments have been purchased.The details of the Bank’s financial derivative instruments as of December 31,
20072008 are summarizedas follows.below. The reader should also refer to Note 15 of the consolidated financial statements in Part II, Item 8 in this report on Form 10-K.INTEREST RATE SWAP AGREEMENT
Description
Maturity
Notional Amount
(in thousands)Fixed Interest Rate
Variable Interest Rate
Maturity
Notional Amount
(in thousands)Fixed Interest Rate
Variable Interest Rate
Receive fixed rate, pay variable rate
01/24/09
$10,000
6.25%
Prime (7.25%)
01/24/09
$10,000
6.25%
Prime (3.25%)
The interest rate swap agreement was designated as a cash flow hedge in accordance with SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges: Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a group of Non-Benchmark-Rate-Based Loans."
The Bank is required to pay a counter-party monthly variable rate payments indexed to Prime, while receiving fixed rate payments based upon an interest rate of 6.25% over the term of the agreement.
The following table summarizes the contractual cash flows of the interest rate swap agreement outstanding at December 31,
2007,2008, based upon the then-current Prime interest rate of7.25%3.25%:
Payments Due by Period
Payments Due by Period
Total
Less Than 1 Year
>1-3 Years
Total
Less Than 1 Year
Fixed payments due from counter-party
$668
$627
$41
$41
Variable payments due to counter-party based on prime rate
775
727
48
21
Net cash flow
($107)
($100)
($ 7)
$20
Total net cash flows received from counter-parties amounted to $116 in 2008, compared with net cash flows paid to counter-parties
amounted toof $363 and $311 in 2007 and 2006, respectively.In 2005, the net cash flows received from counter-parties totaled $3.The changes in net cash flows paid to and received from counter-parties were attributed toincreasesdeclines in the Prime interest rate during2006.2008.INTEREST RATE FLOOR AGREEMENTS
Notional
AmountExpiration
DatePrime
Strike RatePremium
PaidUnamortized Premium
Fair
ValueExpiration
DatePrime
Strike RatePremium
PaidUnamortized Premium at
12/31/08Fair
Value at
12/31/08Cumulative
Cash Flows
Received$20,000
08/02/10
6.00%
$186
$137
$163
08/01/10
6.00%
$186
$91
$708
$203
$10,000
11/01/10
6.50%
$ 69
$ 56
$136
11/01/10
6.50%
$ 69
$39
$521
$148
In 2005, interest rate floor agreements were purchased by the Bank to limit its exposure to falling interest rates on two pools of loans indexed to the Prime interest rate. Under the terms of the agreements, the Bank paid premiums of $186 and $69 for the right to receive cash flow payments if the Prime interest rate falls below the predetermined floor rates of 6.00% and 6.50%, thus effectively ensuring interest income on the pools of prime-based loans at minimum rates of 6.00% and 6.50% on the $20,000 and $10,000 notional amounts for the duration of the agreements, respectively. The interest rate floor agreements were designated as cash flow hedges in accordance with SFAS 133.
Liquidity
Liquidity is measured by the Company’s 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 Company’s 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 approved by the Bank’s Board of Directors. Continual monitoring of these ratios, both historical and through forecasts under multiple rate and stress scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity.
The Bank uses a basic surplus model to measure its liquidity over 30 and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Bank’s policy is to maintain
itsa liquidity position of atapproximatelyleast 5% of total assets. At December 31,2007,2008, liquidity, as measured by the basic surplus model, was9.3%6.3% over the 30-day horizon and9.0%5.2% over the 90-day horizon.A portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.
At December 31,
2007,2008, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB approximating$60$75 million. The Bank also had capacity to borrow funds on a secured basis utilizingcertain un-pledged securities in its securities portfolio. The Bank’s loan portfolio provides an additional sourcethe Borrower In Custody ("BIC") program at the Federal Reserve Bank ofcontingent liquidity that could be accessed in a reasonable time period through pledging or sales. However, there were no loans held for sale atBoston. At December 31,2007.2008 the Bank’s available secured line of credit at the Federal Reserve Bank of Boston stood at $167,871, or 17.3% of the Company’s total assets. The Bank also has access to the national brokered deposit market, and has been using this funding source to bolster its liquidity position.The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company. Company management believes that the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements presented elsewhere in this report have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Unlike many industrial companies, substantially all of the assets and virtually all of the liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates and the U.S. Treasury yield curve may not necessarily move in the same direction or in the same magnitude as inflation.
While the financial nature of the Company’s consolidated balance sheets and statements of income is more clearly affected by changes in interest rates than by inflation, inflation does affect the Company because as prices increase the money supply tends to increase, the size of loans requested tends to increase, total Company assets increase, and interest rates are affected by inflationary expectations. In addition, operating expenses tend to increase without a corresponding increase in productivity. There is no precise method, however, to measure the effects of inflation on the Company’s financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation.RESULTS OF OPERATIONS
Net Income and Earnings Per Share
For the year ended December 31, 2007, net income amounted to $7,155, compared with $6,879 and $6,424 in 2006 and 2005, representing increases of $276 and $455, or 4.0% and 7.1%, respectively.
For the year ended December 31, 2007, fully diluted earnings per share amounted to $2.30, compared with $2.20 and $2.03 in 2006 and 2005, representing increases of $0.10 and $0.17, or 4.5% and 8.4%, respectively.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 year ended December 31,
2007,2008, net interest income on a fully tax- equivalent basis amounted to$23,558$28,090 compared with $23,558 and $22,522 in 2007 and$22,615 in2006,and 2005,representingan increaseincreases of $4,532 and $1,036, or4.6%19.2% anda decline of $93 or 0.4%4.6%, respectively.The 2008 increase in fully tax-equivalent net interest income compared with 2007 was principally attributed to a 22 basis point improvement in the net interest margin combined with average earning asset growth of $87,517, or 10.8%.
The 2007 increase in fully tax-equivalent net interest income compared with 2006 was principally attributed to average earning asset growth of $52,888 or 7.0%, as the fully tax-equivalent net interest margin declined seven basis points to 2.91%
, compared with 2006.
The 2006 decline in fully tax-equivalent net interest income was principally attributed to a 46 basis point decline in the fully tax-equivalent net interest margin, which in 2006 amounted to 2.98% compared with 3.44% in 2005. This decline was largely offset by 2006 earning asset growth of $99,128, or 15.1%.As was widely the situation throughout the banking industry, the 2006 decline in the net interest margin was largely attributed to the seventeen consecutive increases in short-term interest rates by the Federal Reserve Bank from June 2004 to June 2006 and a flat-to-inverted yield curve throughout 2006, the impact of which caused the Bank’s funding costs to increase at a faster pace than the yield on its earning asset portfolios.Factors contributing to the changes in net interest income and the net interest margin are further enumerated in the following discussion and analysis.
Net Interest Income Analysis: The following tables summarize the Company’s daily average balance sheets and the components of net interest income, including a reconciliation of tax equivalent adjustments, for the years ended December 31, 2008, 2007
2006and2005:2006:AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31,20072008
Average
BalanceInterest
Average
RateAverage
BalanceInterest
Average
RateInterest Earning Assets:
Loans (1,3)
$558,795
$38,027
6.81%
$611,373
$37,761
6.18%
Taxable securities
(2)208,641
11,712
5.61%
231,721
13,588
5.86%
Non-taxable securities (3)
26,728
1,804
6.75%
Non-taxable securities (2,3)
36,972
2,537
6.86%
Total securities
235,369
13,516
5.74%
268,693
16,125
6.00%
Federal Home Loan Bank stock
12,601
813
6.45%
13,940
526
3.77%
Fed funds sold, money market funds, and time
deposits with other banks2,068
108
5.22%
2,344
81
3.46%
Total Earning Assets
808,833
52,464
6.49%
�� 896,350
54,493
6.08%
Non-Interest Earning Assets:
Cash and due from banks
6,823
9,752
Allowance for loan losses
(4,573)
(5,171)
Other assets (2)
30,123
25,426
Total Assets
$841,206
$926,357
Interest Bearing Liabilities:
Deposits
$457,475
$16,222
3.55%
$518,702
$14,976
2.89%
Securities sold under repurchase agreements and
fed funds purchased16,216
547
3.37%
Borrowings from Federal Home Loan Bank
244,424
12,137
4.97%
Total Borrowings
260,640
12,684
4.87%
Borrowings
282,954
11,427
4.04%
Total Interest Bearing Liabilities
718,115
28,906
4.03%
801,656
26,403
3.29%
Rate Spread
2.46%
2.79%
Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits
55,634
54,664
Other liabilities
4,669
4,898
Total Liabilities
778,418
861,218
Shareholders' equity
62,788
65,139
Total Liabilities and Shareholders' Equity
$841,206
$926,357
Net interest income and net interest margin (3)
23,558
2.91%
28,090
3.13%
Less: Tax Equivalent adjustment
(655)
(899)
Net Interest Income
$22,903
2.83%
$27,191
3.03%
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31,20062007
Average
BalanceInterest
Average
RateAverage
BalanceInterest
Average
RateInterest Earning Assets:
Loans (1,3)
$538,212
$35,486
6.59%
$558,795
$38,027
6.81%
Taxable securities
(2)169,260
8,342
4.93%
208,641
11,712
5.61%
Non-taxable securities (3)
34,179
2,353
6.88%
Non-taxable securities (2,3)
26,728
1,804
6.75%
Total securities
203,439
10,695
5.26%
235,369
13,516
5.74%
Federal Home Loan Bank stock
12,181
683
5.61%
12,601
813
6.45%
Fed funds sold, money market funds, and time
deposits with other banks2,113
107
5.06%
2,068
108
5.22%
Total Earning Assets
755,945
46,971
6.21%
808,833
52,464
6.49%
Non-Interest Earning Assets:
Cash and due from banks
8,727
6,823
Allowance for loan losses
(4,573)
(4,573)
Other assets (2)
28,458
30,123
Total Assets
$788,557
$841,206
Interest Bearing Liabilities:
Deposits
$428,624
$13,039
3.04%
$457,475
$16,222
3.55%
Securities sold under repurchase agreements and
fed funds purchased14,397
388
2.70%
Borrowings from Federal Home Loan Bank
227,473
11,022
4.85%
Total Borrowings
241,870
11,410
4.72%
Borrowings
260,640
12,684
4.87%
Total Interest Bearing Liabilities
670,494
24,449
3.65%
718,115
28,906
4.03%
Rate Spread
2.56%
2.46%
Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits
54,308
55,634
Other liabilities
6,176
4,669
Total Liabilities
730,978
778,418
Shareholders' equity
57,579
62,788
Total Liabilities and Shareholders' Equity
$788,557
$841,206
Net interest income and net interest margin (3)
22,522
2.98%
23,558
2.91%
Less: Tax Equivalent adjustment
(826)
(655)
Net Interest Income
$21,696
2.87%
$22,903
2.83%
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31,20052006
Average
BalanceInterest
Average
RateAverage
BalanceInterest
Average
RateInterest Earning Assets:
Loans (1,3)
$479,974
$29,601
6.17%
$538,212
$ 35,486
6.59%
Taxable securities
(2)132,604
5,592
4.22%
169,260
8,342
4.93%
Non-taxable securities (3)
31,423
2,222
7.07%
Total securities
164,027
7,814
4.76%
Federal Home Loan Bank stock
10,731
466
4.34%
Non-taxable securities (2,3)
34,179
2,353
6.88%
Total Securities
203,439
10,695
5.26%
Investment in Federal Home Loan Bank stock
12,181
683
5.61%
Fed funds sold, money market funds, and time
deposits with other banks2,085
70
3.36%
2,113
107
5.06%
Total Earning Assets
656,817
37,951
5.78%
755,945
46,971
6.21%
Non-Interest Earning Assets:
Cash and due from banks
8,602
8,727
Allowance for loan losses
(4,767)
(4,573)
Other assets (2)
28,992
28,458
Total Assets
$689,644
$788,557
Interest Bearing Liabilities:
Deposits
$364,120
$ 6,941
1.91%
$428,624
$ 13,039
3.04%
Securities sold under repurchase agreements and
fed funds purchased14,637
272
1.86%
Borrowings from Federal Home Loan Bank
195,124
8,123
4.16%
Total Borrowings
209,761
8,395
4.00%
Borrowings
241,870
11,410
4.72%
Total Interest Bearing Liabilities
573,881
15,336
2.67%
670,494
24,449
3.65%
Rate Spread
3.11%
2.56%
Non-Interest Bearing Liabilities:
Demand and other non-interest bearing deposits
53,830
Demand deposits
54,308
Other liabilities
5,801
6,176
Total Liabilities
633,512
730,978
Shareholders' equity
56,132
57,579
Total Liabilities and Shareholders' Equity
$689,644
$788,557
Net interest income and net interest margin (3)
22,615
3.44%
22,522
2.98%
Less: Tax Equivalent adjustment
(756)
(826)
Net Interest Income
$21,859
3.33%
$ 21,696
2.87%
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.Net Interest Margin: The net interest margin, expressed on a tax-equivalent basis, represents the difference between interest and dividends earned on interest-earning assets and interest paid to depositors and other creditors, expressed as a percentage of average earning assets.
The net interest margin is determined by dividing tax-equivalent net interest income by average interest-earning assets. The interest rate spread represents the difference between the average tax-equivalent yield earned on interest earning-assets and the average rate paid on interest bearing liabilities. The net interest margin is generally higher than the interest rate spread due to the additional income earned on those assets funded by non-interest bearing liabilities, primarily demand deposits and shareholders’ equity.
The Company’s fully tax-equivalent net interest margin amounted to 3.13% in 2008, compared with 2.91% in 2007, representing an improvement of 22 basis points. In 2007, the Company’s fully tax-equivalent net interest margin amounted to 2.91%
in 2007,, representing a decline of seven basis points compared with2.98% and 3.44% in 2006 and 2005, representing year-over-year declines of 7 and 46 basis points, respectively.2006.The following table summarizes the net interest margin components, on a quarterly basis, over the past two years. Factors contributing to the changes in the net interest margin are enumerated in the following discussion and analysis.
NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED
2007
2006
Average Rate
Average Rate
4th Qtr
3rd Qtr
2nd Qtr
1st Qtr
4th Qtr
3rd Qtr
2nd Qtr
1st Qtr
AVERAGE RATES
2008
2007
Quarter:
4
3
2
1
4
3
2
1
Interest Earning Assets:
Loans (1,2)
6.71%
6.88%
6.88%
6.74%
6.68%
6.67%
6.57%
6.45%
Taxable securities
5.78%
5.65%
5.62%
5.38%
5.03%
4.91%
4.97%
4.79%
Non-taxable securities (2)
6.71%
6.66%
6.79%
6.80%
6.80%
6.74%
6.96%
7.02%
Loans (1,3)
5.93%
6.09%
6.19%
6.52%
6.71%
6.88%
6.88%
6.74%
Taxable securities (2)
5.81%
5.89%
5.88%
5.88%
5.78%
5.65%
5.62%
5.38%
Non-taxable securities (2,3)
7.02%
6.88%
6.77%
6.78%
6.71%
6.66%
6.80%
6.80%
Total securities
5.87%
5.75%
5.77%
5.56%
5.30%
5.21%
5.31%
5.21%
5.97%
6.02%
6.00%
6.02%
5.87%
5.75%
5.77%
5.56%
Federal Home Loan Bank stock
6.31%
6.41%
6.56%
6.54%
6.13%
11.04%
0.00%
5.12%
2.46%
3.00%
3.98%
5.73%
6.31%
6.41%
6.56%
6.54%
Fed Funds sold, money market funds, and time
deposits with other banks5.01%
5.19%
5.67%
4.88%
5.20%
5.27%
5.01%
3.41%
Fed Funds sold, money market funds, and time
deposits with other banks
2.16%
3.13%
3.00%
4.37%
5.01%
5.19%
5.67%
4.88%
Total Earning Assets
6.45%
6.53%
6.57%
6.40%
6.29%
6.34%
6.11%
6.09%
5.88%
6.02%
6.08%
6.35%
6.45%
6.53%
6.57%
6.40%
Interest Bearing Liabilities:
Demand and other non-interest bearing deposits
3.51%
3.60%
3.56%
3.51%
3.37%
3.22%
2.92%
2.62%
2.62%
2.72%
2.92%
3.33%
3.51%
3.60%
3.56%
3.51%
Securities sold under repurchase agreements
3.74%
3.28%
3.24%
3.03%
2.96%
2.78%
2.55%
2.46%
Other borrowings
4.77%
5.02%
5.02%
5.06%
5.01%
4.81%
4.54%
Total Borrowings
4.69%
4.92%
4.93%
4.95%
4.87%
4.89%
4.69%
4.42%
Borrowings
3.67%
3.92%
4.21%
4.39%
4.69%
4.92%
4.93%
4.95%
Total Interest Bearing Liabilities
3.95%
4.08%
4.04%
4.04%
3.89%
3.81%
3.58%
3.29%
3.00%
3.14%
3.36%
3.71%
3.95%
4.08%
4.04%
4.04%
Rate Spread
2.50%
2.45%
2.53%
2.36%
2.40%
2.53%
2.53%
2.80%
2.88%
2.88%
2.72%
2.64%
2.50%
2.45%
2.53%
2.36%
Net Interest Margin (2)
2.97%
2.93%
2.96%
2.79%
2.87%
2.97%
2.90%
3.19%
Net Interest Margin (3)
3.21%
3.22%
3.07%
3.03%
2.97%
2.93%
2.96%
2.79%
Net Interest Margin without Tax Equivalent Adjustments
2.89%
2.86%
2.88%
2.70%
2.77%
2.86%
2.79%
3.06%
3.10%
3.12%
2.97%
2.92%
2.89%
2.86%
2.88%
2.70%
(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.From September 2007 through October 2008, the Board of Governors of the Federal Reserve System (the "Federal Reserve") decreased short-term interest rates nine times for a total of 500 basis points. These actions favorably impacted the Bank’s 2008 net interest income, given its liability sensitive balance sheet. Specifically, the Bank’s total weighted average cost of funds declined at a faster pace and to a greater extent than the decline in the weighted average yield on its earning asset portfolios.
For the year ended December 31, 2008, the weighted average yield on average earning assets amounted to 6.08%, compared with 6.49% in 2007, representing a decline of 41 basis points. However, the weighted average cost of interest bearing liabilities amounted to 3.29% in 2008, compared with 4.03% in 2007, representing a decline of 74 basis points. In short, comparing 2008 with 2007, the decline in the Bank’s weighted average cost of interest bearing liabilities exceeded the decline in the weighted average yield on its earning asset portfolios by 33 basis points.
For the year ended December 31, 2007, the Bank’s net interest margin declined seven basis points compared with 2006. In June of 2004, following an extended period of historically low interest rates, the
Board of Governors of theFederal Reserve System(the "Federal Reserve")began increasing short-term interest rates. Through June of 2006, the Fed funds targeted rate had been increased seventeen times for a total of 425 basis points, ending 2006 at 5.25%. However, during this same period of time, the benchmark 10-year U.S. Treasury note increased only 32 basis points, causing a dramatic 393 basis point flattening of the U.S. Treasury yield curve (the "yield curve"). The increase in short-term interest rates and the flattening of the yield curveremained flat-to-inverted throughout 2006.
In 2005,negatively impacted the Bank’s 2007 net interestmargin began to decline and this decline steadily continued through the first quarter of 2007. The declining net interest margin was principally attributed tomargin. In 2007, the increases in the Bank’s cost of fundsoutpacingoutpaced the increases in yields on its interest earning assets, reflecting the re-pricing of a large portion of the Bank’s funding base during a period of rapidly rising short-term interest rates, combined withhighly competitive pricing pressures with respect to loans and deposits, andthe inherent net interest margin challenges widely associated with a flat or inverted U.S. Treasury yield curve.
In the second quarter of 2007, the Bank’s year-over-year net interest margin stabilized, as the increase in the Bank’s weighted average cost of funds was less than the increase in the weighted average yield on its earning asset portfolios. Also in the second quarter of 2007, the yield curve began to steepen, as long-term interest rates advanced to five-year highs, favorably impacting the Bank’s net interest margin. During last four months of 2007, the Federal Reserve lowered short-term interest rates three times for a total of one hundred basis points. These actions favorably impacted the Bank’s net interest margin, reflecting its liability sensitive balance sheet. For the fourth quarter of 2007 the Bank’s net interest margin was showing an increase of 10 basis points compared with the same quarter in 2006 and was up 4 basis points on a linked quarter basis.For the year ended December 31, 2007 the weighted average yield on average earning assets amounted to 6.49%, compared with 6.21%
and 5.78%in 2006,and 2005,representingincreasesan increase of 28and 43basispoints, respectively. Thepoints. However, the weighted average cost of interest bearing liabilities amounted to 4.03% in 2007, compared with 3.65%and 2.67%in 2006,and 2005,representingyear-over-year increasesan increase of 38and 98basispoints, respectively.points. In short, during 2007,and 2006,theincreasesincrease in the weighted average cost of the Bank’s interest bearing liabilities exceeded the increases in weighted average yields on its earning assets portfolios by 10 basis points.Looking forward to 2009 and
55 basis points, respectively.
As noted above, the Federal Reserve’s actions in reducing short-termassuming market interest ratesin late 2007 favorably impacted the Bank’s net interest margin. In the fourth quarter of 2007, the increase in the weighted average yield on earning assets exceeded the increase in the weighted average cost of interest bearing liabilities by 10 basis points, compared with the same quarter in 2006. Fourth quarter 2007 tax-equivalent net interest income was up $691, or 12.4%, compared with the same quarter in 2006.continue at current levels, Company management anticipates that the
Federal Reserve’s actions in reducing short-termnet interestrates (including the additional 125 basis point reduction in January 2008), if sustained,margin will continue to show moderate improvement compared with 2008 and will have a positive impact onthe Bank’s futurenet interestmargin and future levels of net interest income, given its liability sensitive balance sheet.income.The Bank’s interest rate sensitivity position is more fully described in Part II, Item
7a7A of this Annual Report on Form 10-K, Quantitative and Qualitative Disclosures About Market Risk.Interest Income: For the year ended December 31, 2008, total interest income, on a fully tax-equivalent basis, amounted to $54,493, compared with $52,464 in 2007, representing an increase of $2,029, or 3.9%.
The increase in 2008 interest income was principally attributed to average earning asset growth of $87,517, or 10.8%, largely offset by a 41 basis point decline in the weighted average earning asset yield. The decline in the weighted average earning asset yield was principally attributed to the reduction of short-term interest rates by the Federal Reserve, the impact of which reduced the weighted average yield on the Bank’s variable rate loan portfolios. To a lesser extent, the weighted average loan yields were also impacted by the renegotiation of certain fixed rate loans to variable rate loans with lower prevailing interest rates. For the year ended December 31, 2008, the weighted average yield on the Bank’s loan portfolio amounted to 6.18%, compared with 6.81% in 2007, representing a decline of 63 basis points.
For the year ended December 31, 2008, the weighted average yield on the Bank’s securities portfolio amounted to 6.00%, representing an improvement of 26 basis points, compared with 2007. The improved yield on the securities portfolio reflected, in part, the restructuring of a portion of the portfolio in 2007. In addition, because the majority of the securities portfolio is comprised of fixed rate securities, the decline in short-term interest rates has had minimal impact on the portfolio’s weighted average yield.
As depicted on the rate/volume analysis table below, the increased volume of average earning assets on the balance sheet during 2008 contributed $5,483 to the increase in interest income compared with 2007, but this increase was largely offset by a decline of $3,454 attributed to the impact of the lower weighted average earning asset yield.
For the year ended December 31, 2007, total interest income, on a fully tax-equivalent basis, amounted to $52,464, compared with $46,971
and $37,951in 2006,and 2005,representingyear-over-year increasesan increase of $5,493,and $9,020,or 11.7%and 23.8%, respectively..The
$5,493increase in 2007 interest income compared with 2006 was principally attributed to average earning asset growth of $52,888 or 7.0%, combined with a 28 basis point increase in the weighted average earning assetyield, compared with 2006.yield. Interest income from loans increased $2,541, or 7.2%, attributed to average loan growth of $20,583 or 3.8%, and an increase in the weighted average loan portfolio yield of 22 basis points, compared with 2006. Interest income from securities increased $2,821, or 26.4%, which was attributed to average securities growth of $31,930 or 16.0%, and an increase in the weighted average securities portfolio yield of 48 basis points, compared with 2006. The increase in the weighted average yield on the securities portfolio principallyreflectsreflected the restructuring of a portion of the securities portfolio inthe second quarter of2007 and the availability of higher market yields during certain periods in 2007 compared with prior years.
The $9,020 increase in 2006 interest income compared with 2005 was attributed to average earning asset growth of $99,128 or 15.1%, combined with a 43 basis point increase in the weighted average earning asset yield. The increases in short-term interest rates by the Federal Reserve in 2005 and 2006 favorably impacted the weighted average yields on the Bank’s variable rate loan portfolios in 2006. In addition, during 2006 cash flows from the Bank’s fixed rate loan and securities portfolios were generally reinvested into higher yielding earning assets.As depicted on the rate / volume analysis
tablestable below, the increased volume of average earning assets on the balance sheet during 2007 contributed $3,009 to the increase in interest income compared with 2006, while the increase attributed to the impact of a higher weighted average earning assets yield amounted to $2,484.In 2006,Interest Expense: For the year ended December 31, 2008, total interest expense amounted to $26,403, compared with $28,906 in 2007, representing a decline of $2,503, or 8.7%.
The 2008 increase in total interest expense compared with 2007 was principally attributed to an $83,541 or 11.6% increase in average interest bearing liabilities, largely offset by a 74 basis point decline in the weighted average interest rate paid on interest bearing liabilities.
For the year ended December 31, 2008, the weighted average cost of borrowed funds declined 83 basis points to 3.29%, while the weighted average cost of interest bearing deposits declined 66 basis points to 2.89%, compared with 2007. The foregoing declines principally resulted from lower market interest rates in 2008 compared with 2007. The decline in the weighted average cost of borrowed funds outpaced the decline in the weighted average cost of interest bearing deposits, reflecting the shorter maturities of the Bank’s borrowing base as rates began declining, combined with highly competitive market pricing pressures for deposits in the markets served by the Bank.
As depicted on the rate/volume analysis table below, the impact of the lower weighted average rate paid on interest bearing liabilities contributed $5,772 to the 2008 decline in interest expense, but this was largely offset by an increase of $3,269 attributed to the impact of the increased volume of average
earning assets on the balance sheet contributed $5,715 to the increase ininterestincomebearing liabilities compared with2005, while the increase attributed to the impact of a higher weighted average earning assets yield amounted to $3,305.2007.
Interest Expense:For the year ended December 31, 2007, total interest expense amounted to $28,906, compared with $24,449and $15,336in 2006,and 2005,representingyear-over-year increasesan increase of $4,457,and $9,113,or 18.2%and 59.4%, respectively..The
$4,457increase in 2007 interest expense compared with 2006 was principally attributed to a $47,621 or 7.1% increase in average interest bearing liabilities, combined with a 38 basis point increase in the weighted average rate paid on interest bearing liabilities. The increase in the weighted average cost of interest bearing deposits outpaced the weighted average cost of borrowed funds by 36 basis points, reflecting the upward re-pricing of certain maturity time deposits, highly competitive market pricing pressures for deposits in general, and a higher utilization of brokered time deposits. Given the highly competitive market pricing pressures and the need to strengthen customer relationships,induring 2007 the Bank more closely followed the market with respect to the upward pricing and re-pricing of maturity and non-maturity deposits.The
$9,113 increase in 2006 interest expense compared with 2005 was principally attributed to a $96,613 or 16.8% increase in average interest bearing liabilities, combined with a 98 basis point increase in the weighted average rate paid on interest bearing liabilities. The increase in theweighted average cost of interest bearingliabilities was principally attributeddeposits amounted toincreases3.55% inshort-term market interest rates between periods and,2007, compared with 3.04% in 2006, representing an increase of 51 basis points. The weighted average cost of borrowings amounted toa lesser extent, a proportionately higher utilization4.87% in 2007, compared with 4.72% in 2006, representing an increase ofwholesale funding.15 basis points.As depicted on the rate/volume analysis
tablestable below, the increased volume of average interest bearing liabilities on the balance sheet during 2007 contributed $1,810 to the increase in interest expense compared with 2006, while the increase attributed to the impact of a higher weighted average rate paid on interest bearing liabilities contributed $2,647.In 2006, the increased volume of average interest bearing liabilities on the balance sheet contributed $2,851 to the increase in interest expense compared with 2005, while the increase attributed to the impact of a higher weighted average rate paid on interest bearing liabilities contributed $6,262.Rate/Volume Analysis: The following tables set forth a summary analysis of the relative impact on net interest income of changes in the average volume of interest earning assets and interest bearing liabilities, and changes in average rates on such assets and liabilities. The income from tax-exempt assets has been adjusted to a fully tax equivalent basis, thereby allowing uniform comparisons to be made. Because of the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes to volume or rate. For presentation purposes, changes which are not solely due to volume changes or rate changes have been allocated to these categories in proportion to the relationships of the absolute dollar amounts of the change in each.
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
FOR THE YEAR ENDED DECEMBER 31,20072008 VERSUS DECEMBER 31,20062007
INCREASES (DECREASES) DUE TO:
Average
VolumeAverage
RateTotal
ChangeASSETS
Loans (1,2)
$1,381
$1,160
$2,541
Taxable securities
2,110
1,260
3,370
Non-taxable securities (2)
(504)
(45)
(549)
Total Securities
24
106
130
Fed funds sold, money market funds, and time
deposits with other banks(2)
3
1
Total Earning Assets
3,009
2,484
5,493
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
920
2,263
3,183
Securities sold under repurchase agreements and
fed funds purchased53
106
159
Other borrowings
837
278
1,115
Total Interest Bearing Liabilities
$1,810
$2,647
$4,457
Net Change In Net Interest Income (2)
$1,199
$ (163)
$1,036
Average
VolumeAverage
RateTotal
ChangeASSETS
Loans (1,3)
$3,395
$(3,661)
$ (266)
Taxable securities (2)
1,296
580
1,876
Non-taxable securities (2,3)
692
41
733
Investment in Federal Home Loan Bank stock
86
(373)
(287)
Fed funds sold, money market funds, and time
deposits with other banks14
(41)
(27)
Total Earning Assets
5,483
(3,454)
2,029
LIABILITIES AND SHAREHOLDERS EQUITY
Interest bearing deposits
2,181
(3,427)
(1,246)
Borrowings
1,088
(2,345)
(1,257)
Total Interest Bearing Liabilities
3,269
(5,772)
(2,503)
Net Change In Net Interest Income (3)
$2,214
$ 2,318
$ 4,532
(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 atax-equivalenttax equivalent basis..
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
FOR THE YEAR ENDED DECEMBER 31,20062007 VERSUS DECEMBER 31,20052006
INCREASES (DECREASES) DUE TO:
Average
VolumeAverage
RateTotal
ChangeAverage
VolumeAverage
RateTotal
ChangeASSETS
Loans (1,2)
$3,750
$ 2,135
$5,885
Loans (1,3)
$1,381
$1,160
$2,541
Taxable securities
(2)1,708
1,042
2,750
2,110
1,260
3,370
Non-taxable securities (2)
187
(56)
131
Non-taxable securities (2,3)
(504)
(45)
(549)
Total Securities
69
148
217
24
106
130
Fed funds sold, money market funds, and time
deposits with other banks1
36
37
(2)
3
1
Total Earning Assets
$5,715
$ 3,305
$9,020
3,009
2,484
5,493
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
1,397
4,701
6,098
920
2,263
3,183
Securities sold under repurchase agreements and
fed funds purchased(4)
120
116
53
106
159
Other borrowings
1,458
1,441
2,899
837
278
1,115
Total Interest Bearing Liabilities
$2,851
$ 6,262
$9,113
$1,810
$2,647
$4,457
Net Change In Net Interest Income
(2)(3)$2,864
$(2,957)
$ (93)
$1,199
$ (163)
$1,036
(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 atax-equivalenttax equivalent basis.Provision for Loan Losses
The provision for loan losses reflects the amount necessary to maintain the allowance for loan losses (the "allowance") at a level that, in management’s judgment, is appropriate for the amount of inherent risk of probable loss in the Bank’s current loan portfolio.
For the year ended December 31, 2008, the Bank recorded a provision for loan losses ("provision") of $1,995, compared with $456 in 2007, representing an increase of $1,539, or 337.5%. The increase in the provision was largely attributed to the increase in net loan charge-offs, growth in the loan portfolio, generally declining real estate values in much of the Bank’s market area, and other qualitative and environmental considerations.
The Bank’s non-performing loans remained at relatively low levels at December 31, 2008, representing $4,404 or 0.70% of total loans, compared with $2,062 or 0.36% of total loans at December 31, 2007. The allowance expressed as a percentage of non-performing loans stood at 124% at December 30, 2008, compared with 230% at December 31, 2007.
Net charge-offs amounted to $1,292 in 2008, or net charge-offs to average loans outstanding of 0.21%, compared with $238, or net charge-offs to average loans outstanding of 0.04%, in 2007. Two problem loans were accountable for $1,094, or 84.7%, of the 2008 net loan charge-offs.
For the year ended December 31, 2007, the Bank recorded a provision of $456, compared with $131 in 2006, representing an increase of $325, or 248.1%. The increase in the 2007 provision principally reflected the growth in the total loan portfolio and, the increase in non-performing loans, and other qualitative and environmental considerations.
The Bank’s non-performing loans remained at low levels during 2007, despite
ana moderate increase from 2006. At December 31, 2007, total non-performing loans amounted to $2,062, or 0.36% of total loans, compared with $628 or 0.11% at December 31, 2006. The allowance expressed as a percentage of non-performing loans amounted to 230% at December 31, 2007, compared with 721% at December 31, 2006.The
Bank'sBank enjoyed low loan loss experienceremained at low levels during 2007. For the year ended December 31,in 2007, with net loan charge-offsamountedamounting to $238, or net charge-offs to average loans outstanding of 0.04%, compared with $253 or net charge-offs to average loans outstanding of 0.05% in 2006.
For the year ended December 31, 2007, the Bank recorded a provision for loan losses of $456, compared with $131 in 2006 and no provision in 2005. The increase in the 2007 provision for loan losses compared with 2006 principally reflected the growth in the total loan portfolio and, to a lesser extent, the increase in non-performing loans.Refer to Part II, Item 7, Allowance for Loan Losses, in this Annual Report on Form 10-K for further discussion and analysis regarding the provision for loan losses.
Non-Interest Income
In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations.
For the year ended December 31, 2008, total non-interest income amounted to $6,432, compared with $5,929 in 2007, representing an increase of $503, or 8.5%.
For the year ended December 31, 2007, total non-interest income amounted to $5,929, compared with $6,876
and $6,415in 2006,and 2005,representing a decline of $947 or 13.8%and an increase of $461 or 7.2%, respectively.
The $947 decline in 2007 non-interest income compared with 2006 was principally attributed to a $1,426 decline in net securities gains, principally resulting from the Bank’s restructuring of a portion of its securities portfolio in 2007. Excluding securities gains and losses, 2007 non-interest income increased $479, or 7.8%, compared with 2006..Factors contributing to the 2008 and 2007 changes in non-interest income are enumerated in the following discussion and analysis:
Trust and Financial Services Income: Income from trust and financial services represented
39.4%39.1% of the Company’s total non-interest income in2007,2008, compared with 39.4% and 30.5% in 2007 and31.1% in2006,and 2005,respectively.Income from trust and financial services is principally derived from fee income based on a percentage of the market value of client assets under management and held in custody and, to a lesser extent, revenue from brokerage services conducted through Bar Harbor Financial Services, an independent third-party broker.
For the year ended December 31, 2008, income generated from trust and financial services amounted to $2,513, compared with $2,335 in 2007, representing an increase of $178, or 7.6%. Revenue generated from third party brokerage activities posted meaningful increases, which were principally attributed to staff additions and new client relationships. Revenue from trust and investment management activities declined 4.8% in 2008, principally reflecting declining market values of assets under management and held in custody.
At December 31, 2008, total assets under management at Trust Services stood at $230,223, compared with $278,227 at December 31, 2007, representing a decline of $48,004 or 17.3%. The decline in assets under management was principally reflective of the broad declines experienced by the equity markets in general during 2008, offset in part by new managed asset accounts.
For the year ended December 31, 2007, income generated from trust and financial services amounted to $2,335, compared with $2,096
and $1,992in 2006,and 2005,representingyear-over-year increasesan increase of $239,and $104,or 11.4%and 5.2%, respectively.. The 2007 increase in fee income from trust and financial services was principally attributed to the growth of the managed assets portfolio at Trust Services. At December 31, 2007, total assets under management stood at $278,227, compared with $252,057 at December 31, 2006, representing an increase of $26,170, or 10.4%.
The 2006 increase in fee income from trust and financial services was driven by trust and investment services, as revenue generated from third-party brokerage activities at Bar Harbor Financial Services posted moderate declines, reflecting lower trading volumes, including sales of mutual funds and annuity products. During 2006, the Company placed less emphasis on third-party brokerage activities and reduced the associated operating overhead. At December 31, 2006, total assets under management at Trust Services stood at $252,057, compared with $220,537 at December 31, 2005, representing an increase of $31,520, or 14.3%.Service Charges on Deposit Accounts: This income is principally derived from monthly deposit account maintenance and activity fees, overdraft fees, automated teller machine ("ATM") fees and a variety of other deposit account related fees. Income from service charges on deposit accounts represented
27.4%24.8% of total20072008 non-interest income, compared with 27.4% and 22.7% in 2007 and21.7%2006, respectively.For the year ended December 31, 2008, income generated from service charges on deposit accounts amounted to $1,594, compared with $1,624 in
2006 and 2005, respectively.2007, representing a decline of $30, or 1.8%. The 2008 decline in service charges on deposit accounts was principally attributed to relatively small declines in deposit account overdraft activity compared with 2007, combined with the fact that the Bank has not increased its deposit account fee amounts charged to customers since early 2007.For the year ended December 31, 2007, income generated from service charges on deposit accounts amounted to $1,624, compared with $1,559
and $1,390in 2006,and 2005,representingyear-over-year increasesan increase of $65,and $169or 4.2%and 12.2%, respectively.. The 2007 increase in service charges on deposits compared with 2006 was principally attributed to the continued growth of the Bank’s retail, non-maturity deposit account base and, to a lesser extent, increased ATM fees reflecting a relatively strong tourist season in the markets served by the Bank.
The 2006 increase in service charges on deposits compared with 2005 was principally attributed to the introduction of a new overdraft protection service, which was launched by the Bank in the latter part of 2005. The increase also reflected the continued growth of the Bank’s retail, non-maturity deposit base.Credit and Debit Card Service Charges and Fees: This income is principally derived from the Bank’s merchant credit card transaction processing services, its Visa debit card product and, to a lesser extent, fees associated with its Visa credit card portfolio. Historically, the Bank’s merchant credit card activities have been highly seasonal in nature with transaction and fee income volumes peaking in summer and autumn, while declining in winter and spring. Income from credit and debit card service charges and fees represented
35.4%31.8% of total20072008 non-interest income, compared with 35.4% and 26.3% in 2007 and29.2%2006, respectively.For the year ended December 31, 2008, income generated from credit and debit card service charges and fees amounted to $2,044, compared with $2,100 in
20062007, representing a decline of $56, or 2.7%. The 2008 decline in credit and2005, respectively.debit card service charges and fees principally reflected the Bank’s sale of its merchant credit card processing portfolio and its Visa credit card portfolio in the fourth quarter, the details of which are fully enumerated below. This decline was largely offset by 2008 increases in debit card fees, principally reflecting the ongoing growth in the Bank’s demand deposits accounts base, combined with a new program introduced in 2007 that offers rewards for certain debit card transactions.For the year ended December 31, 2007, income generated from credit and debit card service charges and fees amounted to $2,100, compared with $1,812
and $1,876in 2006,and 2005,representing an increase of $288 or 15.9%and a decline of $64 or 3.4%, respectively.. The 2007 increase in credit and debit card service charges and fees compared with 2006 was principally attributed to an increase in debit card fees, reflecting the ongoing growth of the Bank’s non-maturity deposit account base, combined with the highly successful introduction of a new deposit product that offers rewards for debit card transactions. Merchant credit card processing fees also posted an increase, reflecting new business and higher merchant credit card processing volumes compared with 2006.
As previously reported by the Company on October 3, 2008, the Bank entered into a definitive Merchant Portfolio Purchase Agreement (the "Purchase Agreement") with TransFirst, LLC, a Delaware limited liability company ("TransFirst") and Columbus Bank and Trust Company, a Georgia state banking corporation ("Columbus Bank"). On the same date, September 30, 2008, the Bank also entered into a definitive Referral and Sales Agreement ("RSA") with TransFirst. Pursuant to the Purchase Agreement, the Bank sold and assigned, and Columbus as "Transferee" assumed, a mutually agreed list of assets comprised of certain Bank merchant processing agreements and the Bank’s rights under those agreements, including the Bank’s books and records reasonably required to manage and monitor the Bank’s card processing services and other obligations under the transferred merchant agreements (collectively the "Purchased Assets"). The
$288 increasePurchased Assets include those merchant agreements between the Bank and merchants that govern the merchant’s participation in the Bank’s merchant program for creditandor debit card processingfeesservices. The legal transfer of the Purchased Assets occurred on November 1, 2008 (the "Transfer Date"), at which time TransFirst began the conversion of the transferred merchants and related accounts to the purchaser’s processing systems. This conversion wasgreater thancompleted in February 2009. In consideration of the$155 increase in credit and debit card processing expense, whichsale of the Purchased Assets, TransFirst paid to the Bank on the Transfer Date $250 (the "Purchase Price"). This amount is included innon-interest expenseother operating income in the Company’s consolidatedstatementsstatement ofincome.income, net of Broker and de-conversion fees of $147.The
2006 declineRSA is effective as of November 1, 2008. Under the RSA, the Bank has agreed to refer its current and prospective merchant customers exclusively to TransFirst for all payment processing services. The RSA has an initial ten (10) year term with recurring one (1) year renewals thereafter, unless terminated by either party or notice of non-renewal is provided by either party. In consideration for performance of its obligations under the RSA, TransFirst has agreed to pay to the Bank: (i) a monthly cash installment payment of $16, payable incredit card service chargesarrears, for sixty (60) consecutive months beginning November 1, 2008, with the first monthly payment for November 2008 payable on December 1, 2008; (ii) ten percent (10%) of net revenues paid for Payment Processing Services by merchants who were part of the merchant portfolio purchased by TransFirst under the Purchase Agreement; (iii) twenty percent (20%) of net revenues paid for Payment Processing Services by merchants referred to TransFirst by the bank under the RSA; andfees compared with 2005 was principally attributed(iv) 5% of net revenues paid for Payment Processing Services by merchants otherwise solicited by TransFirst under the RSA. In addition, TransFirst will pay the Bank a nominal referral fee for each merchant referred tolowerTransFirst by the Bank that commences Payment Processing Services through TransFirst (not including those merchants that are part of the merchant portfolio purchased by TransFirst pursuant to the Purchase Agreement), and a fee of One Dollar ($1.00) for each cash advance transaction processed by TransFirst for the Bank.The principal objectives underlying the Bank’s decision to terminate its direct participation in the payments industry as a processor of merchant credit card and debit card transactions were the mitigation of risks such as fraud and identity theft, along with the additional costs and resources required to monitor the Bank’s merchants and demonstrate compliance with the standards set forth by the Payment Card Industry (PCI DSS). The Bank will continue to offer and support these services to existing and future merchant processing
volumes. The lower volumes were attributed, in part,clients through a third party processor. Bank management believes this new approach will improve the overall profitability of this business, while offering enhanced levels of service and technology resources to its customers.As previously reported by the
partial relocationCompany on December 5, 2008, the Bank entered into a definitive Credit Card Account Purchase Agreement (the "Agreement") with U.S. Bank National Association, D/B/A Elan Financial Services ("Elan"). Under the terms of the Agreement, the Bank agreed to sell and transfer and Elan agreed to purchase and assume all of the Bank’slargest merchantindividual and business revolving credit cardclient, combinedline accounts as of November 30, 2008. The cash consideration provided to the Bank withintensifying competition from large regional processors.respect to the sale is equivalent to approximately $2,070, which represented 100% of the principal balances of the accounts sold as of November 30, 2008, plus a premium on such balances of approximately $166. Thedeclines in merchantpremium received on the sale of the Bank’s credit cardprocessing revenue were more than offset by declines in merchant credit card processing expense, whichline accounts is included innon-interest expense inother operating income on the Company’s consolidatedstatementsstatement ofincome.income, net of de-conversion fees of $55.
While merchantCompany management believes that any loss of the credit cardprocessing profit margins have generally tightened overportfolio’s contribution to thepast few years,Company’s profitability going forward is not material and will be largely offset by income from certain credit card revenue-sharing and joint marketing arrangements entered into withcompetitionElan in connection with the Agreement. Company management does not expect the sale to result in a significant change in net income fromlarge regional processors intensifying,ongoing operations in theBank has beennear term. Company management anticipates the Company’s longer-term profitability may be favorably impacted if Elan is able tosustain a meaningful revenue stream through new business, increased volumes of transactions, competitive pricing strategies, and the local support offered by a community bank.increase credit card penetration usage, although no assurance can be provided in that regard.Net Securities Gains (Losses): For the year ended December 31, 2008 net securities losses amounted to $831, compared with net securities losses of $671 in 2007, representing an increase in net securities losses of $160, or 23.8%.
The $831 in 2008 net securities losses were comprised of other-than-temporary securities impairment losses of $1,435, largely offset by realized gains on the sale of securities amounting to $604.
For further information about the other-than-temporary securities impairment losses recorded in 2008, refer above in this Report to Part II, Item 7, "Securities" and "Impaired Securities".
For the year ended December 31, 2007, net securities losses amounted to $671, compared with net securities gains of $755
and $580in 2006,and 2005,representing a decline of $1,426 or 188.9%and an increase of $175 or 30.2%, respectively..In April 2007, the Company’s Board of Directors approved the restructuring of a portion of the Bank’s securities portfolio through the sale of $43,337 of its aggregate $227,473 available for sale
securities, the proceeds from which were initially used to pay down short-term borrowings.securities. Since the Company no longer had the intent to hold these securities until a recovery of their amortized cost, which may be at maturity, the Company recorded an adjustment to write down these securities to fair value at March 31, 2007, resulting in a pre-tax impairment loss of $1,162 included in first quarter 2007 earnings as a reduction of non-interest income. The Company’s primary objectives were to improve future period earnings and provide a means to more effectively respond to current and future yield curve environments.The $671 in net securities losses recorded in 2007 were comprised of securities impairment losses of $1,162 and realized losses of $150 on the sale of securities, offset in part by realized gains on the sale of securities amounting to $641.
The recording of securities gains or losses in future reporting periods is uncertain. However, it is important to note that the available for sale securities portfolio is managed in concert with well-structured asset and liability management policies and Bank management will continue to respond to changes in market interest rates and the shape of the yield curve, changes in securities pre-payment or extension risk, changes in the availability of and yields on alternative investments, and the Bank’s need for adequate liquidity.Other Operating Income: Other operating income represented
5.5%13.7% of total20072008 non-interest income, compared with 5.5% and 6.3% in 2007 and5.1% in2006,and 2005,respectively.For the year ended December 31,
20062008, total other operating income amounted to$326,$880, compared with$432 and $330$326 in2006 and 2005,2007, representinga decline of $106 or 24.5% andan increase of$102$554, or30.9%, respectively.169.9%.The
declineincrease in 2008 other operating income was attributed, in part, to a $313 gain recorded in the first quarter of 2008 representing the proceeds from shares redeemed in connection with the Visa, Inc. initial public offering. As previously reported in connection with the Bank’s merchant services and Visa credit card business, prior to September 2007 the Bank was a member of Visa U.S.A. Inc. Card Association. As a part of the Visa Inc. reorganization in 2007, (the "Visa Reorganization"), the Bank received its proportionate number of Class U.S.A. shares of Visa Inc. common stock, or 20,187 shares.In connection with the Visa Inc. initial public offering that occurred in March of 2008, the Bank’s Class U.S.A. shares were converted to 18,949 shares of Visa Inc. Class B Common Stock, of which 7,326 shares were immediately redeemed. The proceeds from this redemption amounted to $313 and were recorded in other operating income in
2007 compared with 2006 was attributedthe Company’s consolidated statement of income. The 11,623 post redemption non-marketable shares owned by the Bank are convertible toa $150 gain onClass A Visa Inc. shares three years after the initial public offering, or upon settlement of certain litigation between Visa Inc. and other third parties, whichever is later.Also included in 2008 other operating income were the previously discussed net gains from the sale of
a parcel of real estate adjacent tothe Bank’sSouthwest Harbor, Maine branch office recorded in 2006. Likewise,merchant credit card processing portfolio and theincrease in 2006 other operating income was attributed to this gain onnet gains from the sale ofreal estate.the Bank’s Visa credit card portfolio and associated lines of credit. Combined, these net gains amounted to $214.Other operating income also includes income from bank-owned life insurance ("BOLI"), representing increases in the cash surrender value of life insurance policies on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies.
For the year ended December 31, 2007 total other operating income amounted to $326, compared with $432 in 2006, representing a decline of $106 or 24.5%. The decline in 2007 other operating income compared with 2006 was attributed to a $150 gain on the sale of a parcel of real estate adjacent to the Bank’s Southwest Harbor, Maine branch office recorded in 2006.
Non-interest Expense
For the year ended December 31, 2008, total non-interest expense amounted to $20,513, compared with $18,201 in 2007, representing an increase of $2,312, or 12.7%.
For the year ended December 31, 2007, total non-interest expense amounted to $18,201, compared with $18,677
and $19,268in 2006,and 2005,representingyear-over-year declinesa decline of $476and $591or 2.5%and 3.1%, respectively.
As more fully discussed below, the decline in 2007 non-interest expense compared with 2006 was principally attributed to the settlement of the Company’s limited post retirement benefit program, the financial impact of which reduced 2007 non-interest expense by $832..Factors contributing to the changes in non-interest expense are enumerated in the following discussion and analysis.
Salaries and Employee Benefits: For the year ended December 31, 2008, total salaries and employee benefit expenses amounted to $10,827, compared with $9,368 in 2007, representing an increase of $1,459, or 15.6%.
The 2008 increase in salaries and employee benefits were attributed to a variety of factors including strategic additions to staff, normal increases in base salaries, increased employee benefit costs, higher levels of incentive compensation, and certain employee severance payments.
For the year ended December 31, 2007, total salaries and employee benefit expenses amounted to $9,368, compared with $9,292
and $9,795in 2006,and 2005,representing an increase of $76 or 0.8%and a decline of $503 or 5.1%, respectively..The relatively small increase in 2007 salaries and employee benefits expense compared with 2006 was principally attributed to normal employee compensation increases, offset in part by changes in overall staffing levels and mix and certain modifications to employee benefit programs.
The $503 decline in 2006 salaries and employee benefits expense compared with 2005 was achieved through a variety of factors including: lower levels of employee health insurance costs in 2006 due to favorable claims experience; changes to employee insurance programs; changes in overall staffing levels and mix; lower levels of incentive compensation; and certain employee severance costs recorded in 2005.Postretirement Plan Settlement: In 2007, the Company settled its limited postretirement benefit program, which funded medical coverage and life insurance benefits to a closed group of active and retired employees who met minimum age and service requirements. The Company voluntarily paid out $699 to plan participants. This payment fully settled all Company obligations related to this program. In connection with the settlement of the postretirement program, the Company recorded a first quarter 2007 reduction in non-interest expense of $832, representing the remaining accrued benefit obligation and the actuarial gain related to the program.
Occupancy Expenses: For the year ended December 31, 2008, total occupancy expense amounted to $1,387, compared with $1,275 in 2007, representing an increase of $112, or 8.8%. The increase in occupancy was principally attributed higher fuel and utilities prices during 2008 compared with 2007. Groundskeeping and snow removal expenses at the Bank’s twelve branch office locations also posted moderate increases in 2008 compared with 2007.
For the year ended December 31, 2007, total occupancy
expensesexpense amounted to $1,275, compared with $1,303and $1,168in 2006,and 2005,representing a decline of $28 or 2.1%and an increase of $135 or 11.6%, respectively.. The $28 decline in 2007 occupancy expenses compared with 2006 was principally attributed to small declines in a variety of expense categories including utilities
grounds keepingandreal estate taxes.
The $135 increase in 2006 occupancy expenses compared with 2005 was principally attributed to the renovation and opening of a new branch office in the community of Somesville, Maine during the first quarter of 2006. The Somesville branch office is a leased facility.groundskeeping.Furniture and Equipment Expenses: For the year ended December 31, 2008, total furniture and equipment expense amounted to $1,539, compared with $1,718 in 2007, representing a decline of $179, or 10.4%. The decline in 2008 furniture and equipment expenses compared with 2007 was principally attributed to declines in depreciation expense, maintenance contract expenses, and personal property taxes.
For the year ended December 31, 2007, total furniture and equipment
expensesexpense amounted to $1,718, compared with $1,844and $1,664in 2006,and 2005,representing a decline of $126, or 6.8%an increase of $180 or 10.8%, respectively.. The
$126decline in 2007 furniture and equipmentexpensesexpense compared with 2006 was attributed to declines in a variety of expense categories including depreciation expense, maintenancecontracts,contract expenses, miscellaneous equipment purchases and repairs, and personal property taxes. The decline alsoreflectsreflected certain expenses associated with the Bank’s major renovation and opening of a new branch office in the community of Somesville, Maine in 2006.
The $180 increase in 2006 furniture and equipment expenses compared with 2005 was principally attributed to certain expenses associated with the Bank’s renovation and opening of a new branch office in the community of Somesville, Maine in early 2006, combined with certain expenses associated with the upgrade and maintenance of the Company’s technology infrastructure.Credit and Debit Card Expenses:
For the year ended December 31, 2007, total credit card expenses amounted to $1,469, compared with $1,314 and $1,397 in 2006 and 2005, representing an increase of $155 or 11.8% and a decline of $83 or 5.9%, respectively.Credit and debit card expenses principally relate to the Bank’s merchant credit and debit card processing activities, Visa debit card processing expenses and, to a lesser extent, its Visa credit card portfolio.
For the year ended December 31, 2008, total credit and debit card expenses amounted to $1,416, compared with $1,469 in 2007, representing a decline of $53, or 3.61%.
The 2008 decline in credit and debit card expenses compared with 2007 principally reflected the Bank’s sale of its merchant credit card processing portfolio and its Visa credit card portfolio in the fourth quarter, the details of which are fully enumerated above. This decline was offset in part by a 2008 increase in debit card expenses, principally reflecting the ongoing growth in the Bank’s demand deposits accounts base, combined with a new program introduced in 2007 that offers rewards for certain debit card transactions. Credit and debit card expenses also included the costs incurred during the first half of 2008 associated with the voluntary re-issuance of a large number of credit and debit cards that were compromised in the widely-publicized Hannaford Bros. Supermarket data breach.
For the year ended December 31, 2007, total credit and debit card expenses amounted to $1,469, compared with $1,314 in 2006, representing an increase of $155 or 11.8%. The increase in 2007 credit and debit card expenses compared with 2006 was principally attributed to increases in the volume of debit card transactions, reflecting the growth of the Bank’s retail checking account base and the introduction of a new deposit product that provides customer rewards for debit card activity. Merchant credit card processing fees were also moderately higher in 2007, principally reflecting higher merchant credit card processing volumes compared with 2006. The 2007 increases in credit and debit card expenses were less than the related increases in credit and debit card income, which is included in non-interest income in the Company’s consolidated statements of income.
The $83 decline in 2006 credit and debit card expenses compared with 2005 was principally attributed to lower merchant credit card processing volumes. The lower processing volumes were principally attributed to the partial relocation of the Bank’s largest merchant credit card client and, to a lesser extent, a somewhat slower tourist season in the markets served by the Bank compared with 2005.Other Operating Expenses: For the year ended December 31,
2007,2008, total other operatingexpensesexpense amounted to$5,203,$5,344, compared with$4,924 and $5,244$5,203 in2006 and 2005,2007, representing an increase of$279$141, or5.7% and a decline of $320 or 6.1%, respectively.2.71%. The
$279increase in20072008 other operating expenses compared with20062007 was attributed to a variety of factors including increases in charitable contributions, FDIC deposit insurance assessments, professional services, marketing expenses, staff development costs and regulatory examination expenses. These increases were partially offset by declines in courier services, and telecommunications costs. The decline in courier services was principally attributed to therecordingmid 2007 implementation of remote image item capture technology in all of the Bank’s branch office locations.Also included in 2008 other operating expenses was a
$243$128 reduction in the Company’s liability(litigation accrual)related to theBank’s membership interest inVisa Reorganization and the Visa Inc.
The Bank’s merchant services and Visa credit card business acquires and issues credit and debit card transactions through Visa U.S.A. Inc. Card Association or its affiliates (collectively "Visa U.S.A."). The Bank has a de minimus membership interest in Visa U.S.A. (0.00473%). In October 2007, Visa, Inc. ("Visa") completed a restructuring including Visa U.S.A. and issued shares of Visa Inc. common stock to its financial institution members in preparation for its plannedinitial public offering("IPO"), anticipated in the first quarter of 2008 (the "Visa Reorganization"). As previously reported in Part II, Item 7 of the Company’s 2007 Annual Report on Form 10-K, as a former member of Visa, the Bank has an obligation to indemnify Visa U.S.A. under its bylaws and Visa Inc. under a retrospective responsibility plan, approved as part of the Visa Reorganization, for contingent losses in connection with covered litigation (the "Visa Indemnification") disclosed inVisa’sVisa Inc.’s public filings with theSecurities and Exchange Commission ("SEC"),SEC, based on its membership proportion. The Bank is not a party to the lawsuits brought against Visa U.S.A.
As part of the Visa Reorganization,In 2007 the Bankreceived its proportionate number of Class USA shares of Visa Inc. common stock, or 20,187 shares. Inrecorded a $243 liability in connection with theIPO, it is expected that a portion of these shares will be redeemed for cash, with the remaining shares to be converted to Class A shares three years after the IPO or upon settlement of the litigation, whichever is later. Additionally,Visais expected to set aside a portion of the proceeds from the IPO in an escrow account for the benefit of member financial institutions to fund expenses of the litigation as well as the members proportionate share of any judgments or settlements that may arise out of the litigation.
In November 2007, the SEC accounting staff provided preliminary guidance with respect to a number of accounting issues arising out of the Visa Reorganization. Also in November 2007, Visa announced the settlement of the portion of the litigation involving American Express. In December 2007, the SEC accounting staff provided further guidance on these accounting matters, including among other things, that Visa member institutions are required to recognize theirIndemnification. The Company recognizes its portion of the VisaindemnificationIndemnification at the estimated fair value of such obligation in accordance with FASB Interpretation No. 45, "Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others".WhileFor the
determinationyear ended December 31, 2007, total other operating expenses amounted to $5,203, compared with $4,924 in 2006, representing an increase offair value$279 or 5.7%. The $279 increase in 2007 other operating expenses compared with 2006 was principally attributed to theBank’s Visa indemnification is highly judgmental, the Company recognizedrecording of a $243 liabilityof $243. Also as a result of the guidance provided by the SEC staff, the Company has not reflected in its financial statements any value for("litigation accrual") related to the Bank’s membership interest in Visa Inc., asa result of the Visa Reorganization. Upon completion of the anticipated IPO, the fair value of such interest will be realized in the Company’s financial statements based on the value of shares utilized to establish the escrow account (limited to the amount of the obligation recorded) and shares redeemed for cash. Company management expects the value of these shares to exceed the $243 charge recorded in 2007.discussed immediately above.Excluding the $243 Visa litigation
charge,accrual, other operating expenses totaled $4,960 for the year ended December 31, 2007, compared with $4,924 in 2006, representing an increase of $36, or 0.7%. The increase was principally attributed to moderate increases in a variety of expense categories including telecommunications, charitable contributions and loan collections expense, largely offset by declines in marketing, training, software depreciation, and courier expenses.
The $320 decline in 2006 other operating expensesIncome TaxesFor the year ended December 31, 2008, total income taxes amounted to $3,384, compared with
2005 was attributed to declines$3,020 ina wide variety2007, representing an increase ofexpense categories including professional services, equipment maintenance, charitable contributions, loan collection, marketing, public relations, audits and exams, ATM processing, and a variety of other miscellaneous expenses. The decline in other operating expenses reflected management’s continuing efforts to improve operating efficiencies and reduce the Company’s overall operating overhead.
Income Taxes$364, or 12.1%.For the year ended December 31, 2007, total income taxes amounted to $3,020, compared with $2,885
and $2,582in 2006,and 2005,representingyear-over-year increasesan increase of $135,and $303,or 4.7%and 11.7%, respectively..The Company’s effective income tax rate in
20072008 amounted to29.7%30.4%, compared with 29.7% and 29.5% in 2007 and28.7% in2006,and 2005,respectively. The income tax provisions for these periods were less than the expense that would result from applying the federal statutory rate of 34% to income before income taxes, principally because of the impact of tax-exempt income on certain investment securities, loans and bank owned life insurance.Fluctuations in the Company’s 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.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements presented elsewhere in this report have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Unlike many industrial companies, substantially all of the assets and virtually all of the liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates and the U.S. Treasury yield curve may no necessarily move in the same direction or in the same magnitude as inflation.
While the financial nature of the Company’s consolidated balance sheets and statements of income is more clearly affected by changes in interest rates than by inflation, inflation does affect the Company because as prices increase the money supply tends to increase, the size of loans requested tends to increase, total Company assets increase, and interest rates are affected by inflationary expectations. In addition, operating expenses tend to increase without a corresponding increase in productivity. There is no precise method, however, to measure the effect of inflation on the Company’s financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation.
Recent Accounting Developments
The following information addresses new or proposed accounting pronouncements that could have an impact on the
Company’sCompany��s financial condition or results of operations.Business Combinations: In December 2007, the Financial Accounting Standards Board ("FASB") issued revised Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," or SFAS No. 141(R). SFAS No. 141(R) retains the fundamental requirements of SFAS 141 that the acquisition method of accounting (formally the purchase method) be used for all business combinations; that an acquirer be identified for each business combination; and that intangible assets be identified and recognized separately from goodwill. SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the assets acquired, the liabilities assumed and any non-controlling interest in the
acquireeacquired entity at the acquisition date, measured at their fair values as of that date, with limited exceptions. Additionally, SFAS No. 141(R) changes the requirements for recognizing assets acquired and liabilities assumed arising from contingencies and recognizing and measuring contingent consideration. SFAS No. 141(R) also enhances the disclosure requirements for business combinations. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 (January 1, 2009 for the Company) and may not be applied before that date.Non-controlling interests in Consolidated Financial Statements: In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin ("ARB") No. 51", "Consolidated Financial Statements". SFAS No. 160 amends ARB No. 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Among other things, SFAS No. 160 clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. SFAS No. 160 also amends SFAS No. 128, "Earnings per Share," so that earnings per share calculations in consolidated financial statements will continue to be based on amounts attributable to the parent. SFAS No. 160 is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2008 (January 1, 2009 for the Company) and is applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements which are to be applied retrospectively for all periods presented. SFAS No. 160
isdid notexpected to havean impact on the Company’s consolidated financial condition or results of operations.
Written Loan Commitments Recorded at Fair Value Through Earnings:Disclosures About Derivative Instruments and Hedging Activities: InNovember 2007,March 2008, theSEC staffFASB issuedStaff Accounting Bulletin ("SAB")SFAS No.109, "Written Loan Commitments Recorded at Fair Value Through Earnings.161, "Disclosures About Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133."SABSFAS No.109 provides views on161 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," to amend and expand theaccounting for written loan commitments recorded at fair value under GAAP. SABdisclosure requirements of SFAS No.109 supersedes SAB No. 105, "Application of Accounting Principles133 toLoan Commitments." Specifically, SAB No. 109 states that the expected net future cash flowsprovide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and relatedto the associated servicing of a loan should be included in the measurement of all written loan commitments thathedge items are accounted foratunder SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity's financial position, results of operations and cash flows. To meet those objectives, SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair valuethrough earnings. The provisionsamounts ofSABgains and losses on derivative instruments and disclosures about credit-risk related features in derivative agreements. SFAS No.109 are applicable on a prospective basis to written loan commitments recorded at fair value under GAAP that are issued or modified in161 must be applied prospectively for interim periods and fiscalquartersyears beginning afterDecemberNovember 15,20072008 (January 1,20082009 for the Company).SABSFAS No.161 did not have a significant impact on the Company's consolidated results of operation or financial condition.Determining the Useful Life of Intangible Assets: In April 2008, the FASB issued FASB Staff Position ("FSP") FSP FAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). FSP FAS 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB SFAS No.
109142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). The intent of FSP FAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R). FSP FAS 142-3 is effective for the Company on January 1, 2009, and applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. The adoption of FSP FAS 142-3 is not expected to have a material impact on the Company’s consolidated financialcondition or resultsstatements.The Hierarchy of
operations.Generally Accepted Accounting
for Income Tax Benefits of Dividends on Share-Based Payment Awards:Principles: InJune 2007,May 2008, the FASBratified a consensus reached byissued SFAS No. 162, "TheHierarchy of Generally Accepted Accounting Principles". SFAS No. 162 identifies theEmerging Issues Task Force (the "EITF") on Issue No. 06-01, "Accountingsources of accounting principles and the framework forIncome Tax Benefitsselecting the principles used in the preparation ofDividends on Share-Based Payment Awards," which clarifies the accounting for income tax benefits related to the paymentfinancial statements ofdividends on equity-classified employee share-based payment awardsnongovernmental entities that arecharged to retained earnings underpresented in conformity with generally accepted accounting principles (the "GAAP hierarchy"). SFAS No.123(R). The EITF concluded that a realized income tax benefit from dividends or dividend equivalents that are charged162 will become effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments toretained earnings and are paid to employees for equity classified non-vested equity shares, non-vested equity share units and outstanding equity share options should be recognized as an increase to additional paid-in capital. EITF Issue No. 06-11 should be applied prospectively to the income tax benefits that result from dividends on equity-classified employee share-based payment awards that are declaredAU Section 411, "The Meaning of Present Fairly infiscal years beginning after payment awards that are declared in fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. Retrospective application to previously issued financial statements is prohibited. EITF Issue No. 06-11Conformity With Generally Accepted Accounting Principles." SFAS No.162 is not expected to haveana significant impact on theCompany’s financial condition orCompany's consolidated results ofoperations.operation or financial condition.
Fair Value Measurements for Financial Assets and Liabilities:Impairment Guidance: InFebruary 2007,January 2009, the FASB issuedSFASFSP EITF 99-20-01, "Amendments to the Impairment Guidance of EITF Issue No.159, "The Fair Value Option for Financial Assets99-20," ("FSP EITF 99-20-01"). The objective of FSP EITF 99-20-01 is to achieve more consistency in the determination of whether an other-than-temporary impairment has occurred. FSP EITF 99-20-01 also retains andFinancial Liabilities, includingemphasizes the objective of anamendment ofother-than-temporary impairment assessment and the related disclosure requirements in FASB Statement No. 115,"which permits entities to choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. At the effective date, an entity may elect the fair value option for eligible items that exist at that date and report the effect of the first re-measurement to fair value as a cumulative-effect adjustment to the opening balance of retained earnings. Subsequent to the effective date, unrealized gains and losses on items for which the fair value option has been elected are to be reported in earnings. If the fair value option is elected for any available-for-sale or held-to-maturity securities at the effective date, cumulative unrealized gains and losses at that date are included in the cumulative-effect adjustment and those securities are to be reported as trading securities under SFAS No. 115, "AccountingAccounting for Certain Investments in Debt and EquitySecurities," butSecurities", and other related guidance. The adoption of FSP EITF 99-20-01, which was effective for theaccounting for a transferCompany on December 31, 2008, was not material to thetrading category under SFAS No. 115 does not apply. Electing the fair value option for an existing held-to-maturity security will not call into question the intent of an entity to hold other debt securities to maturity in the future.
The objective of SFAS 159 is to reduce both complexity in accounting forCompany’s consolidated financialinstruments and the volatility in earnings caused by measuring related assets and liabilities using different measurement attributes. SFAS 159 establishes presentation and disclosure requirements including a requirement to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. SFAS 159 does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, "Fair Value Measurements," and SFAS No. 107, "Disclosures about Fair Value of Financial Instruments."SFAS 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 (January 1, 2008 for the Company). Early adoption was permitted as of the beginning of the previous fiscal year provided that the entity made that choice in the first 120 days of that fiscal year and also adopts the provisions of SFAS 157 at the same time. The Company did not adopt SFAS 159 early and does not anticipate that the adoption of this standard will have a material impact on its financial condition or results of operations. The fair value option was not elected for any financial instrument as of January 1, 2008.statements.
Fair Value Measurements: In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This statement establishes a single authoritative definition of fair value, sets out a framework for measuring fair value, and requires additional disclosures about fair value measurements. The expanded disclosures include a requirement to disclose fair value measurements according to a hierarchy, segregating measurements using: (1) quoted prices in active markets for identical assets and liabilities, (2) significant other observable inputs and (3) significant unobservable inputs. SFAS No. 157 applies only to fair value measurements already required or permitted by other standards and does not impose requirements for additional fair value measures. SFAS No. 157 was issued to increase consistency and comparability in reporting fair values. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within that fiscal year (January 1, 2008 for the Company). The provisions are to be applied prospectively as of the beginning of the fiscal year in which the Statement is applied, with certain exceptions. A transition adjustment, measured as the difference between the carrying amounts and the fair values of certain specific financial instruments at the date SFAS No. 157 is initially applied, is to be recognized as a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption. While SFAS No. 157 will affect certain of the Company’s fair value disclosures, it is not expected to have a material impact on the Company’s financial condition or results of operations.ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
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 Company’s business activities.
The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee ("ALCO"), chaired by the Chief Financial Officer and composed of various members of senior management. ALCO meets regularly to review balance sheet structure, formulate strategies in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.
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 balanceoff-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 Bank’s ALCO and Board of Directors.The Bank's Asset Liability Management Policy, approved annually by the Bank’s 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.
Interest rate risk is monitored through the use of two complementary measures: static gap analysis ("gap") and interest rate sensitivity modeling. While each measurement may have its limitations, taken together they form a reasonably comprehensive view of the magnitude of the Bank’s interest rate risk, the level of risk over time, and the quantification of exposure to changes in certain interest rate relationships.
Static Gap Analysis: Interest rate gap analysis provides a static view of the maturity and re-pricing characteristics of the Bank’s on- and off-balance sheet positions. Gap is defined as the difference between assets and liabilities re-pricing or maturing within specified periods. An asset-sensitive position, or "positive gap," indicates that there are more rate sensitive assets than rate-sensitive liabilities re-pricing or maturing within a specified time period, which would imply a favorable impact on net interest income during periods of rising interest rates. Conversely, a liability-sensitive position, or "negative gap," generally implies a favorable impact on net interest income during periods of falling interest rates.
The Bank’s static interest rate sensitivity gap is summarized below:
INTEREST RATE RISK
CUMULATIVE STATIC GAP POSITION
December 31,20072008 and20062007
One Day
To Six MonthsOver Six Months
To One YearOver One
To Two YearsOne Day
To Six MonthsOver Six Months
To One YearOver One Year
December 31, 2008
$ 79,467
$133,823
$194,616
December 31, 2007
$ (66,095)
$ (49,609)
$ 19,011
$ (66,095)
$ (49,609)
$123,183
December 31, 2006
$(150,320)
$(137,085)
$ 79,549
Change ($)
$ 84,225
$ 87,476
$(60,538)
$145,562
$183,432
$ 71,433
The Bank’s December 31,
20072008 cumulative interest rate risk sensitivity static gap position indicated that the Bank’s balance sheet wasliabilityasset sensitive over the twelve-month horizon andwas moderately asset sensitive beyond the twelve-month horizon.beyond.Comparing
20072008 with2006,2007, the liability sensitivity of the Bank’s balancesheet declined.at December 31, 2007 changed to an asset sensitive position at December 31, 2008. Changes in the Bank’s cumulative static gap position from the prior year principallyreflectreflected higher levels of longer term funding, and overall changes in the maturity and re-pricing mix of earning assets and interest bearing liabilities.Additionally, pursuantPursuant to the Bank’s asset and liability management strategy, management extended the maturities on a portion of its wholesale funding base during2007,2008, in order to lessen the Bank’s exposure to rising interest rates. In addition, a portion of the Bank’s fixed rate loan portfolios migrated to variable rates during 2008, further increasing the asset sensitivity of the Bank’s balance sheet.There are certain limitations inherent in static gap analysis. These limitations include the fact that it is a static measurement and it does not reflect the degrees to which interest earning assets and interest bearing liabilities may respond non-proportionally to changes in market interest rates. Although ALCO reviews all data used in the model in detail, assets and liabilities do not always have clear re-pricing dates, and re-pricing may occur earlier or later than assumed in the model.
Interest Rate Sensitivity Modeling: 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 for 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 estimates of prepayment speeds, based upon similar coupon ranges and degree of seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:
A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption;
A 200 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve-month horizon together with a dynamic balance sheet anticipated to be consistent with such interest rate changes;
- Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes; and
- 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 interest 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 December 31,
2007,2008, over one and two year horizons and under different interest rate scenarios. In light of the prevailing Federal Funds rate of 0.25% and the five-year U.S. Treasury note of 1.55% at December 31, 2008, the analysis incorporates a declining interest rate scenario of 100 basis points, rather than the 200 basis points as would traditionally be the case. The table also summarizes net interest income sensitivity under a non-parallel shift in the yield curve, whereby short term rates increase by 200 basis points.INTEREST RATE RISK
CHANGES IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
DECEMBER 31,20072008
-200 Basis Points Parallel Yield Curve Shift
+200 Basis Points Parallel Yield Curve Shift
-200 Basis Points Short Term
RatesYear 1
Net interest income change ($)
$ 932
$(1,555)
$1,711
Net interest income change (%)
3.57%
(5.96%)
6.56%
Year 2
Net interest income change ($)
$1,455
$(1,964)
$4,883
Net interest income change (%)
5.58%
(7.53%)
18.72%
-100 Basis Points Parallel Yield
Curve Shift+200 Basis Points Parallel Yield
Curve Shift+200 Basis Points Short-term Rates
Year 1
Net interest income
$88
($298)
($1,239)
% change
0.29%
(0.99%)
(4.12%)
Year 2
Net Int Income
($887)
$1,629
$1,998
% change
(2.95%)
5.42%
(6.64%)
The foregoingDuring 2008, the interest rate risk profile of the Bank’s balance sheet became less liability sensitive than exhibited over the past few years. This was principally attributed to the extension of FHLB borrowings into longer-term maturities out to five years, as well as adding longer-term certificates of deposit to the Bank’s balance sheet. These actions were taken to protect the Bank’s net interest margin and net interest income in a rising rate environment, at times when borrowing costs were at cyclical lows. Also impacting the liability sensitivity of the Bank’s December 31, 2008 balance sheet was the renegotiation of certain fixed rate loans to variable rate, combined with a proportionately higher level of new variable rate loans added to the balance sheet during 2008.As more fully discussed below, the December 31, 2008 interest rate sensitivity modeling results indicate that the Bank’s balance sheet is
liability sensitiveabout evenly matched over the one-year horizon and is favorably positioned fordecliningparallel increases in short-term and or long-term interest rates over theone andtwo-yearhorizons. The interest rate sensitivity model also suggests that the Bank is moderately exposed to a parallel increase in short-term and long-term rates over the one and two-year horizons but, as discussed below, management believes that this is a scenario that is less likely to occur.horizon.Assuming interest rates remain at or near their current levels and the Bank’s balance sheet structure and size remain at current levels, the interest rate sensitivity simulation model suggests that net interest income will trend moderately upward over the one and two-year horizons and beyond. The upward trend principally results from
the downward re-pricing of a large portion of the Bank’s short termfundingbase in response to the 100 basis point reduction in the Fed Funds rate in late 2007, unlike the Bank’s fixed ratecosts rolling over at current lower interest rates while earning assetportfolios which were generally not impacted by the declining Fed Funds rate. The upward trend also reflects the re-investment of a portion of securities and loan cash flows into higher current interest rate levels. Management anticipates that only moderate earning asset growth would be needed to meaningfully increase the Bank’s current level of net interest income, should interest ratesyields remainat current levels.relatively stable.Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will increase slightly over the one year horizon, and
two-year horizons.will show a moderate decline over the two year horizon. The simulation model suggests that in a falling rate environment net interest income will initial trend in line with the base case scenario, as reductions in funding costs essentially offset lower earning asset yields. Over the two year horizon, the interest rate sensitivity simulation model suggeststhat funding cost reductions will outpace falling asset yields, favorably impactingthe net interestincome. While the interest rate sensitivity model suggests that net interest incomemargin will be pressured by accelerated cash flows on fixed rate earning assets and the re-pricing of the Bank’s variable rate earning assetbase, management believes this isbase. Should the yield curve steepen as rates fall, the model suggests that accelerated earning asset prepayments will slow, resulting in ascenario that is not likely to occur. In this regard, at December 31, 2007 long-term interest rates continued below historical norms, with the 10-year U.S. Treasury note closing the year at 4.02%. Management believes that a 200 basis pointsmaller decline inlong-termnet interestrates, or a 10-year U.S. Treasury note of 2.02%, would be unprecedented and unlikely to occur. Notwithstanding, managementincome over the two year horizon. Management anticipates thatonly moderatecontinued earning asset growth will be needed to meaningfully increase the Bank’s current level of net interest income should both long-term and short-term interest rates decline in parallel.
The interest rate sensitivity model is used to evaluate the impact on net interest income given certain non-parallel shifts in the yield curve, including changes in either short-term or long-term interest rates. Given the shape of the yield curve at December 31, 2007 combined with the prospect of further interest rate reductions by the Federal Reserve, management modeled alternative future interest rate scenarios and the anticipated impact on net interest income. Assuming the Bank’s balance sheet structure and size remain at current levels, with the short-term Federal Funds interest rate declining 200 basis points, and with the balance of the yield curve returning to its historical ten-year average, the interest rate sensitivity model suggests that net interest income will significantly improve over the twelve-month horizon and continue to strengthen over the twenty-four month horizon. The model indicates that funding costs will show significant declines while earning asset yields will only decline moderately. In addition, loan and securities cash flows will be reinvested into higher yielding earning assets. Management believes the foregoing scenario is more likely than a parallel 200 basis point decline in short and long-term interest rates, given the current shape of the yield curve. Management also believes this scenario will significantly increase net interest income without the benefit of earning asset growth.Assuming the Bank’s balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points, and the balance of the yield curve shifts in parallel with these increases, management believes net interest income will post a moderate
declinesdecline over the twelveand twenty fourmonthhorizons, andhorizon, then begin a steadyrecovery.recovery over the two year horizon and beyond. The interest rate sensitivity simulation model suggests that as interest rates rise, the Bank’s funding costs will initially re-price more quickly than its earning asset portfolios, causing a moderate decline in net interestincome.income over the twelve month horizon. As funding costs begin to stabilizetowards the end ofearly in the second year of the simulation, the earning asset portfolios will continue to re-price at prevailing interest rate levels and cash flows from earning asset portfolios will be reinvested into higher yielding earning assets, resulting in a widening of spreads and improving levels of net interest income over the two year horizon and beyond. Management believes strong earning asset growth will be necessary to meaningfully increase the current level of net interest income over the one year horizon should short-term and long-term interest rates rise in parallel. Over the two year horizon and beyond, management believes moderate earning asset growth will be necessary to meaningfully increase the current level of net interest income. Management also believes that, based on a variety of current economic indicators, it is not likely the Federal Reserve will increase short-term interest rates any time in the near future.The interest rate sensitivity model is used to evaluate the impact on net interest income given certain non-parallel shifts in the yield curve, including changes in either short-term or long-term interest rates. Given the overall state of the economy and the historic trauma in the financial markets at December 31, 2008, management modeled an alternative future interest rate scenario and the anticipated impact on net interest income. Assuming the Bank’s balance sheet structure and size remain at current levels, with the short-term Federal Funds interest rate increasing 200 basis points, and with the balance of the yield curve returning to its historical ten-year average, the interest rate sensitivity model suggests that net interest income will decline over the twelve month horizon and this decline will continue over the twenty-four month horizon. The model indicates that funding costs will show significant increases over the twelve and twenty-four month horizons, while earning asset yields will increase moderately. Management believes that strong earning asset growth will be
necessaryrequired to meaningfully increasethe current level ofnet interest income shouldshort and long-terminterest ratesriseincrease 200 basis points in parallel. Management also believes that, based on a variety of current economic indicators, it is not likely the Federal Reserve will increase short-term interest rates any time in the near future. Notwithstanding this consideration, management has the ability to respond to anticipated or potential changes in interest rates in order to protect future levels of net interest income. For example, to protect against rising interest rates, longer term funding, which is currently at cyclical interest rate lows, could be added to the balance sheet asshort termshort-term funding maturities come due.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 /reinvestment/replacement of asset and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate change caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Bank’s ALCO and Board of Directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Bank’s net interest income.
The Bank engages an independent consultant to periodically review its interest rate risk position and the reasonableness of assumptions used, with periodic reports provided to the Bank’s Board of Directors. At December 31,
2007,2008, there were no significant differences between the views of the independent consultant and management regarding the Bank’s interest rate risk exposure.The following table summarizes the Bank’s net interest income sensitivity analysis that was prepared as of December 31,
2006,2007, over one and two-year horizonsandassuminga200 basis point parallelshiftshifts in the yield curve. The table alsosummarizessummarized net interest income sensitivity under a non-parallel shift in the yield curve, whereby short-term rates declined by 200 basis points.INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
DECEMBER 31,20062007
-200 Basis Points
Parallel Yield
Curve Shift+200 Basis Points
Parallel Yield
Curve Shift-200 Basis Points
Short Term
Rates-200 Basis Points
Parallel Yield
Curve Shift+200 Basis Points
Parallel Yield
Curve Shift-200 Basis Points
Short-term
RatesYear 1
Net interest income change ($)
$1,796
$ (2,352)
$2,327
$ 932
$(1,555)
$1,711
Net interest income change (%)
8.15%
(10.67%)
10.56%
3.57%
(5.69%)
6.56%
Year 2
Net interest income change ($)
$2,860
$(3,014)
$5,594
$1,455
$(1,964)
$4,883
Net interest income change (%)
12.98%
(13.68%)
25.38%
5.58%
(7.53%)
18.72%
During 2008, the
first nine months of 2007,short-term Federal Funds interest rate(Fed Funds) remained unchanged.declined 400 basis points and the benchmark 10-year U.S. Treasury note declined 181 basis points. As had been largely anticipated by management through use of the interest rate sensitivity model in aflatdeclining interest ratescenario,environment, the Bank’s net interestincome growth of 3% during that period was largely a reflection of earning asset growth.
From September 20, 2007margin increased 22 basis points in 2008, and materially contributed toDecember 31, 2007,theFederal Reserve decreased short-term interest rates three times for a total of 100 basis points. As was anticipated by Management through use of the interest rate sensitivity model, the Bank’s$4,288 increase in 2008 net interestincome was favorable impacted by the decline in short-term interest rates. While the full impact of interest rate reductions are typically not immediate, the Bank’s fourth quarter net interest margin was up 12 basis points over the same quarter in 2006 and 4 basis points on a linked quarter basis.income.ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Bar Harbor Bankshares:We have audited the accompanying consolidated balance sheets of Bar Harbor Bankshares and subsidiaries (the "Company") as of December 31,
20072008 and2006,2007, and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31,2007.2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bar Harbor Bankshares and subsidiaries as of December 31,
20072008 and2006,2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31,2007,2008, in conformity with U. S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company adopted Staff Accounting Bulletin No. 108,"Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,"as of January 1, 2006.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31,
2007,2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March13, 200816, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting./s/ KPMG LLP
Albany, New York
March13, 200816, 2009
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,20072008 AND20062007
(in thousands, except share data)
December 31,
2007December 31,
2006December 31,
2008December 31,
2007Assets
Cash and due from banks
$ 7,726
$ 11,838
$ 9,041
$ 7,726
Overnight interest bearing money market funds
5
7,709
1
5
Total cash and cash equivalents
7,731
19,547
9,042
7,731
Securities available for sale, at fair value
264,617
213,252
290,502
264,617
Federal Home Loan Bank stock
13,156
11,849
14,796
13,156
Loans
579,711
555,099
633,603
579,711
Allowance for loan losses
(4,743)
(4,525)
(5,446)
(4,743)
Loans, net of allowance for loan losses
574,968
550,574
628,157
574,968
Premises and equipment, net
10,795
11,368
10,854
10,795
Goodwill
3,158
3,158
3,158
3,158
Bank owned life insurance
6,340
6,116
6,573
6,340
Other assets
8,707
9,013
9,206
8,707
TOTAL ASSETS
$889,472
$824,877
$972,288
$889,472
Liabilities
Demand and other non-interest bearing deposits
$ 65,161
$ 53,872
$ 57,954
$ 65,161
NOW accounts
67,050
63,588
67,747
67,050
Savings and money market deposits
163,009
164,213
163,780
163,009
Time deposits
140,204
132,285
200,206
140,204
Brokered time deposits
103,692
82,361
88,506
103,692
Total deposits
539,116
496,319
578,193
539,116
Short-term borrowings
148,246
175,246
121,672
148,246
Long-term debt
130,607
85,466
Long-term advances from Federal Home Loan Bank
197,231
130,607
Junior subordinated debentures
5,000
---
Other liabilities
5,529
6,795
4,747
5,529
TOTAL LIABILITIES
823,498
763,826
906,843
823,498
Shareholders' equity
Capital stock, par value $2.00; authorized 10,000,000 shares;
issued 3,643,614 shares at December 31, 2007 and December 31, 20067,287
7,287
Capital stock, par value $2.00; authorized 10,000,000 shares; issued 3,643,614 shares at
December 31, 2008 and December 31, 20077,287
7,287
Surplus
4,668
4,365
4,903
4,668
Retained earnings
63,292
59,339
67,908
63,292
Accumulated other comprehensive income (loss):
Prior service cost and unamortized net actuarial gains/losses on employee
benefit plans, net of tax of ($64) and $80, at December 31, 2007 and
December 31, 2006, respectively(124)
156
Net unrealized appreciation (depreciation) on securities available for sale, net of tax
of $616 and ($351), at December 31, 2007 and December 31, 2006, respectively1,196
(680)
Net unrealized appreciation (depreciation) on derivative instruments, net of tax
of $24 and ($221) at December 31, 2007 and December 31, 2006, respectively46
(429)
Total accumulated other comprehensive income (loss)
1,118
(953)
Less: cost of 640,951 and 596,169 shares of treasury stock at December 31, 2007
and December 31, 2006, respectively(10,391)
(8,987)
Accumulated other comprehensive (loss) income:
Prior service cost and unamortized net actuarial gains/losses on employee
benefit plans, net of tax of ($59) and ($64), at December 31, 2008
and December 31, 2007, respectively(115)
(124)
Net unrealized (depreciation) appreciation on securities available for sale, net of tax
of ($573) and $616, at December 31, 2008 and December 31, 2007, respectively(1,149)
1,196
Net unrealized appreciation (depreciation) on derivative instruments, net of tax
of $382 and $24 at December 31, 2008 and December 31, 2007, respectively740
46
Total accumulated other comprehensive (loss) income
(524)
1,118
Less: cost of 769,635 and 640,951 shares of treasury stock at December 31, 2008
and December 31, 2007, respectively
(14,129)
(10,391)
TOTAL SHAREHOLDERS' EQUITY
65,974
61,051
65,445
65,974
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$889,472
$824,877
$972,288
$889,472
The accompanying notes are an integral part of these consolidated financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2008, 20072006AND20052006
(in thousands, except share data)
2007
2006
2005
2008
2007
2006
Interest and dividend income:
Interest and fees on loans
$ 37,923
$ 35,388
$ 29,553
$ 37,653
$ 37,923
$ 35,388
Interest and dividends on securities and other earning assets
13,886
10,757
7,642
Interest and dividends on securities
15,941
13,886
10,757
Total interest and dividend income
51,809
46,145
37,195
53,594
51,809
46,145
Interest expense:
Deposits
16,222
13,039
6,941
14,976
16,222
13,039
Short-term borrowings
5,967
6,359
2,648
1,421
5,967
6,359
Long-term debt
6,717
5,051
5,747
10,006
6,717
5,051
Total interest expense
28,906
24,449
15,336
26,403
28,906
24,449
Net interest income
22,903
21,696
21,859
27,191
22,903
21,696
Provision for loan losses
456
131
---
1,995
456
131
Net interest income after provision for loan losses
22,447
21,565
21,859
25,196
22,447
21,565
Non-interest income:
Trust and other financial services
2,335
2,096
1,992
2,513
2,335
2,096
Service charges on deposit accounts
1,624
1,559
1,390
1,594
1,624
1,559
Other service charges, commissions and fees
215
222
247
232
215
222
Credit card service charges and fees
2,100
1,812
1,876
Credit and debit card service charges and fees
2,044
2,100
1,812
Net securities (losses) gains
(671)
755
580
(831)
(671)
755
Other operating income
326
432
330
880
326
432
Total non-interest income
5,929
6,876
6,415
6,432
5,929
6,876
Non-interest expense:
Salaries and employee benefits
9,368
9,292
9,795
10,827
9,368
9,292
Postretirement plan settlement
(832)
---
---
---
(832)
---
Occupancy expense
1,275
1,303
1,168
1,387
1,275
1,303
Furniture and equipment expense
1,718
1,844
1,664
1,539
1,718
1,844
Credit card expenses
1,469
1,314
1,397
Credit and debit card expenses
1,416
1,469
1,314
Other operating expense
5,203
4,924
5,244
5,344
5,203
4,924
Total non-interest expense
18,201
18,677
19,268
20,513
18,201
18,677
Income before income taxes
10,175
9,764
9,006
11,115
10,175
9,764
Income taxes
3,020
2,885
2,582
3,384
3,020
2,885
Net income
$ 7,155
$ 6,879
$ 6,424
$ 7,731
$ 7,155
$ 6,879
Computation of Earnings Per Share:
Weighted average number of capital stock shares outstanding
Basic
3,037,074
3,049,777
3,076,498
2,943,694
3,037,074
3,049,777
Effect of dilutive employee stock options
75,662
72,048
90,300
63,555
75,662
72,048
Diluted
3,112,736
3,121,825
3,166,798
3,007,249
3,112,736
3,121,825
Basic Earnings Per Share
$ 2.36
$ 2.26
$ 2.09
$ 2.63
$ 2.36
$ 2.26
Diluted Earnings Per Share
$ 2.30
$ 2.20
$ 2.03
$ 2.57
$ 2.30
$ 2.20
The accompanying notes are an integral part of these consolidated financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2008, 20072006AND20052006
(in thousands, except share data)
Capital
StockSurplus
Retained
EarningsAccumulated
Other
Comprehensive
Income (loss)Treasury
StockTotal
Shareholders'
EquityBalance December 31, 2004
$7,287
$4,002
$51,733
$ 1,118
$( 8,098)
$56,042
Net income
---
---
6,424
---
---
6,424
Total other comprehensive loss
---
---
---
(2,856)
---
(2,856)
Cash dividends declared ($0.840 per share)
---
---
(2,584)
---
---
(2,584)
Purchase of treasury stock (53,812 shares)
---
---
---
---
(1,473)
(1,473)
Stock options exercised (34,122 shares), including related tax effects
---
---
(392)
---
943
551
Balance December 31, 2005
$7,287
$4,002
$55,181
$(1,738)
$( 8,628)
$56,104
Capital
StockSurplus
Retained
EarningsAccumulated
Other
Comprehensive
(loss) incomeTreasury
StockTotal
Shareholders'
EquityBalance December 31, 2005
$7,287
$4,002
$55,181
$(1,738)
$( 8,628)
$56,104
$7,287
$4,002
$55,181
$(1,738)
$ (8,628)
$56,104
Cumulative effect adjustment from the adoption of SAB No. 108
---
---
331
---
---
331
---
---
331
---
---
331
Adjusted balance December 31, 2005
7,287
4,002
55,512
(1,738)
(8,628)
56,435
7,287
4,002
55,512
(1,738)
(8,628)
56,435
Net income
---
---
6,879
---
---
6,879
--- --- 6,879
---
--- 6,879
Total other comprehensive income
---
---
---
629
---
629
--- --- ---
629
--- 629
Cash dividends declared ($0.905 per share)
---
---
(2,761)
---
---
(2,761)
--- --- (2,761)
--- --- (2,761)
Purchase of treasury stock (40,270 shares)
---
---
---
---
(1,162)
(1,162)
--- --- ---
--- (1,162)
(1,162)
Stock options exercised (27,756 shares), including related tax effects
---
216
(291)
---
803
728
--- 216
(291)
--- 803
728
Recognition of stock option expense
---
147
---
---
---
147
--- 147
--- --- --- 147
Adjustment for adoption of SFAS No. 158
---
---
---
156
---
156
--- ---
--- 156
--- 156
Balance December 31, 2006
$7,287
$4,365
$59,339
$ (953)
$( 8,987)
$61,051
$7,287
$4,365
$59,339
$ (953)
$ (8,987)
$61,051
Balance December 31, 2006
$7,287
$4,365
$59,339
$ (953)
$( 8,987)
$61,051
$7,287
$4,365
$59,339
$ ( 953)
$ (8,987)
$61,051
Net income
---
---
7,155
---
---
7,155
--- --- 7,155
---
--- 7,155
Total other comprehensive income
---
---
---
2,071
---
2,071
--- --- ---
2,071
--- 2,071
Cash dividends declared ($0.955 per share)
---
---
(2,899)
---
---
(2,899)
--- --- (2,899)
--- --- (2,899)
Purchase of treasury stock (67,599 shares)
---
---
---
---
(2,118)
(2,118)
--- --- ---
--- (2,118)
(2,118)
Stock options exercised (22,817 shares), including related tax effects
---
99
(303)
---
714
510
--- 99
(303)
--- 714
510
Recognition of stock option expense
---
204
---
---
---
204
--- 204
---
--- ---
204
Balance December 31, 2007
$7,287
$4,668
$63,292
$ 1,118
$(10,391)
$65,974
$7,287
$4,668
$63,292
$ 1,118
$(10,391)
$65,974
Balance December 31, 2007
$7,287
$4,668
$63,292
$ 1,118
$(10,391)
$65,974
Net income
--- --- 7,731
---
--- 7,731
Total other comprehensive loss
--- --- ---
(1,642)
--- (1,642)
Cash dividends declared ($1.02 per share)
--- --- (3,004)
--- --- (3,004)
Purchase of treasury stock (138,409 shares)
--- --- ---
--- (4,028)
(4,028)
Stock options exercised (9,725 shares),
including related tax effects--- 31
(111)
--- 290
210
Recognition of stock option expense
--- 204
---
--- ---
204
Balance December 31, 2008
$7,287
$4,903
$67,908
$ (524)
$(14,129)
$65,445
The accompanying notes are an integral part of these consolidated financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2008, 20072006AND20052006
(in thousands)
2007
2006
2005
Net income
$7,155
$6,879
$6,424
Net unrealized appreciation (depreciation) on securities available for sale,
net of tax of $739, $536 and ($1,094), respectively1,433
1,044
(2,123)
Less reclassification adjustment for net losses (gains) related to securities available for sale
included in net income, net of tax of $228, ($256), and ($197), respectively443
(499)
(383)
Net unrealized appreciation (depreciation) and other amounts for interest rate derivatives,
net of tax of $245, $44, and ($180), respectively475
84
(350)
Reversal of actuarial gain upon postretirement plan settlement,
net of tax of $151(289)
---
---
Amortization of actuarial gain for supplemental executive retirement plan,
net of related tax of $79
---
---
Total other comprehensive income (loss)
2,071
629
(2,856)
Total comprehensive income
$9,226
$7,508
$3,568
2008
2007
2006
Net income
$ 7,731
$7,155
$6,879
Net unrealized (depreciation) appreciation on securities
available for sale, net of tax of ($1,472), $739 and $536, respectively(2,893)
1,433
1,044
Less reclassification adjustment for net losses (gains) related to securities
available for sale included in net income, net of tax of $283, $228,
and ($256), respectively548
443
(499)
Net unrealized appreciation and other amounts for interest rate derivatives,
net of tax of $358, $245, and $44, respectively694
475
84
Reversal of actuarial gain upon postretirement plan settlement,
net of tax of $151---
(289)
---
Amortization of actuarial gain for supplemental executive retirement plan,
net of related tax of $5, $7, and $0, respectively9
9
---
Total other comprehensive (loss) income
(1,642)
2,071
629
Total comprehensive income
$ 6,089
$9,226
$7,508
The accompanying notes are an integral part of these consolidated financial statements.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2008, 20072006AND20052006
(in thousands)
2007
2006
2005
2008
2007
2006
Cash flows from operating activities:
Net income
$ 7,155
$ 6,879
$ 6,424
$ 7,731
$ 7,155
$ 6,879
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment
1,211
1,280
1,394
1,004
1,211
1,280
Amortization of core deposit intangible
67
67
67
67
67
Provision for loan losses
456
131
---
1,995
456
131
Net securities losses (gains)
671
(755)
(580)
831
671
(755)
Net amortization of bond premiums
93
282
859
Net (accretion) amortization of bond discounts and premiums
(748)
93
282
Recognition of stock option expense
204
147
---
204
204
147
Postretirement plan settlement
(832)
---
---
---
(832)
---
Net gain on sale of credit card loans
(111)
---
Net gain on sale of merchant processing business
(103)
---
Net change in other assets
(713)
(766)
(1,624)
822
(713)
(766)
Net change in other liabilities
(138)
617
840
(768)
(138)
401
Net cash provided by operating activities
8,174
7,882
7,380
10,924
8,174
7,666
Cash flows from investing activities:
Purchases of securities available for sale
(154,501)
(77,987)
(60,146)
(100,222)
(154,501)
(77,987)
Proceeds from maturities, calls and principal paydowns of securities available for sale
50,702
41,283
36,709
Proceeds from maturities, calls and principal paydowns of mortgage-backed securities
49,656
50,702
41,283
Proceeds from sales of securities available for sale
54,513
8,050
12,398
21,064
54,513
8,050
Net increase in Federal Home Loan Bank stock
(1,307)
(525)
(824)
(1,640)
(1,307)
(525)
Proceeds from sale of student loan portfolio
2,539
---
---
---
2,539
---
Proceeds from sale of credit card and merchant processing business
2,284
---
---
Net loans made to customers
(27,729)
(40,486)
(66,570)
(57,337)
(27,729)
(40,486)
Proceeds from sale of other real estate owned
340
2,539
---
Capital expenditures
(638)
(863)
(1,244)
(1,063)
(638)
(863)
Net cash used in investing activities
(76,421)
(70,528)
(79,677)
(86,918)
(76,421)
(70,528)
Cash flows from financing activities:
Net increase in deposits
42,797
50,588
47,459
39,077
42,797
50,588
Net increase (decrease) in securities sold under repurchase agreements and fed funds purchased
7,619
(1,511)
1,361
(1,177)
7,619
(1,511)
Proceeds from Federal Home Loan Bank advances
101,000
29,500
44,300
97,180
101,000
29,500
Repayments of Federal Home Loan Bank advances
(90,478)
(6,973)
(12,888)
(55,953)
(90,478)
(6,973)
Purchases of treasury stock
(2,118)
(1,162)
(1,473)
(4,028)
(2,118)
(1,162)
Proceeds from issuance of junior subordinated debentures
5,000
---
Proceeds from stock option exercises, including excess tax benefits
510
512
551
210
510
728
Payments of dividends
(2,899)
(2,761)
(2,584)
(3,004)
(2,899)
(2,761)
Net cash provided by financing activities
56,431
68,193
76,726
77,305
56,431
68,409
Net (decrease) increase in cash and cash equivalents
(11,816)
5,547
4,429
Net increase (decrease) in cash and cash equivalents
1,311
(11,816)
5,547
Cash and cash equivalents at beginning of year
19,547
14,000
9,571
7,731
19,547
14,000
Cash and cash equivalents at end of year
$ 7,731
$ 19,547
$ 14,000
$ 9,042
$ 7,731
$ 19,547
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
$ 28,194
$ 23,411
$ 14,840
$ 26,667
$ 28,194
$ 23,411
Income taxes
2,712
2,643
2,940
3,427
2,712
2,643
Schedule of noncash investing activities
Transfer from loans to other real estate owned
$ 340
$ ---
$ ---
Schedule of noncash investing activities:
Transfers from loans to other real estate owned
$ 83
$ 340
$ ---
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BAR HARBOR BANKSHARES AND SUBSIDIARIES
(All dollar amounts expressed in thousands, except per share data)
Note 1: Summary of Significant Accounting Policies
The accounting and reporting policies of Bar Harbor Bankshares (the "Company") and its
wholly ownedwholly-owned operating subsidiary, Bar Harbor Bank & Trust (the "Bank"), conform to U.S. generally accepted accounting principles and to general practice within the banking industry.The Company’s principal business activity is retail and commercial banking and, to a lesser extent, financial services including trust, financial planning, investment management and third-party brokerage services. The Company’s business is conducted through the Company’s twelve banking offices located throughout downeast and midcoast Maine.
The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System. The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the
Statestate of Maine, and as such is subject to the jurisdiction of the Superintendent of the Maine Bureau of Financial Institutions. The Bank is subject to the supervision, regulation, and examination of the FDIC and the Maine Bureau of Financial Institutions.Financial Statement Presentation: The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles.
The consolidated financial statements include the accounts of Bar Harbor Bankshares and its
wholly ownedwholly-owned subsidiary, Bar Harbor Bank & Trust. All significant inter-company balances and transactions have been eliminated in consolidation. Whenever necessary, amounts in the prioryearsyears’ financial statements are reclassified to conform to current presentation. Assets held in a fiduciary capacity are not assets of the Company and, accordingly, are not included in the consolidated balance sheets.In preparing financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change in the near term relate to the determination of the allowance for loan losses, reviews of goodwill and intangible assets for impairment, accounting for postretirement plans, and income taxes.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and other short-term investments with maturities less than 90 days.
The Bank is required to maintain an average reserve balance with the Federal Reserve Bank or maintain such reserve balance in the form of cash on hand. The required reserve balance at December 31, 2008 and 2007 was $394 and
2006 was$414,and $147,respectively, and was met by holding cash on hand. The Bank’s clearing balance requirement was $150 at December 31,20072008 and2006.2007.In the normal course of business, the Bank has funds on deposit at other financial institutions in amounts in excess of the
$100$250 that is insured by the Federal Deposit Insurance Corporation.Investment Securities: Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as "held-to-maturity" ("HTM") and reflected at amortized cost. Securities not classified as "held-to-maturity" are classified as "available-for-sale" ("AFS"). All securities held at December 31,
20072008 and20062007 were classified as AFS. Securitiesavailable-for-saleAFS primarily consist of debt securities and mortgage-backed securities, and are carried at estimated fair value. Changes in estimated fair value ofavailable-for-saleAFS securities, net of applicable income taxes, are reported in accumulated other comprehensive income (loss) as a separate component of shareholders’ equity. The Bank does not have a securities trading portfolio or securities held to maturity.When a decline in the estimated fair value of a security is considered other-than-temporary, the cost basis of the individual security is written down to estimated fair value as the new cost basis and the loss is charged to net securities gains (losses) in the consolidated statements of income.
Premiums and discounts on securities are amortized and accreted over the term of the securities using the interest method. Gains and losses on the sale of securities are recognized at the trade date using the specific-identification method and are shown separately in the consolidated statements of income.
Other-Than-Temporary Impairments on Investment Securities: One of the significant estimates relating to securities is the evaluation of other-than-temporary impairments. If a decline in the fair value of a security is judged to be other-than-temporary, a charge is recorded in net securities gains (losses) equal to the difference between the fair value and cost or amortized cost basis of the security. In addition, for impaired available-for-sale securities expected to be sold, an other-than-temporary impairment charge is recognized if the Company does not expect the fair value of a security to recover to cost or amortized cost prior to the expected date of sale. The fair value of the other-than-temporarily impaired investment security becomes its new cost basis.
The evaluation of securities for impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses. The Company has a security monitoring process that identifies securities that, due to certain characteristics, as described below, are subjected to an enhanced analysis on a quarterly basis. Based on this evaluation, during the fourth quarter of 2008, the Company concluded that during the fourth quarter of 2008 unrealized losses on available-for-sale securities with an amortized cost of $4,255 had other-than-temporarily impairment of $1,435. The Company also concluded that as of December 31, 2008, the Company’s unrealized losses on available-for-sale securities with an amortized cost of $76,323 were temporarily impaired.
Securities not subject to EITF Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continued to Be Held by a Transferor in Securitized Financial Assets" ("non-EITF Issue No. 99-20 securities") that are in an unrealized loss position, are reviewed at least quarterly to determine if an other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. At December 31, 2008 all of the Company’s temporarily impaired securities were non-EITF Issue No. 99-20 securities. The primary factors considered in evaluating whether a decline in value for non-EITF Issue No. 99-20 securities is other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security (b) the financial condition, credit rating and future prospects of the issuer (c) whether the debtor is current on contractually obligated interest and principal payments (d) the volatility of the securities market price (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of the receipt of all principal and interest due.
For securitized financial assets with contractual cash flows, such as private-label mortgage-backed securities, the Company periodically updates its best estimate of cash flows over the life of the security. The Company’s best estimate of cash flows is based upon assumptions consistent with an economic recession, similar to those the Company believes market participants would use. If the fair value of a securitized financial asset is less than its cost or amortized cost and there has been an adverse change in timing or amount of anticipated future cash flows since the last revised estimate to the extent that the Company does not expect to receive 100% of future contractual principal and interest, an other-than-temporary impairment charge is recognized. The Company also considers its intent and ability to retain a temporarily depressed security until recovery or maturity. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third party sources along with certain assumptions and judgments regarding the future performance of the underlying collateral. In addition, projections of expected future cash flows may change based upon new information regarding the performance of the underlying collateral.
Each quarter, during this analysis, the Company asserts its intent and ability to retain until recovery, which may be to maturity, those securities judged to be temporarily impaired.
Federal Home Loan Bank Stock:
AsThe Bank is a member of the Federal Home Loan Bank ("FHLB") of Boston. The FHLB of Boston("FHLB"),is a cooperatively owned wholesale bank for housing and finance in the six New England States. As a requirement of membership in the FHLB of Boston, the Bankismust own a minimum requiredto holdamount of FHLB stock,incalculated periodically based primarily on its level of borrowings from the FHLB. The Bank uses the FHLB of Boston for most of its wholesale funding needs.FHLB stock is
carrieda non-marketable equity security and therefore is reported at cost,since there is no readily available marketwhich equals par value.The stock cannot be sold, but can be redeemed byShares held in excess of the minimum required amount are generally redeemable at par value; however, the FHLBat cost.recently announced a moratorium on such redemptions in order to preserve its capital in response to current market conditions. The minimum required shares are redeemable, subject to certain limitations, five years following termination of FHLB membership. The Bank has no intention of terminating its FHLB membership. The investment in FHLB of Boston stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB of Boston and its overall financial condition. No impairment losses have been recorded through December 31, 2008.Loans: Loans are carried at the principal amounts outstanding adjusted by partial charge-offs and net deferred loan origination costs or fees.
Interest on loans is accrued and credited to income based on the principal amount of loans outstanding. Residential real estate loans are generally placed on non-accrual status when reaching
12090 days past due, or in process of foreclosure, or sooner if judged appropriate by management. All consumer loans are generally placed on non-accrual when reaching 90 days or more past due, or sooner if judged appropriate by management, and any equity line in the process of foreclosure is generally placed on non-accrual status, or sooner if judged appropriate by management. Secured consumer loans are written down to realizable value and unsecured consumer loans are charged-off upon reaching 120 days past due. Commercial real estate loans and commercial business loans that are 90 days or more past due are generally placed on non-accrual status, unless secured by sufficient cash or other assets immediately convertible to cash, and the loan is in the process of collection. Commercial real estate and commercial business loans may be placed on non-accrual status prior to the 90 days delinquency date if considered appropriate by management. When a loan has been placed on non-accrual status, previously accrued and uncollected interest is reversed against interest on loans. A loan can be returned to accrual status when collectibility of principal is reasonably assured and the loan has performed for a period of time, generally six months.Commercial real estate and commercial business loans are considered impaired when it becomes probable the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status and collateral value.
Loan origination and commitment fees and direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loans’ yield, using the level yield method over the estimated lives of the related loans.
Allowance
Forfor Loan Losses: The allowance for loan losses (the "allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance is available to absorb losses on loans and is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the loan portfolio, given past and present conditions. The allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged off, and is decreased by loans charged off as uncollectible.Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated regularly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. The ongoing evaluation process includes a formal analysis, which considers among other factors: the character and size of the loan portfolio, business and economic conditions, real estate market conditions, collateral values, changes in product offerings or loan terms, changes in underwriting and/or collection policies, loan growth, previous charge-off experience, delinquency trends, nonperforming loan trends, the performance of individual loans in relation to contract terms, and estimated fair values of collateral.
The allowance for loan losses consists of allowances established for specific loans including impaired loans; allowances for pools of loans based on historical charge-offs by loan types; and supplemental allowances that adjust historical loss experience to reflect current economic conditions, industry specific risks, and other observable data.
While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.
Premises and Equipment: Premises and equipment and related improvements are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of related assets; generally 25 to 40 years for premises and 3 to 7 years for furniture and equipment.
Goodwill and Identifiable Intangible Assets: In connection with acquisitions, the Company generally records as assets on its consolidated financial statements both goodwill and identifiable intangible assets, such as core deposit intangibles.
The Company evaluates whether the carrying value of its goodwill has become impaired, in which case the value is reduced through a charge to its earnings. Goodwill is evaluated for impairment at least annually, or upon a triggering event as defined by SFAS No. 142, using certain fair value techniques. Goodwill impairment testing is performed at the segment (or "reporting unit") level. Goodwill is assigned to reporting units at the date the goodwill is initially recorded. Once goodwill has been assigned to the reporting units, it no longer retains its association with a particular acquisition, and all if the activities within a reporting unit, whether acquired or organically grown, are available to support the value of the goodwill.
The goodwill impairment analysis is a two-step test. The first steps used to identify potential impairment, involves comparing each unit’s fair value to its carrying value including goodwill. If the fair value of a reporting unit exceeds its carrying value, applicable goodwill is considered not to be impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is to measure the amount of impairment.
Identifiable intangible assets, included in other assets on the consolidated balance sheet, consist of core deposit intangibles amortized over their estimated useful lives on a straight-line method, which approximates the amount of economic benefits to Company. These assets are reviewed for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be
recoverable. Furthermore,recoverable in accordance with SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets," ("SFAS No. 144"), furthermore, the determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets.Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company’s consolidated results of operations.
Bank-Owned Life Insurance: Bank-owned life insurance ("BOLI") represents life insurance on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received in excess of the cash value, are recorded in other non-interest income, and are not subject to income taxes. The cash surrender value is included in other assets on the Company’s consolidated balance sheet. The Company reviews the financial strength of the insurance carrier prior to the purchase of BOLI and annually thereafter.
Mortgage Servicing Rights: Mortgage servicing rights are recognized as separate assets when purchased or when retained in a sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the carrying value of the rights.
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 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 market value below the carrying value are charged to other operating expenses.
Derivative Financial Instruments: The Company recognizes all derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Company designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items.
Changes in fair value of derivative instruments that are highly effective, and qualify as a cash flow hedge, are recorded in other comprehensive income or loss. Any ineffective portion is recorded in earnings. For fair value hedges that are highly effective, the gain or loss on the derivative and the loss or gain on the hedged item attributable to the hedged risk are both recognized in earnings, with the differences (if any) representing hedge ineffectiveness. The Company discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk on the hedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.
Off-Balance Sheet Financial Instruments: In the ordinary course of business the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
Stock Based Compensation: The Company has a stock option plan, which is described more fully in Note 13. In
December 2004, the Financial Accounting Standards Board ("FASB") issued a revision ofaccordance with Statement of Financial Accounting Standards ("SFAS") No.123. SFAS No.123(R), "Share-Based Payment,"makes significant changes to accounting for "payments" involving employee compensation and "shares" or securities in the form of stock options, restricted stock or other arrangements settled in the reporting entity’s securities. Most significant in the standard is the requirement that all stock options be measured at estimated fair value at the grant date and recorded as compensation expense over the requisite service period associated with the option, usually the vesting period. The revised standard was effective on January 1, 2006 for calendar-year public companies and could be applied prospectively to stock options granted after the effective date and any unvested stock options at that date. The primary effect of the revised standard’s implementation onthe Companyis recognition of compensation expense associated with stock options.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R), using the modified-prospective-transition method. Under that transition method, compensation expense that the Company recognizes beginning in 2006 includes: (a) the compensation expense for all stock-based payments granted prior to, but not yet vested as of, January 1, 2006, based onexpenses the grant date fairvalue; and (b)value of options granted. The expense is recognized over thecompensation expense for all share-based payments granted on or after January 1, 2006, based on the grant date fair value. Because the Company elected to use the modified-prospective-transition method, results for priorvesting periodshave not been restated. Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value recognition and measurement principles of APB Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations ("intrinsic value method"). Under the provisionsof theCompany’s ISOP, the exercise price per share of each option granted cannot be less than the fair market value of the underlying common shares on the date of the grant. Accordingly, the Company did not recognize stock-based employee compensation expense in net income with respect to stock options prior to January 1, 2006.grants.Accounting for Defined Benefit Pension and 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 supplemental executive retirement agreements with certain current executive officers. These agreements provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or in the event that the participating executive leaves the Company following a change of control event. The Company recognizes the net present value of payments associated with these agreements over the service periods of the participating executive officers. Upon retirement, interest costs will continue to be recognized on the benefit obligation.
Prior to the first quarter of 2007, the Company sponsored a limited postretirement benefit program, which funded medical coverage and life insurance benefits to a closed group of active and retired employees who met minimum age and service requirements. It was the Company’s policy to record the cost of postretirement health care and life insurance plans based on actuarial estimates, which were dependent on claims and premiums paid. The cost of providing these benefits was accrued during the active service period of the employee.
In the first quarter of 2007, the Company settled its limited
post-retirementpostretirement benefit program. The Company voluntarily paid out $699 to plan participants, representing 64% of the accrued post retirement benefit obligation. This payment fully settled all Company obligations related to this program. In connection with the settlement of the postretirement program, the Company recorded a reduction in non-interest expense of $832, representing the elimination of the $390 remaining accrued benefit obligation included in other liabilities on the consolidated balance sheet, and the $442 actuarial gain ($291, net of tax) related to the program. The actuarial gain was previously included in accumulated other comprehensive income, net of tax effect of $151.Statement of Financial Accounting Standards ("SFAS") No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)" requires employers to recognize the over-funded or under-funded status of defined benefit pension and other postretirement benefit plans as an asset or liability on the balance sheet and to recognize changes in that funded status through other comprehensive income. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts that have not yet been recognized through net periodic benefit costs are recognized in accumulated other comprehensive income (loss), net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, which is the date at which the benefit obligation and plan assets are measured, is required to be the company's fiscal year end. SFAS 158 was effective for publicly held companies for fiscal years ending after December 15, 2006 (December 31, 2006 for the Company). The adoption of SFAS 158 did not have a significant impact on the
Company'sCompany’s financial condition or results of operations.Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information indicates that it is more likely than not that deferred tax assets will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
In June 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109" ("FIN 48"). This interpretation clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a
company'scompany’s financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, and disclosure and transition.On January 1, 2007 the Company adopted the provisions of FIN 48 and there was no impact on the consolidated financial statements. The Company performed an analysis of its tax positions and did not identify any uncertain tax positions for which tax benefits should not be recognized under FIN 48 upon either adoption or as of December 31, 2007. The Company’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense in the Consolidated Statements of Income.
The Company’s income tax returns are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2005 through
2007.2008.Earnings Per Share: Earnings per share have been computed in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share exclude dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company, such as the Company’s dilutive stock options.
Segment Reporting: An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and evaluate performance. The Company has determined that its operations are solely in the community banking industry and include traditional community banking services, including lending activities, acceptance of demand, savings and time deposits, business services, investment management, trust and third-party brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities. Accordingly, disaggregated segment information is not presented in the Notes to the Consolidated Financial Statements.
Prior Year Financial Statement Misstatements: In September 2006, the staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements". SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. There are two widely recognized methods for quantifying the effects of financial statement misstatements: the "roll-over" and "iron curtain" methods. The roll-over method, the method the Company historically used, focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements. Because the focus is on the income statement, the roll-over method can lead to the accumulation of misstatements in the balance sheet that may become material to the balance sheet. The iron curtain method focuses primarily on the effect of correcting the accumulated misstatement as of the balance sheet date, with less emphasis on the reversing effects of prior year errors on the income statements. In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements under both the roll-over and iron curtain methods. This framework is referred to as the "dual approach." SAB 108 permits companies to initially apply its provisions either by restating prior financial statements as if the dual approach had always been used or recording the cumulative effect of initially applying the dual approach as an adjustment to retained earnings as of January 1, 2006.
The Company completed an analysis under the "dual approach" and adopted SAB 108 effective as of January 1, 2006. The Company applied the SAB 108 provisions using the cumulative effect transition method. Upon adoption of SAB 108, the Company reversed $331 of income taxes payable resulting from cumulative over-accruals of income tax expense. These misstatements primarily resulted from the incorrect determination of depreciation and deferred loan origination costs for tax purposes and principally occurred prior to 2004, with certain amounts dating back to the 1990s. After considering all of the quantitative and qualitative factors, the Company determined these misstatements had not previously been material to any of those prior periods when measured using the roll-over method. Given that the effect of correcting these misstatements during 2006 would be material to the Company’s 2006 financial statements, the Company concluded that the cumulative effect adjustment method of initially applying the guidance in SAB 108 was appropriate. In accordance with the transition provisions of SAB 108, the Company recorded this cumulative effect adjustment, resulting in a $331 increase in other assets and a $331 increase in retained earnings as of January 1, 2006.
Note 2: Recently Issued Accounting
PronouncementsPronouncementThe following information addresses recently issued accounting pronouncements that could have an impact on the Company’s financial condition or results of operations.
Business Combinations: In December 2007, the FASB issued revised Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," or SFAS No. 141(R). SFAS No. 141(R) retains the fundamental requirements of SFAS No. 141 that the acquisition method of accounting (formally the purchase method) be used for all business combinations; that an acquirer be identified for each business combination; and that intangible assets be identified and recognized separately from goodwill. SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the assets acquired, the liabilities assumed and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. Additionally, SFAS No. 141(R) changes the requirements for recognizing assets acquired and liabilities assumed arising from contingencies and recognizing and measuring contingent consideration. SFAS No. 141(R) also enhances the disclosure requirements for business combinations. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 (January 1, 2009 for the Company) and may not be applied before that date.
Non-controlling interests in Consolidated Financial Statements: In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin ("ARB") No. 51", "Consolidated Financial Statements". SFAS No. 160 amends ARB No. 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Among other things, SFAS No. 160 clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. SFAS No. 160 also amends SFAS No. 128, "Earnings per Share," so that earnings per share calculations in consolidated financial statements will continue to be based on amounts attributable to the parent. SFAS No. 160 is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2008 (January 1, 2009 for the Company) and is applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements which are to be applied retrospectively for all periods presented. SFAS No. 160
isdid notexpected tohave an impact on the Company’s financial condition or results of operations.Written Loan Commitments Recorded at Fair Value Through Earnings: In November 2007, the SEC staff issued Staff Accounting Bulletin ("SAB"), No. 109, "Written Loan Commitments Recorded at Fair Value Through Earnings." SAB No. 109 provides views on the accounting for written loan commitments recorded at fair value under GAAP. SAB No. 109 supersedes SAB No. 105, "Application of Accounting Principles to Loan Commitments." Specifically, SAB No. 109 states that the expected net future cash flows related to the associated servicing of a loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The provisions of SAB No. 109 are applicable on a prospective basis to written loan commitments recorded at fair value under GAAP that are issued or modified in fiscal quarters beginning after December 15, 2007 (January 1, 2008 for the Company). SAB No. 109
isdid notexpected tohave a material impact on the Company’s financial condition or results of operations.Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards: In June 2007, the FASB ratified a consensus reached by the Emerging Issues Task Force ("EITF") on Issue No. 06-11, "Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards," which clarifies the accounting for income tax benefits related to the payment of dividends on equity-classified employee share-based payment awards that are charged to retained earnings under SFAS No. 123(R). The EITF concluded that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified non-vested equity shares, non-vested equity share units and outstanding equity share options should be recognized as an increase to additional paid-in capital. EITF Issue No. 06-11 should be applied prospectively to the income tax benefits that result from dividends on equity-classified employee share-based payment awards that are declared in fiscal years beginning after payment awards that are declared in fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. Retrospective application to previously issued financial statements is prohibited. EITF Issue No. 06-11
isdid notexpected tohave an impact on the Company’s financial condition or results of operations.Fair Value Measurements for Financial Assets and Liabilities: Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157, "Fair Value Measurements," for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board Staff Position (FSP) No. 157-2, "Effective Date of FASB Statement No. 157," the Company has delayed application of SFAS No. 157 for non-financial assets and non-financial liabilities, until January 1, 2009. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.
SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
SFAS No. 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS No. 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets (Level 1 measurements) for identical assets or liabilities and the lowest priority to unobservable inputs (Level 3 measurements). The fair value hierarchy is as follows:
- Level 1 – Valuation is based on unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
- Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and model-based techniques for which all significant assumptions are observable in the market.
- Level 3 – Valuation is principally generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates that market participants would use in pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques.
SFAS 157 indicates that the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
The most significant instruments that the Company values are securities, all of which fall into Level 2 in the fair value hierarchy. The securities in the available for sale portfolio are priced by independent providers. In obtaining such valuation information from third parties, the Company has evaluated their valuation methodologies used to develop the fair values in order to determine whether valuations are appropriately placed within the fair value hierarchy and whether the valuations are representative of an exit price in the Company’s principal markets. The Company’s principal markets for its securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in those markets. Additionally, the Company periodically tests the reasonableness of the prices provided by these third parties by obtaining desk bids from a variety of institutional brokers.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value effective January 1, 2008.
- Securities Available for Sale: Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from independent pricing providers. The fair value measurements used by the pricing providers consider observable data that may include dealer quotes, market maker quotes and live trading systems. If quoted prices are not readily available, fair values are determined using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as market pricing spreads, credit information, callable features, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, default rates, loss severity ratios, credit enhancements, and the securities’ terms and conditions, among other things.
- Derivative Instruments: Derivative instruments are reported at fair value utilizing Level 2 inputs. The Company obtains independent dealer market price estimates to value its Prime interest rate swaps and floors. Derivative instruments are priced by independent providers using observable market data and assumptions with adjustments based on widely accepted valuation techniques. A discounted cash flow analysis on the expected cash flows of each derivative reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, implied volatilities, transaction size, custom tailored features, counterparty credit quality, and the estimated current replacement cost of the derivative instrument.
The foregoing valuation methodologies may produce fair value calculations that may not be fully indicative of net realizable value or reflective of future fair values. While Company management believes these valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Level 1
InputsLevel 2
InputsLevel 3
InputsTotal Fair Value
Securities available for sale
$ ---
$290,502
$ ---
$290,502
Derivative assets
$ ---
$ 1,252
$ ---
$ 1,252
SFAS No. 157 also requires disclosure of assets and liabilities measured and recorded at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
The following table summarizes financial assets and financial liabilities measured at fair value on a non-recurring basis as of December 31, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.
Principal Balance as of
12/31/08Level 1
InputsLevel 2 Inputs
Level 3
InputsFair Value
as of
12/31/08Collateral dependent impaired loans
$846
$ ---
$---
$846
$846
Specific allowances for impaired loans are determined in accordance with SFAS No. 114 "Accounting by Creditors For Impairment of a Loan," as amended by SFAS 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." For the year ended December 31, 2008, specific loan loss allowance totaling $380 were established for two collateral dependent impaired commercial loans with principal balances totaling $2,019. This specific loan loss allowances were included in the provision for loan losses during the period in which the allowances were established. During 2008, one of these impaired loans was subsequently charged down to $200, requiring a $564 adjustment to the corresponding loan loss allowance. Company management determined the impairment charges based on the fair values of collateral. These impaired loans were classified as Level 3 for valuation purposes.
The Fair Value Option for Financial Assets and Financial Liabilities: In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115," which permits entities to choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. At the effective date, an entity may elect the fair value option for eligible items that exist at that date and report the effect of the first re-measurement to fair value a cumulative-effect adjustment to the opening balance of retained earnings.
Subsequent to the effective date, unrealized gainsThe Company adopted SFAS 159 andlosses on items for which the fair value option has been elected are to be reported in earnings. If the fair value option is elected for any available-for-sale or held-to-maturity securities at the effective date, cumulative unrealized gains and losses at that date are included in the cumulative-effect adjustment and those securities are to be reported as trading securities under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," but the accounting for a transfer to the trading category under SFAS No. 115 doesdid notapply. Electingelect the fair value option foran existing held-to-maturity security will not call into question the intent of an entity to hold other debt securities to maturity in the future.
The objective of SFAS 159 is to reduce both complexity in accounting forany financialinstrumentsinstrument andthe volatility in earnings caused by measuring related assets and liabilities using different measurement attributes. SFAS 159 establishes presentation and disclosure requirements including a requirement to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. SFAS 159 does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, "Fair Value Measurements," and SFAS No. 107, "Disclosures about Fair Value of Financial Instruments."SFAS 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 (January 1, 2008 for the Company). Early adoption was permitted as of the beginning of the previous fiscal year provided that the entity made that choice in the first 120 days of that fiscal year and also adopts the provisions of SFAS 157 at the same time. The Company did not adopt SFAS 159 early and does not anticipate thataccordingly the adoption of this standardwill have a materialhad no impact onitsthe Company’s consolidated financialcondition or results of operations. The fair value option was not elected for any financial instrument as of January 1, 2008.statements.
Fair Value Measurements:Disclosures About Derivative Instruments and Hedging Activities: InSeptember 2006,March 2008, the FASB issued SFAS No.157, "Fair Value Measurements.161, "Disclosures About Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133."This statement establishes a single authoritative definitionSFAS No. 161 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," to amend and expand the disclosure requirements offair value, sets out a frameworkSFAS No. 133 to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted formeasuring fair value,under SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity's financial position, results of operations and cash flows. To meet those objectives, SFAS No. 161 requiresadditionalqualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair valuemeasurements. The expandedamounts of gains and losses on derivative instruments and disclosuresinclude a requirement to disclose fair value measurements according to a hierarchy, segregating measurements using: (1) quoted pricesabout credit-risk related features inactive markets for identical assets and liabilities, (2) significant other observable inputs and (3) significant unobservable inputs.derivative agreements. SFAS No.157 applies only to fair value measurements already required or permitted by other standards161 must be applied prospectively for interim periods anddoes not impose requirements for additional fair value measures. SFAS No. 157 was issued to increase consistency and comparability in reporting fair values. SFAS No. 157 is effective for financial statements issued forfiscal years beginning after November 15,2007, and interim periods within that fiscal year2008 (January 1,20082009 for the Company).The provisions are to be applied prospectively asSFAS No.161 did not have a significant impact on the Company's consolidated results of operation or financial condition.Determining the Useful Life of Intangible Assets: In April 2008, the FASB issued FASB Staff Position ("FSP") FSP FAS 142-3, "Determination of the
beginningUseful Life of Intangible Assets" ("FSP FAS 142-3"). FSP FAS 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). The intent of FSP FAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of thefiscal year in which the Statement is applied, with certain exceptions. A transition adjustment, measured as the difference between the carrying amounts and the fair values of certain specific financial instruments at the dateasset under SFAS No.157141(R). FSP FAS 142-3 isinitially applied, iseffective for the Company on January 1, 2009, and applies prospectively tobe recognized asintangible assets that are acquired individually or with acumulative-effect adjustment to the opening balancegroup ofretained earnings. While SFAS No. 157 will affect certainother assets in business combinations and asset acquisitions. The adoption ofthe Company’s fair value disclosures, itFSP FAS 142-3 is not expected to have a material impact on the Company’s consolidated financialcondition orstatements.The Hierarchy of Generally Accepted Accounting Principles: In May 2008, the FASB issued SFAS No. 162, "TheHierarchy of Generally Accepted Accounting Principles". SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the "GAAP hierarchy"). SFAS No. 162 will become effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles." SFAS No.162 is not expected to have a significant impact on the Company's consolidated results of
operations.operation or financial condition.Impairment Guidance: In January 2009, the FASB issued FSP EITF 99-20-01, "Amendments to the Impairment Guidance of EITF Issue No. 99-20," ("FSP EITF 99-20-01"). The objective of FSP EITF 99-20-01 is to achieve more consistency in the determination of whether an other-than-temporary impairment has occurred. FSP EITF 99-20-01 also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and other related guidance. The adoption of FSP EITF 99-20-01, which was effective for the Company on December 31, 2008, was not material to the Company’s consolidated financial statements.
Note 3: Securities Available For Sale
A summary of the amortized cost and market values of securities available for sale follows:
December 31, 2007
Amortized
CostGross
Unrealized
GainsGross
Unrealized
LossesEstimated
Fair
ValueAvailable for Sale:
Obligations of U.S. Government-sponsored enterprises
$ 17,250
$ 99
$ ---
$ 17,349
Mortgage-backed securities:
U.S. Government-sponsored enterprises
161,057
1,781
120
162,718
U.S. Government agencies
10,848
57
�� 36
10,869
Other mortgage-backed securities
34,879
105
281
34,703
Obligations of State and Political Subdivisions thereof
38,771
493
286
38,978
TOTAL
$262,805
$2,535
$723
$264,617
December 31, 2008
Available for Sale:
Amortized Cost*
Gross Unrealized Gains
Gross Unrealized Losses
Estimated Fair Value
Obligations of US Government-sponsored enterprises
$ 700
$ 1
$ ---
$ 701
Mortgage-backed securities:
US Government-sponsored enterprises
172,661
4,874
10
177,525
US Government agency
32,750
961
26
33,685
Private-label
43,579
172
4,193
39,558
Obligations of states and political subdivisions thereof
42,534
166
3,667
39,033
Total
$292,224
$6,174
$7,896
$290,502
*Includes the writedown of securities considered to be other than temporarily impaired at December 31, 2008, with impairment writedowns totaling $1,435.
December 31, 2006
Amortized
CostGross
Unrealized
GainsGross
Unrealized
LossesEstimated
Fair
ValueAvailable for Sale:
Obligations of U.S. Government-sponsored enterprises
$ 27,844
$ 8
$ 229
$ 27,623
Mortgage-backed securities:
U.S. Government-sponsored enterprises
116,666
182
1,827
115,021
U.S. Government agencies
9,830
31
56
9,805
Other mortgage-backed securities
29,543
5
507
29,041
Obligations of State and Political Subdivisions thereof
30,400
1,378
16
31,762
TOTAL
$214,283
$1,604
$2,635
$213,252
December 31, 2007
Amortized
CostGross
Unrealized
GainsGross
Unrealized
LossesEstimated
Fair ValueAvailable for Sale:
Obligations of US Government-sponsored enterprises
$ 17,250
$ 99
$ ---
$ 17,349
Mortgage-backed securities:
US Government-sponsored enterprises
161,057
1,781
120
162,718
US Government agency
10,848
57
36
10,869
Private-label
34,879
105
281
34,703
Obligations of states and political subdivisions thereof
38,771
493
286
38,978
Total
$262,805
$2,535
$723
$264,617
Securities Impairment: As a part of the Company’s ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired.
Based on the Company’s evaluation of other than temporary impairment considerations, during the fourth quarter of 2008, the Company concluded that unrealized losses on certain available-for-sale, private-label mortgage-backed securities with an amortized cost of $4,255 were other-than-temporarily impaired, because the Company could no longer conclude that it is probable that it will recover all of its principal and interest. Accordingly, in the fourth quarter, the Company recorded an other-than-temporary impairment charge of $1,435. This charge was recorded as securities losses in the Company’s consolidated statement of income.
The Company also concluded that as of December 31, 2008, the unrealized losses of $7,896 on available-for-sale securities with an amortized cost of $76,323 and a fair value of $68,427, as identified in the table below, were temporarily impaired. This conclusion was based on the issuers’ continued satisfaction of the securities obligations in accordance with their contractual terms and the expectation that they will continue to do so, through the maturity of the security, management’s intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value which may be at maturity, the expectation that the Company will receive 100% of future contractual cash flows, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence.
The following tables summarize the fair value of securities with continuous unrealized losses for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer as of December 31,
20072008 and2006.2007. All securities referenced are debt securities. At December 31,20072008 and2006,2007, the Company did not hold any common stock or other equity securities in its securities portfolio.
Less Than 12 Months
12 Months or Longer
Total
Description of Securities:
Fair Value
Number of Investments
Unrealized Losses
Fair Value
Number of Investments
Unrealized
LossesFair
ValueNumber of Investments
Unrealized Losses
Obligations of U.S. Government
–sponsored enterprises$ ---
--- $ ---
$ ---
--- $ ---
$ ---
--- $ ---
Mortgage-backed securities:
U.S. Government-sponsored
enterprises7,948
9
19
13,321
41
101
21,269
50
120
U.S. Government agencies
3,474
12
22
1,109
10
14
4,583
22
36
Other mortgage-backed securities
13,841
15
118
9,297
27
163
23,138
42
281
Obligations of states of the U.S.
and political subdivisions thereof12,796
46
216
760
4
70
13,556
50
286
Total temporarily impaired securities
$38,059
82
$375
$24,487
82
$348
$62,546
164
$723
2008
Less than 12 months
12 months or longer
Total
Description of Securities:
Estimated
Fair
ValueNumber of
InvestmentsUnrealized
LossesEstimated
Fair
ValueNumber of
InvestmentsUnrealized
LossesEstimated
Fair
ValueNumber of
InvestmentsUnrealized
LossesMortgage-backed securities:
US Government-sponsored
Enterprises$ 2,423
3
$ 7
$ 451
3
$ 3
$ 2,874
6
$ 10
US Government agency
1,660
16
19
230
7
7
1,890
23
26
Private-label
27,140
37
3,560
6,620
23
633
33,760
60
4,193
Obligations of states of the U. S.
and political subdivisions thereof25,975
79
2,330
3,928
18
1,337
29,903
97
3,667
Total
$57,198
135
$5,916
$11,229
51
$1,980
$68,427
186
$7,896
2006
Less Than 12 Months
12 Months or Longer
Total
Description of Securities:
Fair
ValueNumber of
InvestmentsUnrealized
LossesFair
ValueNumber of
InvestmentsUnrealized
LossesFair
ValueNumber of
InvestmentsUnrealized
LossesObligations of U.S. Government
-sponsored enterprises$ 9,825
18
$ 34
$14,324
26
$ 195
$ 24,149
44
$ 229
Mortgage-backed securities:
U.S. Government-sponsored
enterprises23,297
33
111
64,308
157
1,716
87,605
190
1,827
U.S. Government agencies
3,348
4
15
1,954
11
41
5,302
15
56
Other mortgage-backed securities
7,908
10
52
17,419
40
455
25,327
50
507
Obligations of states of the U.S.
and political subdivisions thereof359
2
5
810
3
11
1,169
5
16
Total temporarily impaired securities
$44,737
67
$217
$98,815
237
$2,418
$143,552
304
$2,635
2007
Less than 12 months
12 months or longer
Total
Description of Securities:
Estimated
Fair
ValueNumber of
InvestmentsUnrealized
LossesEstimated
Fair
ValueNumber of
InvestmentsUnrealized
LossesEstimated
Fair
ValueNumber of
InvestmentsUnrealized
LossesMortgage-backed securities:
US Government-sponsored
enterprises$ 7,948
9
$ 19
$13,321
41
$101
$21,269
50
$120
US Government agency
3,474
12
22
1,109
10
14
4,583
22
36
Private-label
13,841
15
118
9,297
27
163
23,138
42
281
Obligations of states of the U. S.
and political subdivisions thereof12,796
46
216
760
4
70
13,556
50
286
Total
$38,059
82
$375
$24,487
82
$348
$62,546
164
$723
In evaluating whether impairments are other-than-temporary, the Company considers a variety of factors including the nature of the investment security, the cause of the impairment, and the severity and duration of the impairment. Other data considered by management includes, for example, sector credit ratings, volatility of the security’s market price, and any other information considered relevant.For securities with unrealized losses, the following information was considered in determining that the impairments were not
other-than-temporary.other-than-temporary:
Securities backedMortgage-backed securities issued by U.S. Government-sponsoredenterprises, allenterprises: All ofwhichthese securities were credit rated "AAA",by the major credit rating agencies. The Company believes these securities have minimal credit risk, as these enterprises play a vital role in the nation’s financial markets.Mortgage-backed securities issued by U.S. Government agencies all of which were credit rated "AAA", are backed byThe Company attributes thefull faith and credit of the United States and therefore bear no credit risk.Other mortgage-backed securities, all of which were corporate mortgage-backed securities, were all credit rated "AAA". These securities were additionally evaluated for credit risk based on the strength and performance of the underlying borrowers and collateral, and the extent of the current underlying credit support within the structure of each security.Obligations of states of the U.S. and political subdivisions thereof, none of which were credit rated below "A", were additionally evaluated for credit risk based on the underlying credit ratings and strength of the issuers and bond insurers, as well as the defined sources of repayment (e.g. local property taxes, tax revenue, etc).
Theunrealized lossesin the securities portfolioat December 31,20072008 to changes in current market yields and2006 were attributed to market interest rate increases, reflectingspreads since thevolatile movements indate theU.S. Treasury yield curve over the past several years. Specifically, certain debtunderlying securities were purchased,when market interest rates were lower than the rates prevailingand does not consider these securities to be other-than-temporarily impaired at December 31,2007 and 2006. Because the decline in market value was attributable to changes in interest rates and not credit quality2008, orother factors, and because the Bank2007. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be atmaturity,maturity.
- Mortgage-backed securities issued by U.S. Government agencies: All of these securities were credit rated "AAA" by the major credit rating agencies. The Company believes these securities bear no credit risk because they are backed by the full faith and credit of the United States. The Company attributes the unrealized losses at December 31, 2008 to changes in current market yields and spreads for similar securities since the date the underlying securities were purchased, and does not consider these securities to be other-than-temporarily impaired at December 31, 2008, or 2007. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity.
- Private-label mortgage-backed securities: The Company attributes the unrealized losses at December 31, 2008 to current market liquidity conditions, massive de-leveraging, risk related market pricing discounts for non-agency mortgage-backed securities, and the historical disruption in the financial markets in general. Based upon the foregoing considerations and the expectation that the Company will receive all of the future contractual cash flows on these securities, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2008, or 2007. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity.
- Obligations of states of the U.S. and political subdivisions thereof: The Company’s municipal securities are largely insured and are generally supported by the general taxing authority of the municipality and in the cases of school districts, are supported by state aid. At December 31, 2008, and 2007, all municipal bond issuers were current on contractually obligated interest and
2006.principal payments. The Company attributes the unrealized losses at December 31, 2008 to changes in prevailing market yields and pricing spreads since the date underlying securities were purchased, combined with current market liquidity conditions and the disruption in the financial markets in general. Accordingly, the Company does not consider the Bank’s municipal securities to be other-than-temporarily impaired at December 31, 2008 or 2007. The Company also has the ability and intent to hold these securities until a recovery of their amortized cost, which may be at maturity.Maturity Distribution: The following table summarizes the maturity distribution of the amortized cost and estimated fair value of securities available for sale as of December 31,
2007.2008. Actual maturities may differ from the final contractual maturities noted below because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities are allocated among the maturity groupings based on their final maturity dates.
December 31, 2007
December 31, 2008
Securities Available for Sale
Amortized
CostEstimated
Fair ValueAmortized
Cost*Estimated
Fair ValueDue in one year or less
$ 35
$ 35
$ 56
$ 56
Due after one year through five years
6,470
6,492
844
832
Due after five years through ten years
19,311
19,362
13,164
13,238
Due after ten years
236,989
238,728
278,160
276,376
Totals
$262,805
$264,617
$292,224
$290,502
*includes the writedown of securities considered to be other than temporarily impaired at December 31, 2008 with impairment writedowns totaling $1,435.
Realized Gains and Losses:
The following table summarizes realized gains and losses and other than temporary impairment losses on securities available for sale for the years ended December 31, 2008, 2007
2006and2005.2006.
Realized Realized Realized
Gains
Losses
Net
Gains
Losses
Other
Than Temporary
Impairment LossesNet
2008
$604
$ ---
$1,435
$(831)
2007
$641
$1,312
$(671)
$641
$ 150
$1,162
$(671)
2006
$755
$ ---
$ 755
$755
$ ---
$ ---
$ 755
2005
$590
$ 10
$ 580
Pledged Securities:
At December 31,
20072008 and2006,2007, securities available for sale, at fair value, totaling$49,321$59,678 and$29,044,$49,321, respectively, were pledged as collateral for securities sold under repurchase agreements and for other purposes required by law.Note 4: Loans
The Company’s lending activities are principally conducted in downeast and midcoast Maine. The following table summarizes the composition of the loan portfolio as of December 31,
20072008 and2006:2007:
2007
2006
2008
2007
Commercial real estate mortgages
$183,663
$159,330
$236,674
$183,663
Commercial and industrial loans
65,238
61,634
65,717
65,238
Agricultural and other loans to farmers
15,989
17,706
19,390
15,989
Total commercial loans
264,890
238,670
321,781
264,890
Residential real estate mortgages
251,625
253,114
249,543
251,625
Consumer loans
10,267
10,889
4,773
10,267
Home equity loans
45,783
45,062
51,095
45,783
Total consumer loans
307,675
309,065
305,411
307,675
Tax exempt loans
6,001
6,213
5,358
6,001
Deferred origination costs, net
1,145
1,151
1,053
1,145
Total loans
579,711
555,099
633,603
579,711
Allowance for loan losses
(4,743)
(4,525)
(5,446)
(4,743)
Total loans net of allowance for loan losses
$574,968
$550,574
$628,157
$574,968
Non-performing Loans: The following table sets forth information regarding non-accruing loans and accruing loans 90 days or more overdue at December 31, 2008, 2007
2006and2005.2006.
2007
2006
2005
2008
2007
2006
Loans accounted for on a non-accrual basis:
Real Estate:
Construction and development
$ 25
$ ---
$---
Residential mortgage
$ 450
$111
$267
1,722
450
111
Commercial, industrial and agricultural
1,598
456
593
Commercial and industrial, and agricultural
2,138
1,598
456
Consumer
5
3
5
16
5
3
Total non-accrual loans
2,053
570
865
3,901
2,053
570
Accruing loans contractually past due 90 days or more
9
58
3
503
9
58
Total non-performing loans
$2,062
$628
$868
$4,404
$2,062
$628
During the years ended December 31, 2008, 2007 and 2006,
and 2005,thetotalforegone interestnot recordedon non-accrual loans amounted to$86, $172,$268, $99, and$50,$49, respectively.At December 31,
2007,2008, the Bank had$340$83 of other real estate owned, compared with$0$340 at December 31,2006.2007.Loan Concentrations: Because of the Company’s proximity to Acadia National Park, a large part of the economic activity in the area is generated from the hospitality business associated with tourism. At December 31,
20072008 and2006,2007, loans to the lodging industry amounted to approximately $54,855 and $50,282,and $30,210,respectively.Loans to Related Parties: In the ordinary course of business, the
CompanyBank has made loans at prevailing rates and terms to directors, officers and other related parties. In management’s opinion, such loans do not present more than the normal risk of collectibility or incorporate other unfavorable features, and were made under terms that are consistent with the Company’s lending policies.Loans to related parties at December 31 are summarized below. Balances have been adjusted to reflect changes in status of directors and officers for each year presented.
2007
2006
2008
2007
Beginning balance
$ 9,050
$9,174
$8,057
$9,050
Changes in composition
---
5
New loans
505
856
---
505
Less: repayments
(1,498)
(985)
(497)
(1,498)
Ending balance
$ 8,057
$9,050
$7,560
$8,057
As of December 31,
2007,2008, and2006,2007, there were no non-performing loans to related parties.Mortgage Loan Servicing: The Bank, from time to time, will sell mortgage loans to
other institutions, and investors.government-sponsored enterprises. The sale of loans allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31,2007,2008, the unpaid balance of mortgage loans serviced for others totaled$5,609$4,575 compared with$6,566$5,609 at December 31,2006.2007. The capitalized mortgage servicing rights related to loans serviced for others is included in other assets on the consolidated balance sheets and is not significant.Note 5: Allowance For Loan Losses
A summary of changes in the allowance for loan losses for each of the three years ended December 31 follows:
2007
2006
2005
2008
2007
2006
Balance, beginning of year
$4,525
$4,647
$4,829
$ 4,743
$4,525
$4,647
Provision for loan losses
456
131
---
1,995
456
131
Less: loans charged off
(303)
(349)
(238)
Less: Loans charged off
(1,336)
(303)
(349)
Recoveries on loans previously charged off
65
96
56
44
65
96
Net loans charged off
(238)
(253)
(182)
(1,292)
(238)
(253)
Balance, end of year
$4,743
$4,525
$4,647
$ 5,446
$4,743
$4,525
Impaired Loans: Impaired loans are commercial and commercial real estate loans for which the Company believes it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan
agreement.agreement, as well as all loans restructured in a troubled debt restructuring, if any. Allowances for losses on impaired loans are determined by thedifference betweenlower of the present value of the expected cash flows related to the loan, using the original contractual interest rate, and its recorded value, or in the case of collateral dependant loans, thedifference betweenlower of the fair value of the collateral, less costs to dispose, and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral less cost to sell.
The majority of the Company’s impaired loans are collateral dependent.Information pertaining to impaired loans at December 31, 2008, 2007
2006and20052006 follows:
2007
2006
2005
Investment in impaired loans
$1,598
$456
$593
Portion of impaired loan balance for which
an allowance for loan losses is allocated$1,598
$456
$593
Portion of allowance for loan losses allocated
to the impaired loan balance$ 280
$130
$238
Interest income on impaired loans recognized on a cash basis
$ 32
$ 23
$ 1
2008
2007
2006
Investment in impaired loans
$2,138
$1,598
$456
Portion of impaired loan balance for which
an allowance for loan losses is allocated
$2,138
$1,598
$456
Portion of allowance for loan losses allocated
to the impaired loan balance
$ 176
$ 280
$130
Interest not recorded on impaired loans at year end
$ 263
$ 111
�� $ 41
During the years ended December 31, 2008, 2007
2006and2005,2006, the total average balance of impaired loans amounted to approximately $1,956, $830, and $482, respectively.There was significant disruption and
$385, respectively.volatility in the financial and capital markets during the second half of 2008. Turmoil in the mortgage market adversely impacted both domestic and global markets, and led to a significant credit and liquidity crisis in many domestic markets. These market conditions were attributable to a variety of factors, in particular the fallout associated with the subprime mortgage loans (a type of lending the Company has never actively pursued). This disruption has been exacerbated by the continued decline of the real estate housing market. While the Bank continues to adhere to prudent underwriting standards, as a lender, it may be adversely impacted by general economic weaknesses and, in particular, a sharp downturn in the housing market nationally. Decreases in real estate values could adversely affect the value of property used as collateral for the Bank’s loans. Adverse changes in the economy may have a negative effect on the ability of the Bank’s borrowers to make timely loan payments, which would have an adverse impact on the Company’s earnings. A further increase in loan delinquencies would decrease the Company’s net interest income and adversely impact the Company’s loan loss experience, causing increases in the Bank’s provision for loan losses.Note 6: Premises and Equipment
The detail of premises and equipment as of December 31 follows:
2007
2006
2008
2007
Land
$ 2,056
$ 2,052
$ 2,056
$ 2,056
Buildings and improvements
13,263
13,016
13,844
13,263
Furniture and equipment
9,393
9,163
9,649
9,393
Less: accumulated depreciation
(13,917)
(12,863)
(14,695)
(13,917)
Total
$ 10,795
$ 11,368
$ 10,854
$ 10,795
Depreciation expense amounted to $1,004, $1,211 and $1,280 in 2008, 2007 and
$1,394 in 2007,2006,and 2005,respectively.Note 7: Goodwill and Other Intangible Assets
Goodwill totaled $3,158 at December 31,
20072008 and2006,2007, and there were no additions or impairments recorded during the yearsthen ended.ended December 31, 2008, 2007 or 2006 As a result of recent stock market volatility, especially in the financial services sector, community banking companies have experienced declines in stock market prices. If these declines continue or worsen in 2009, impairment of the Company’s goodwill may occur.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 Bank’s acquisition of a branch office in Rockland, Maine. The core deposit intangible asset is being amortized over an estimated useful life of six years, and is included in other assets on the Company’s consolidated balance sheet.
A summary of the core deposit intangible asset as of December 31 follows:
(in thousands)
December 31,
2007December 31,
2006December 31,
2008December 31,
2007Core deposit intangibles:
Gross carrying amount
$391
$391
$391
$391
Less: accumulated amortization
257
190
324
257
Net carrying amount
$134
$201
$ 67
$134
Amortization expense on core deposit intangible assets is expected to total $67
each yearfor2008 and2009.Note 8: Income Taxes
The following table summarizes the current and deferred components of income tax expense (benefit) for each of the three years ended December 31:
2007
2006
2005
2008
2007
2006
Current
Federal
$2,503
$2,493
$2,271
$3,943
$2,503
$2,493
State
143
135
129
155
143
135
2,646
2,628
2,400
4,098
2,646
2,628
Deferred
374
257
182
(714)
374
257
$3,020
$2,885
$2,582
$3,384
$3,020
$2,885
The following table reconciles the expected federal income tax expense (computed by applying the federal statutory tax rate of 34% to income before taxes) to recorded income tax expense, for each of the three years ended December 31:
2007
2006
2005
2008
2007
2006
Computed tax expense
$3,459
$3,320
$3,062
$3,779
$3,459
$3,320
Increase (reduction) in income
taxes resulting from:Officers' life insurance
(71)
(53)
(75)
(74)
(71)
(53)
Tax exempt interest
(416)
(549)
(497)
(590)
(416)
(549)
State taxes, net of federal benefit
94
89
84
102
94
89
Other
(46)
78
8
167
(46)
78
$3,020
$2,885
$2,582
$3,384
$3,020
$2,885
The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities at December 31,
20072008 and20062007 are summarized below. The net deferred tax asset, which is included in other assets, amounted to $2,379 at December 31, 2008 and $839 at December 31,2007 and $2,281 at December 31, 2006.2007.
2007
2006
2008
2007
Asset
Liability
Asset
Liability
Asset
Liability
Asset
Liability
Allowance for losses on loans and
other real estate owned
$1,612
$ ---
$1,539
$ ---
$1,852
$ ---
$1,612
$ ---
Deferred compensation
942
---
892
---
989
---
942
---
Postretirement benefit liability
---
---
531
---
Unrealized gain or loss on
---
---
---
---
securities available for sale
---
616
351
---
573
---
---
616
Unrealized gain or loss
on derivatives
---
24
221
---
---
382
---
24
Unfunded retirement benefits
64
---
---
80
59
---
64
---
Depreciation
---
107
---
170
---
171
--- 107
Deferred loan origination costs
---
826
---
825
---
770
--- 826
Write down of impaired investments
488
---
--- ---
Other
285
491
203
381
224
483
285
491
$2,903
$2,064
$3,737
$1,456
$4,185
$1,806
$2,903
$2,064
As discussed in Note 1, in connection with the Company’s adoption of SAB 108 the Company reduced deferred tax assets by $233 and current tax liability by $98 as of January 1, 2006.The Company has determined that a valuation allowance is not required for its net deferred tax asset since it is more likely than not that this asset is realizable principally through the ability to carry-back to taxable income in prior years, future reversals of existing taxable temporary differences, and future taxable income.
Note 9: Deposits
The aggregate amount of jumbo
certificates of deposit,time deposits, each with a minimum denomination of $100, was$36,142$65,437 and$29,118$36,142 at December 31,20072008 and2006,2007, respectively. At December 31,2007,2008, the scheduled maturities of jumbo certificates of deposit were as follows:
Three months or less
$
8,06527,996Over three to six months
13,42115,580Over six to twelve months
4,23113,046Over twelve months
10,4258,815
Total
$36,142$65,437At December 31,
2007,2008, the scheduled maturities of total time deposits were as follows:
2008
$188,529
2009
35,167
$211,852
2010
16,330
28,280
2011
610
23,584
2012
3,081
10,737
2013 and thereafter
179
2013
14,147
2014 and thereafter
112
Total
$243,896
$288,712
Note 10: Short-term Borrowings
The Company’s short-term borrowings consist of borrowings from the Federal Home Loan Bank (the "FHLB") and securities sold under agreements to repurchase. The following table summarizes short-term borrowings at December 31,
20072008 and2006.2007.
2007
2006
2008
2007
Total
PrincipalWeighted
Average
RateTotal
PrincipalWeighted
Average
RateTotal
PrincipalWeighted
Average
RateTotal
PrincipalWeighted
Average
RateFederal Home Loan Bank Advances
$125,700
4.66%
$160,319
5.16%
$100,303
1.80%
$125,700
4.66%
Securities sold under agreements to repurchase
22,546
3.69%
14,927
2.99%
21,369
2.55%
22,546
3.69%
Total short-term borrowings
$148,246
$175,246
$121,672
$148,246
Federal Home Loan Bank Advances
Information concerning short-term Federal Home Loan Bank advances for 2008, 2007,
2006,and20052006 is summarized below:
2007
2006
2005
2008
2007
2006
Average daily balance during the year
$105,441
$118,709
$ 71,090
$ 73,697
$105,441
$118,709
Maximum month-end balance during the year
$160,101
$160,319
$114,900
$100,303
$160,101
$160,319
Amount outstanding at end of year
$125,700
$160,319
$114,900
$100,303
$125,700
$160,319
Securities Sold Under Agreements to Repurchase: Securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Information concerning securities sold under agreements to repurchase for 2008, 2007,
2006,and20052006 is summarized below:
2007
2006
2005
2008
2007
2006
Average daily balance during the year
$16,106
$14,397
$14,588
$18,445
$16,106
$14,397
Average interest rate during the year
3.26%
2.58%
1.77%
2.83%
3.26%
2.58%
Maximum month-end balance during the year
$22,546
$15,984
$17,705
$24,178
$22,546
$15,984
Amount outstanding at end of year
$22,546
$14,927
$16,438
$21,369
$22,546
$14,927
Securities collateralizing repurchase agreements, which are held in safekeeping by nonaffiliated financial institutions and not under the Bank's control, were as follows at December 31:
2007
2006
2005
2008
2007
2006
Amortized cost
$48,835
$29,419
$21,504
$42,635
$48,835
$29,419
Estimated fair value
$49,280
$28,994
$20,987
$43,922
$49,280
$28,994
Note 11: Long-term Debt
A summary of long-term debt by contractual maturity is as follows:
December 31,
20072008
Total
Range of
Maturity
Total
PrincipalRate
Range of
Interest RatesPrincipal
Rate
Interest Rates
2009
$ 29,413
4.59%
2.69% to 5.30%
2010
$ 26,000
4.81%
3.77% to 5.95%
$ 29,000
4.62%
2.84% to 5.95%
2011
$ 26,229
5.08%
3.86% to 5.30%
$ 58,699
4.08%
2.75% to 5.30%
2012
$ 22,965
4.62%
3.60% to 5.07%
$ 40,552
4.03%
2.99% to 5.07%
2013
$ ---
---%
---%
$ 37,980
3.77%
3.02% to 4.39%
2014 and thereafter
$ 26,000
4.13%
3.35% to 4.50%
2014
$ 12,000
4.07%
3.35% to 4.33%
2015 and thereafter
$ 19,000
4.00%
2.25% to 4.70%
Total long-term debt
$130,607
$197,231
December 31,
20062007
Total
Range of
Maturity
Total
PrincipalWeighted Average Rate
Range of
Interest RatesPrincipal
Rate
Interest Rates
2008
$33,900
4.22%
2.78% to 5.68%
2009
$14,472
4.18%
2.69% to 5.30%
$ 29,413
4.59%
2.69% to 5.30%
2010
$ 8,000
5.81%
4.81% to 5.95%
$ 26,000
4.81%
3.77% to 5.95%
2011
$26,738
5.06%
3.86% to 5.30%
$ 26,229
5.08%
3.86% to 5.30%
2012
$ 2,356
4.87%
4.71% to 5.07%
$ 22,965
4.62%
3.60% to 5.07%
2013
---
0.00%
---%
2014 and thereafter
$ 26,000
4.13%
3.35% to 4.50%
Total long-term debt
$85,466
$130,607
All of the long-term debt represents advances from the FHLB. All FHLB advances are fixed-rate instruments. Pursuant to an agreement with the FHLB, advances are collateralized by stock in the FHLB and a blanket lien on qualified collateral, consisting primarily of loans with first mortgages secured by one to four family properties, certain unencumbered investment securities, and other qualifying assets. Advances are payable at their call dates or final maturity.
The maturity distribution of the long-term debt with callable features
werewas as follows:December 31, 2008
Maturity
Total
PrincipalWeighted
Average
Interest Rate2010
$12,000
5.34%
2011
10,500
5.20%
2012
21,000
4.60%
2013
7,500
3.73%
2014 and thereafter
31,000
4.03%
Total
$82,000
December 31, 2007
Maturity
Total
PrincipalWeighted Average
Interest Rate2009
$ 4,000
2.95%
2010
14,000
5.28%
2011
22,500
5.21%
2012
21,000
4.60%
2013 and thereafter
26,000
4.13%
Total
$87,500
December 31, 2006
Maturity
Total
PrincipalWeighted Average
Interest Rate2008
$ 5,000
5.11%
2009
4,000
2.95%
2010
7,000
5.95%
2011
22,500
5.21%
Total
$38,500
At December 31,
2007,2008, and2006,2007, the Company had $35,000 and $11,000 of long-term debt that was currentlycallable.callable, respectively. The remaining callable debt has call dates ranging from February 2010 to January 2018.Junior Subordinated Debentures: In April 2008, the Company’s wholly-owned subsidiary, Bar Harbor Bank & Trust (the "Bank"), issued $5,000 aggregate principal amount of subordinated debentures. These debt securities qualify as Tier 2 capital for the Company and the Bank. The subordinated debt securities are due in 2023, but are callable by the Bank after five years without penalty. The rate of interest on these debt securities is three month Libor plus 345 basis points. The subordinated debt securities are classified as borrowings on the Company’s consolidated balance sheet. The Company incurred $197 in costs to
November 2012.issue the securities and these costs are being amortized over 15 years using the interest method.Note 12: Shareholders’ Equity
Dividend Limitations: Dividends paid by the Bank are the primary source of funds available to the Company for payment of dividends to its shareholders. The Bank is subject to certain requirements imposed by federal banking laws and regulations. These requirements, among other things, establish minimum levels of capital and restrict the amount of dividends that may be distributed by the Bank to the Company. At December 31,
2007,2008, the Bank had$9,363$10,623 available for dividends that could be paid without prior regulatory approval.Regulatory Capital Requirements: The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and Bank’s capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and average assets. Management believes, as of December 31,
2007,2008, that the Company and the Bank exceed all capital adequacy requirements to which they are subject. As of December 31,2007,2008, the most recent notification from the federal regulators categorized the Bank aswell capitalizedwell-capitalized under the regulatory framework for prompt corrective action. To be categorized aswell capitalized,well-capitalized, the Company andBank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s or the Company’s category.
The following table sets forth the Company’s and the Bank’s regulatory capital at December 31,
2007,2008, under the rules applicable at that date.
Actual
Required
For CapitalAdequacy PurposesTo be well
Capitalized under
Prompt Corrective
Action ProvisionsConsolidated
For Capital
Adequacy PurposesTo be well
Capitalized under
Prompt corrective
Action provisionsActual
AmountRatio
Required
AmountRatio
Required
AmountRatio
Required Required Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2007
As of December 31, 2008
Total Capital
(To Risk-Weighted Assets)
Consolidated
$66,307
11.59%
$45,774
8.0%
N/A
$73,191
11.60%
$50,458
8.0%
N/A
Bank
$66,495
11.64%
$45,706
8.0%
$57,132
10.0%
$73,540
11.69%
$50,333
8.0%
$62,917
10.0%
Tier 1 Capital
(To Risk-Weighted Assets)
Consolidated
$61,564
10.76%
$22,887
4.0%
N/A
$62,745
9.95%
$25,229
4.0%
N/A
Bank
$64,259
11.25%
$22,853
4.0%
$34,279
6.0%
$63,094
10.03%
$25,167
4.0%
$37,750
6.00%
Tier 1 Capital
Tier 1Capital
(To Average Assets)
Consolidated
$61,564
7.10%
$34,674
4.0%
N/A
$62,745
6.61%
$37,977
4.0%
N/A
Bank
$64,259
7.44%
$34,541
4.0%
$43,177
5.0%
$63,094
6.65%
$37,944
4.0%
$47,430
5.0%
The following table sets forth the Company’s and the Bank’s regulatory capital at December 31,
2006,2007, under the rules applicable at that date.
Actual
Required
For Capital
Adequacy PurposesTo be well
Capitalized under
Prompt Corrective
Action ProvisionsConsolidated
For Capital
Adequacy PurposesTo be well
Capitalized under
Prompt corrective
Action provisionsActual
Amount
Ratio
Required
Amount
Ratio
Required
Amount
Ratio
Required Required Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2006
As of December 31, 2007
Total Capital
(To Risk-Weighted Assets)
Consolidated
$63,325
11.65%
$43,491
8.0%
N/A
$66,307
11.59%
$45,774
8.0%
N/A
Bank
$62,687
11.55%
$43,425
8.0%
$54,281
10.0%
$66,495
11.64%
$45,706
8.0%
$57,132
10.0%
Tier 1 Capital
(To Risk-Weighted Assets)
Consolidated
$58,800
10.82%
$21,745
4.0%
N/A
$61,564
10.76%
$22,887
4.0%
N/A
Bank
$60,669
11.18%
$21,712
4.0%
$32,569
6.0%
$64,259
11.25%
$22,853
4.0%
$34,279
6.0%
Tier 1 Capital
(To Average Assets)
Consolidated
$58,800
7.34%
$32,040
4.0%
N/A
$61,564
7.10%
$34,674
4.0%
N/A
Bank
$60,669
7.60%
$31,927
4.0%
$39,909
5.0%
$64,259
7.44%
$34,541
4.0%
$43,177
5.0%
Stock Repurchase Plan: In
March 2004,August 2008, theCompany announcedCompany’s Board of Directors approved asecond stockprogram to repurchaseplan, authorizing open market and privately negotiated purchasesof up to10%300,000 shares of the Company’soutstanding shares ofcommon stock, or310,000 shares. Purchases began on March 4, 2004approximately 10.2% of the shares currently outstanding. The new stock repurchase program became effective as of August 21, 2008 andcontinued through December 31, 2007. In December 2007, the Company announced the continuanceis authorized to continue for a period ofthis plan through December 31, 2008.up to twenty-four consecutive months. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or fromtime-to-time,time to time, without prior notice and may be made in the open market or through privately negotiated transactions. As of December 31,2007,2008, the Company had repurchased211,60161,211 shares of stock underthethis plan, at a total cost of $1,688 and an average price of$28.93$27.58 per share. The Companyrecordsrecorded the repurchased shares as treasury stock. Under the terms of the Purchase Agreement with Treasury in connection with the Company’s participation in the CPP, the Company must have the consent of Treasury to redeem, repurchase, or acquire any shares of Company common stock or other equity or capital securities, other than in connection with employee benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement. In January 2009 the Company suspended purchases under the Plan as required under the Purchase Agreement with Treasury in connection with the Company’s participation in the CPP.The new stock repurchase program replaced the Company’s stock repurchase program that had been in place since February 2004, which had authorized the repurchase of up to 310,000 or approximately 10% of the Company’s outstanding shares of common stock. As of August 19, 2008, the date this program was terminated, the Company had repurchased 288,799 shares at a total cost of $8,441,454 and an average price of $29.23 per share.
Note 13: Stock Based Compensation:
On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and Subsidiaries Incentive Stock Option Plan of 2000 ("ISOP") for its officers and employees, which provides for the issuance of up to 450,000 shares of common stock. At December 31,
2007, 46,7732008, 23,829 shares are still available for future stock option grants. The purchase price of the stock covered by each option shall be at least 100% of the trading value on the date such option is granted. Vesting terms range from three to seven years. No option shall be granted after October 3, 2010, ten years after the effective date of the ISOP.
As a result of adopting SFAS 123(R), inIn 2008 and 2007,and 2006the Company recognized $204 and$147,$204, respectively, of share-based compensation in salaries and employee benefits expense.
The following table illustrates the effect on the Company’s net income and earnings per share had the Company applied fair value recognition provisions of SFAS No. 123 to its stock-based employee compensation in 2005.
Earnings Per Share
Year Ended December 31, 2005:
Net Income
Basic
Diluted
As reported
$6,424
$2.09
$2.03
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effect113
0.04
0.04
Pro forma
$6,311
$2.05
$1.99
For the years ended December 31, 2008, 2007,
2006,and2005,2006, the total anti-dilutive stock options amounted to 138, 72,81,and2281 thousand shares, respectively.The fair value of options was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for stock option grants during the years ended December 31:
2007
2006
2005
2008
2007
2006
Risk free interest rate
4.64%
4.87%
4.32%
3.08%
4.64%
4.87%
Expected market volatility factor for the Company's stock
18.85%
22.50%
16.76%
18.82%
18.86%
22.50%
Dividend yield
2.98%
2.97%
3.19%
3.41%
2.99%
2.97%
Expected life of the options (years)
6.4
7.0
3.5
7.0
6.5
7.0
Options granted
38,700
11,500
29,500
27,000
40,700
11,500
Estimated fair value of options granted
$ 6.26
$ 6.74
$ 3.27
$ 4.61
$ 6.27
$ 6.74
The expected market price volatility for the grants during
20072008 was determined by using the Company’s historical stock price volatility on a daily basis during the 3-7 year periods ending December 31,2007,2008, consistent with the expected life of the20072008 options.Stock Option Activity: A summary status of the ISOP as of December 31,
2007,2008, and changes during the year then ended is presented below:
Number of Stock Options Outstanding
Exercise Price Range
Weighted Average Exercise Price
Intrinsic Value
Aggregate Intrinsic Value
From
To
Outstanding at January 1, 2007
262,532
$15.40
$31.00
$19.64
Granted
38,700
$30.95
$33.00
$32.30
Exercised
(22,817)
$15.40
$27.77
$17.98
Forfeited
3,062
$18.09
$29.00
$23.42
Outstanding at December 31, 2007
275,353
$15.40
$33.00
$21.51
$10.03
$2,761
Ending vested and expected to vest at
December 31, 2007241,915
$15.40
$33.00
$20.68
$10.84
$2,622
Exercisable at December 31, 2007
150,234
$15.40
$31.00
$18.01
$13.39
$2,011
Number of Stock Options Outstanding
Exercise Price
RangeWeighted Average Exercise Price
Intrinsic Value
Aggregate Intrinsic Value
From
To
Outstanding at January 1, 2008
277,353
$15.40
$33.00
$21.59
Granted
27,000
$26.60
$31.16
30.55
Exercised
(9,725)
$15.40
$27.77
18.37
Forfeited
(6,056)
$17.75
$29.10
27.32
Outstanding at December 31, 2008
288,572
$15.40
$33.00
$22.42
$5.10
$1,473
Ending vested and expected to vest
December 31, 2008276,147
$15.40
$33.00
$22.06
$5.33
$1,472
Exercisable at December 31, 2008
192,871
$15.40
$33.00
$18.91
$7.44
$1,434
The intrinsic value of the options exercised and cash received by the Company for options exercised for the years ended December 31, 2008, 2007,
2006,and2005,2006, was approximately $72 and $179, $306 and $411 and $370 and $512,and $346 and $551,respectively.The tax benefit received related to the exercise of options in 2008, 2007 and 2006, was $31, $99 and
2005, was $99,$216,and $0,respectively.The Company’s policy for fulfilling option exercises is to release shares from treasury stock.
As of December 31,
2007,2008, there was approximately$306$381 of unrecognized compensation cost related to unvested stock option awards, net of estimated forfeitures. This amount is expected to be recognized as expense over the next seven years, with a weighted average recognition period of3.064.02 years.Stock Options Outstanding: The following table summarizes stock options outstanding and exercisable by exercise price range at December 31,
2007:2008:
Options Outstanding
Options Exercisable
Options Outstanding
Options Exercisable
Range of Exercise Prices
Range of Exercise Prices
Number Outstanding As of 12/31/07
Weighted Average Remaining Contractual Term (years)
Weighted Average Exercise Price
Number Exercisable As of 12/31/07
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term (years)
Range of
Exercise PricesNumber Outstanding
As of
12/31/08Weighted Average Remaining Contractual Term (years)
Weighted Average Exercise Price
Number Exercisable
As of
12/31/08Weighted Average Exercise
PriceWeighted Average Remaining Contractual Term
$15.40
$15.80
40,194
$15.42
27,543
$15.42
$15.80
35,155
$15.43
35,155
$15.43
$16.05
$16.05
90,000
$16.05
75,000
$16.05
$16.05
90,000
$16.05
90,000
$16.05
$17.75
$26.99
61,267
$21.84
34,579
$20.56
$18.09
$26.99
59,877
$22.16
40,368
$21.05
$27.00
$31.50
57,192
$28.77
13,112
$27.95
$31.16
69,840
$29.46
18,542
$28.22
$31.61
$33.00
26,700
$32.80
---
$ ---
$31.50
$33.00
33,700
$32.57
8,806
$32.71
$15.40
$33.00
275,353
5.60
$21.51
150,234
$18.01
4.52
$33.00
288,572
5.06
$22.42
192,871
$18.91
3.79
Note 14: Retirement Benefit Plans
Prior to the first quarter of 2007, the Company sponsored a limited postretirement benefit program, which funded medical coverage and life insurance benefits to a closed group of active and retired employees who met minimum age and service requirements.
In the first quarter of 2007, the Company settled its limited
post-retirementpostretirement benefit program. The Company voluntarily paid out $699 to plan participants, representing 64% of the accrued post retirement benefit obligation. This payment fully settled all Company obligations related to this program. In connection with the settlement of the postretirement program, the Company recorded a reduction in non-interest expense of $832, representing the elimination of the $390 remaining accrued benefit obligation included in other liabilities on the consolidated balance sheet, and the $442 actuarial gain ($291, net of tax) related to the program. The actuarial gain was previously included in accumulated other comprehensive income, net of tax.The Company also has non-qualified supplemental executive retirement agreements with certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company also has supplemental executive retirement agreements with certain current executive officers. These agreements provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or in the event that the participating executive leaves the Company following a change of control event.
As discussed in Note 1, the Company adopted SFAS 158 effective December 31, 2006. SFAS 158 requires employers to recognize the over-funded or under-funded status of defined benefit pension and other postretirement benefit plans as an asset or liability on the balance sheet and to recognize changes in that funded status in other comprehensive income after the adoption date. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts that have not yet been recognized through net periodic benefit costs are recognized in accumulated other comprehensive income (loss), net of tax effects, until they are amortized as a component of net periodic cost.
The after tax components of accumulated other comprehensive income (loss), which have not yet been recognized in net periodic benefit cost, related to postretirement benefits are
summarized belownet actuarial losses related to supplemental retirement plans of $115 and $124, as of December31:31, 2008 and 2007, respectively.
Postretirement
Health BenefitsSupplemental Executive
Retirement Plans2007
2006
2007
2006
Net actuarial loss (gain)
$ ---
$(272)
$124
$133
Prior service cost (credit)
---
(17)
---
---
Total
$ ---
$(289)
$124
$133
A December 31 measurement date is used for the postretirement health benefits and supplemental executive retirement plans. The following table sets forth changes in benefit obligation, changes in plan assets, and the funded status of the plans as of and for the years ended December 31:
Postretirement
Health BenefitsSupplemental Executive
Retirement PlansPostretirement
Health BenefitsSupplemental Executive
Retirement PlansFiscal Year Ending
Fiscal Year Ending
2007
2006
2007
2006
2008
2007
2008
2007
Obligations and Funded Status
Change in Benefit Obligation
Benefit obligation at beginning of year
$1,089
$1,272
$2,813
$2,512
$ ---
$1,089
$ 2,950
$ 2,813
Service cost
---
---
197
186
---
---
209
197
Interest cost
13
71
162
540
--- 13
170
162
Postretirement plan settlement
(390)
---
---
---
--- (390)
---
---
Actuarial gain
(13)
(181)
---
(202)
--- (13)
---
---
Benefits paid
(699)
(73)
(222)
(223)
--- (699)
(222)
(222)
Benefit obligation at end of year
$ ---
$1,089
$2,950
$2,813
$ ---
$ ---
$ 3,107
$ 2,950
Change in plan assets
Fair value of plan assets at beginning of year
$ ---
$ ---
$ ---
$ ---
$ ---
$ ---
$ ---
$ ---
Employer contributions
699
73
222
223
--- 699
222
222
Benefits paid
(699)
(73)
(222)
(223)
--- (699)
(222)
(222)
Fair value of plan assets at end of year
$ ---
$ ---
$ ---
$ ---
$ ---
$ --- $ ---
$ ---
Over (under) funded status at end of year $ --- $(1,089) $(2,950) $(2,813) Under funded status at end of year
$ ---
$ --- $(3,107)
$(2,950)
As of December 31,
20072008 and2006,2007, the Company had recognized liabilities of$0 and $1,089 for the postretirement health benefits,$3,107 and $2,950,and $2,813respectively, for the supplemental executive retirementplans, respectively.plans. These amounts are reported within other liabilities on the consolidated balance sheets.
Postretirement
Health BenefitsSupplemental Executive
Retirement PlansPostretirement
Health BenefitsSupplemental Executive
Retirement PlansAssumptions
Fiscal Year Ending
Fiscal Year Ending
2007
2006
2005
2007
2006
2005
2008
2007
2006
2008
2007
2006
Weighted-average assumptions used to determine benefit obligations at
December 31Weighted-average assumptions used to determine
benefit obligations at December 31:Discount rate
N/A
6.00%
5.75%
6.00%
6.00%
5.75%
N/A
N/A
6.00%
6.00%
6.00%
Weighted-average assumptions used to determine net periodic benefit cost
for the years ended December 31:Discount rate
6.00%
5.75%
6.00%
6.00%
5.75%
6.00%
N/A
6.00%
5.75%
6.00%
6.00%
5.75%
Assumed health care cost trend rates
Health care cost trend rate assumed for next year
N/A
10.50%
11.00%
N/A
N/A
10.50%
Ultimate health care cost trend rate
N/A
5.50%
5.50%
N/A
N/A
5.50%
Year that the rate reaches the ultimate trend rate
N/A
2018
2017
N/A
N/A
2,018
The net periodic benefit cost (benefit) for the years ended December 31 included the following components:
Postretirement
Health BenefitsSupplemental Executive
Retirement PlansPostretirement
Health BenefitsSupplemental Executive
Retirement PlansFiscal Year Ending
Fiscal Year Ending
2008
2007
2006
2008
2007
2006
Components of Net Periodic Benefit Cost and Other Amounts
Recognized in the Consolidated Income Statements2007
2006
2005
2007
2006
2005
Service cost
$ ---
$ ---
$ ---
$197
$186
$179
$ ---
$ ---
$ ---
$209
$197
$186
Interest cost
13
71
71
162
540
171
---
13
71
170
162
540
Amortization of prior service cost
(26)
(2)
---
---
---
(26)
(2)
---
---
Recognition of net actuarial gain (loss)
(414)
(8)
(15)
16
(202)
---
---
(414)
(8)
14
16
(202)
Postretirement settlement
(390)
---
---
---
---
---
(390)
---
---
---
Total recognized in the consolidated income statements
$(817)
$ 61
$ 56
$375
$524
$350
$ ---
$(817)
$ 61
$393
$375
$524
Other Changes in Plan Assets and Benefit Obligations
Recognized in Other Comprehensive Income (pre-tax)Other Changes and Benefit Obligations Recognized
in Other Comprehensive Income (pre-tax)Recognition of net actuarial (gain) loss
414
---
---
(16)
---
---
414
---
(14)
(16)
---
Amortization of prior service cost
26
---
---
---
---
26
---
---
Total recognized in other comprehensive income (pre-tax)
440
---
---
(16)
---
---
440
---
(14)
(16)
---
Total recognized in the consolidated income statements and other
comprehensive income (pre-tax)$(377)
$ 61
$ 56
$359
$524
$350
$ ---
$(377)
$61
$379
$359
$524
The estimated net actuarial loss for the supplemental executive retirement plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is ($
10)14).The Company expects to contribute the following amounts to fund benefit payments under the supplemental executive retirement plans:
2008
$ 222
2009
$ 222
$ 222
2010
$ 242
242
2011
$ 340
340
2012
$ 340
340
2013 - 2017
$1,553
2013
340
2014 - 2017
1,213
401(k) Plan: The Company maintains a Section 401(k) savings plan for substantially all of its employees. Employees are eligible to participate in the 401(k) Plan on the first day of any quarter following their date of hire. Under the plan, the Company makes a matching contribution of a portion of the amount contributed by each participating employee, up to a percentage of the employee’s annual salary. The plan allows for supplementary profit sharing contributions by the Company, at its discretion, for the benefit of participating employees. The total expense for this plan in 2008, 2007 and 2006 was $265, $245, and
2005 was $245,$428,and $424,respectively.Note 15: Financial Derivative Instruments
As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant effect on net interest income. Derivative instruments that management periodically uses as part of its interest rate risk management strategy include interest rate swap agreements and interest rate floor agreements.
At December 31,
2007,2008, the Bank had three outstanding derivative instruments with notional principal amounts totaling $40,000. These derivative instruments included an interest rate swap agreement and interest rate floor agreements, with notional principal amounts totaling $10,000 and $30,000, respectively. The details are summarized as follows:Interest Rate Swap Agreement:
Description
Maturity
Notional Amount
(in thousands)Fixed Interest Rate
Variable Interest Rate
Maturity
Notional Amount (in thousands)
Fixed Interest Rate
Variable Interest Rate
Receive fixed rate, pay variable rate
01/24/09
$10,000
6.25%
Prime (7.25%)
01/24/09
$10,000
6.25%
Prime (3.25%)
The Bank is required to pay a counter-party monthly variable rate payments indexed to Prime, while receiving monthly fixed rate payments based upon an interest rate of 6.25%, over the term of the agreement.
The interest rate swap agreement was designated as a cash flow hedge in accordance with SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges: Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans."
At December 31,
2007,2008, the fair market value of the interest rate swap agreement was an unrealizedlossgain of$34$23 compared with an unrealized loss of$473$34 at December 31,2006.2007. The fair market value of the interest rate swap agreement is included in other assets on the consolidated balance sheets.In 2008, the total net cash flows received from counter-parties amounted to $116. The net cash flows paid to counterparties were recorded as an increase to net interest income. In 2007 and 2006, the total net cash flows paid to counter-parties amounted to $363
compared withand $311,in 2006 and $3 in 2005.respectively. The net cash flows paid to counter-parties were recorded as a reduction of interest income.At December 31,
2007,2008, the net unrealizedlossgain (loss) on the interest rate swap agreement included in accumulated other comprehensive income (loss), net of tax, amounted to$22,$16, compared with$313($22) at December 31,2006.2007.Interest Rate Floor Agreements:
Notional
AmountTermination
DatePrime Strike Rate
Premium
PaidUnamortized Premium at 12/31/07
Fair Value 12/31/07
Termination
DatePrime Strike Rate
Premium
PaidUnamortized Premium at 12/31/08
Fair Value 12/31/08
$20,000
08/01/10
6.00%
$186
$137
$163
08/01/10
6.00%
$186
$91
$708
$10,000
11/01/10
6.50%
$ 69
$ 56
$136
11/01/10
6.50%
$ 69
$39
$521
During 2005, interest rate floor agreements were purchased to limit the Bank’s exposure to falling interest rates on two pools of loans indexed to the Prime interest rate. Under the terms of the agreements, the Bank paid premiums of $186 and $69 for the right to receive cash flow payments if the Prime interest rate falls below the floors of 6.00% and 6.50%, thus effectively ensuring interest income on the pools of prime-based loans at minimum rates of 6.00% and 6.50% for the duration of the agreements. The interest rate floor agreements were designated as cash flow hedges in accordance with SFAS 133.
At December 31,
2007,2008, the total fair market value of the interest rate floor agreements was$299$1,229 compared with$40$299 at December 31,2006.2007. The fair market values of the interest rate floor agreements are included in other assets on the Company’s consolidated balance sheets. Pursuant to SFAS 133, changes in the fair value, representing unrealized gains or losses, are recorded in accumulated other comprehensive income (loss).The premiums paid on the interest rate floor agreements are being recognized as reductions of interest income over the duration of the agreements using the floorlet method, in accordance with SFAS 133. During 2008, 2007, and 2006, $63, $42, and
2005, $42,$19and $2of the premiums were recognized as reductions of interest income, respectively. At December 31,2007,2008, the remaining unamortized premiums, net of tax, totaled$128,$87, compared with$154$128 at December 31,2006.2007. During the next twelve months,$61$76 of the premiums will be recognized as reductions of interest income.At December 31,
20072008 and2006,2007, the following amounts were recorded in accumulated other comprehensive income (loss) on the consolidated balance sheets:
2007
2006
Gross
Net of Tax
Gross
Net of Tax
Unrealized gain on interest rate floors, including
ineffectiveness of $28 at December 31, 2006$ 299
$197
$ 68
$ 44
Unrealized loss on interest rate swaps
(34)
(22)
(473)
(313)
Unamortized premium on interest rate floors
(193)
(128)
(235)
(154)
Net deferred loss from de-designation of
interest rate swaps(2)
(1)
(10)
(6)
Total
$ 70
$ 46
$(650)
$(429)
December 31, 2008
December 31, 2007
Gross
Net of Tax
Gross
Net of Tax
Unrealized gain on interest rate floors
$1,229
$811
$299
$ 197
Unrealized gain (loss) on interest rate swaps
23
16
(34)
(22)
Unamortized premium on interest rate floors
(130)
(87)
(193)
(128)
Net deferred loss on de-designation of
interest rate swaps---
---
(2)
(1)
Total
$1,122
$740
$ 70
$ 46
Note 16: Commitments and Contingent Liabilities
The Bank is a party to financial instruments in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit.
Commitments to originate loans, including unused lines of credit, are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. The Bank evaluates each customer’s 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 management’s credit evaluation of the borrower.
The Bank guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are primarily issued in support of third party debt or obligations. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet instruments. Exposure to credit loss in the event of nonperformance 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 December 31,
20072008 and2006.2007.
December 31,
2007December 31,
2006December 31,
2008December 31,
2007Commitments to originate loans
$ 15,075
$ 13,340
$ 31,584
$ 15,075
Unused lines of credit
85,530
81,800
70,610
85,530
Un-advanced portions of construction loans
19,752
7,638
4,284
19,752
Total
$120,357
$102,778
$106,478
$120,357
Standby letters of credit
$ 506
$ 442
$ 262
$ 506
As of December 31,
20072008 and2006,2007, the fair values of the standby letters of credit were not significant to the Company’s consolidated financial statements.Operating Lease Obligations
The Company leases certain properties used in operations under terms of operating leases, which include renewal options. The following table sets forth the approximate future lease payments over the remaining terms of the non-cancelable leases as of December 31,
2007.2008.
2008
$85
2009
69
$88
2010
73
$73
2011
38
$38
In connection the foregoing lease obligations, in 2008, 2007
2006and2005,2006, the Company recorded $88, $87,$79,and$24$79 in rent expense, respectively, which is included in occupancy expense in the consolidated statements of income.Note 17: 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.
The following describes the methods and 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.
Securities available-for-sale: Fair values are based on quoted bid market prices, where available. Where quoted market prices for an instrument are not available, fair values are based on market prices of similar instruments, adjusted for differences between the instruments. The carrying value of securities available-for-sale reported on the consolidated balance sheets represents estimated fair value.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 Company’s 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
fair values of the interest rate swap agreements and interest rate floor agreements are based on quoted market prices. TheCompany’sotheroff-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 Company’s significant financial instruments at December 31,
20072008 and20062007 follows:
December 31, 2007
December 31, 2006
2008
2007
Carrying
ValueFair
ValueCarrying
ValueFair
ValueCarrying
ValueFair
ValueCarrying
ValueFair
ValueFinancial assets:
Cash and cash equivalents
$ 7,731
$ 7,731
$ 19,547
$ 19,547
$ 9,042
$ 9,042
$ 7,731
$ 7,731
Securities available for sale
264,617
264,617
213,252
213,252
Loans, net
574,968
582,300
550,574
544,144
628,157
629,587
574,968
582,300
Interest receivable
4,289
4,289
4,118
4,118
3,999
3,999
4,289
4,289
Financial liabilities:
Deposits (with no stated maturity)
295,220
295,220
281,673
281,673
289,481
289,481
295,220
295,220
Time deposits
243,896
244,810
214,646
213,410
288,712
293,741
243,896
244,810
Securities sold under repurchase agreements
22,546
22,546
14,927
14,909
21,369
21,369
22,546
22,546
Borrowings from the FHLB
256,307
259,758
245,785
245,492
Borrowings from the FHLB and junior
subordinated debentures302,534
313,575
256,307
259,758
Interest payable
1,614
1,614
1,824
1,824
1,351
1,351
1,614
1,614
Financial derivative instruments:
Interest rate swaps
(34)
(34)
(473)
(473)
Interest rate floors
299
299
40
40
Note 18: Legal Contingencies
The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management based upon currently available information will have no material effect on the Company's consolidated financial statements.
Note 19: Condensed Financial Information – Parent Company Only
The condensed financial statements of Bar Harbor Bankshares as of December 31,
20072008 and2006,2007, and for the years ended December 31, 2008, 20072006and20052006 are presented below:BALANCE SHEETS
December 31
2007
2006
2008
2007
Cash
$ 131
$ 688
$ 475
$ 131
Investment in subsidiaries
66,063
60,412
65,867
66,063
Premises
729
731
767
729
Other assets
223
95
6
223
Total assets
$67,146
$61,926
$67,115
$67,146
Liabilities
Total liabilities
$ 1,172
$ 875
$ 1,670
$ 1,172
Shareholders' equity
Total shareholders' equity
$65,974
$61,051
$65,445
$65,974
Total Liabilities and Shareholders' equity
$67,146
$61,926
$67,115
$67,146
STATEMENTS OF INCOME
Years Ended December 31
2007
2006
2005
2008
2007
2006
Dividend income from subsidiaries
$4,229
$3,628
$3,873
$7,249
$4,229
$3,628
Equity in undistributed earnings of subsidiaries
3,580
3,727
2,992
1,242
3,580
3,727
Bankshares expenses
(885)
(653)
(669)
(1,046)
(885)
(653)
Tax benefit
231
177
228
286
231
177
Net income
$7,155
$6,879
$6,424
$7,731
$7,155
$6,879
STATEMENTS OF CASH FLOWS
Years Ended December 31
2007
2006
2005
2008
2007
2006
Cash flows from operating activities:
Net income
$ 7,155
$ 6,879
$ 6,424
$ 7,731
$ 7,155
$ 6,879
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation
11
14
11
Net decrease in other assets
76
73
34
217
76
73
Net increase in other liabilities
297
133
206
498
297
133
Equity in undistributed earnings of subsidiaries
(3,580)
(3,727)
(2,992)
(1,242)
(3,580)
(3,727)
Net cash provided by operating activities
3,959
3,369
3,683
7,218
3,959
3,369
Cash flows from investing activities:
Capital expenditures
(9)
---
(8)
(52)
(9)
---
Net cash used in investing activities
(9)
---
(8)
(52)
(9)
---
Cash flows from financing activities:
Purchases of treasury stock
(2,118)
(1,162)
(1,473)
(4,028)
(2,118)
(1,162)
Proceeds from stock option exercises
510
512
551
210
510
512
Dividend paid
(2,899)
(2,761)
(2,584)
(3,004)
(2,899)
(2,761)
Net cash used in financing activities
(4,507)
(3,411)
(3,506)
(6,822)
(4,507)
(3,411)
Net (decrease) increase in cash
(557)
(42)
169
Net increase (decrease) in cash
344
(557)
(42)
Cash, beginning of year
688
730
561
131
688
730
Cash, end of year
$ 131
$ 688
$ 730
$ 475
$ 131
$ 688
Note 20: Subsequent Event
Capital Purchase Program ("CPP"): In 2008, the U.S. Treasury instituted the Troubled Asset Relief Program ("TARP") in response to adverse economic conditions in the financial markets, particularly the inability of creditworthy borrowers to obtain credit. Under the TARP, the U.S. Treasury developed the Capital Purchase Program ("CPP"), whereby it purchased non-voting senior preferred shares of participating financial institutions. The Company sold $18,751 of Senior Fixed Rate Cumulative Perpetual Preferred Shares, Series A, no par value per share, liquidation preference $1,000 per share (the "CPP Shares"), to the Treasury under the CPP in January 2009. The CPP Shares will pay cumulative dividends at a rate of five percent (5%) per year for the first five (5) years and will reset to a rate of nine percent (9%) per year after the fifth year. The CPP Shares are callable at par after three (3) years, including any accrued and unpaid dividends, and may be redeemed with the proceeds from a qualified equity offering of any Tier 1 perpetual preferred or common stock (a "Qualified Equity Offering") prior to the end of three (3) years. For as long as any CPP Shares are outstanding, no dividend may be declared or paid on any junior preferred shares, preferred shares ranking pari passu with the CPP Shares, or common shares unless all the accrued and unpaid dividends for the cumulative CPP Shares are fully paid. Dividends may be declared on pari passu preferred shares on a pro rata basis with the CPP Shares. The Company may not repurchase or redeem any junior preferred shares, preferred shares ranking pari passu with the CPP Shares or common shares unless all the accrued and unpaid dividends for the CPP Shares are fully paid.
In addition, the consent of the Treasury will be required for any increase in common dividends per share for the first three (3) years (other than regular quarterly cash dividends of not more than $0.26 per share of common stock), unless prior to the end of three (3) years the CPP Shares have been redeemed in full or the Treasury has transferred all of the CPP Shares to third parties. The consent of the Treasury will also be required for repurchase of any shares or common shares in connection with any benefit plan in the ordinary course of business consistent with past practice, for the first three (3) years, unless prior to the end of three years the CPP Shares have been redeemed in full or the Treasury has transferred all of the CPP Senior Preferred Shares to third parties. No repurchases of junior preferred shares, preferred shares ranking pari passu with the CPP Shares or common shares will be allowed if such repurchase is prohibited by a restriction on dividends.
In conjunction with the purchase of CPP Shares, the Treasury received warrants to purchase 104,910 shares of common stock with an aggregate market price equal to 15 percent of its investment in the CPP Senior Preferred Shares (the "CPP Warrants"). The exercise price on the CPP Warrants is $26.81 per share. The CPP Warrants have a term of 10 years and will be immediately exercisable, in whole or in part. The CPP Warrants will be freely transferable; however, the Treasury may only transfer or exercise an aggregate of one-half of the warrants prior to the earlier of (i) the date on which the Company has received aggregate gross proceeds of at least one hundred percent of the issue price of the CPP Shares from one or more Qualified Equity Offerings, or (ii) December 31, 2009. In the event that the participating financial institution has received aggregate gross proceeds of at least one hundred percent of the issued price of the CPP Shares from one or more Qualified Equity Offerings on or prior to December 31, 2009, the number of shares of common stock underlying the CPP Warrants then held by the Treasury shall be reduced by a number of shares equal to the product of (i) the number of shares originally underlying the CPP Warrants (taking into account all adjustments), and (ii) 0.5.
Rules issued by Treasury and certain provisions of the American Recovery and Reinvestment Act of 2009 require participating institutions in the CPP, including the Company, to adopt certain standards for executive compensation and corporate governance rules for the period during which Treasury holds CPP Senior Preferred Shares. These standards include: (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) requiring "clawback" of any bonus or incentive compensation paid to a senior executive based on statement of earnings, gains, or other criteria that are later proven to be materially inaccurate; (3) prohibiting the financial institution from making any golden parachute payment to a senior executive (generally, severance payment in excess of three times the senior executive’s prior five-year average compensation); and (4) agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. These standards generally apply to the chief executive officer, chief financial officer, plus the next three (3) most highly compensated executive officers. The Company and the officers covered by these standards have granted the Treasury a waiver releasing the Treasury from any claims that the Company or such officer may otherwise have as a result of the issuance of any regulation which modify the terms of benefits plans, arrangements and agreements to eliminate any provisions that would not be in compliance with these executive compensation, and corporate governance standards. In addition, the American Recovery and Reinvestment Act requires CPP participants to hold a non-binding "say-on-pay" shareholder vote to approve the compensation of their executives.
Importantly, the CPP Securities Purchase Agreement may be unilaterally amended by the Treasury to the extent required to comply with any changes after January 16, 2009 (the "signing date") in applicable federal statutes. Accordingly, the Company or the Bank may be subject to further restrictions or obligations as a result of participation in the CPP.
Note 21: Selected Quarterly Financial Data (Unaudited)
QUARTER
2007
1
2
3
4
TOTAL
Year 2008
Quarter
1
2
3
4
Total
Interest and dividend income
$12,360
$12,606
$13,366
$13,477
$51,809
$13,430
$13,165
$13,515
$13,484
$53,594
Interest expense
7,078
7,010
7,453
7,365
28,906
7,138
6,633
6,387
6,245
26,403
Net interest income
5,282
5,596
5,913
6,112
22,903
6,292
6,532
7,128
7,239
27,191
Provision for loan losses
---
33
214
209
456
512
297
860
326
1,995
Non-interest income
378
1,658
2,263
1,630
5,929
2,049
1,932
2,224
227
6,432
Non-interest expense
3,797
4,553
4,796
5,055
18,201
4,988
5,234
5,112
5,179
20,513
Income before income taxes
1,863
2,668
3,166
2,478
10,175
2,841
2,933
3,380
1,961
11,115
Income taxes
488
825
1,019
688
3,020
889
904
1,047
544
3,384
Net income
$ 1,375
$ 1,843
$ 2,147
$ 1,790
$ 7,155
$ 1,952
$ 2,029
$ 2,333
$ 1,417
$ 7,731
Earnings per share:
Basic
$ 0.45
$ 0.61
$ 0.71
$ 0.59
$ 2.36
$ 0.65
$ 0.69
$ 0.80
$ 0.49
$ 2.63
Diluted
$ 0.44
$ 0.59
$ 0.69
$ 0.58
$ 2.30
$ 0.64
$ 0.67
$ 0.78
$ 0.48
$ 2.57
QUARTER
2006
1
2
3
4
TOTAL
Interest and dividend income
$10,694
$11,324
$ 12,080
$12,047
$46,145
Interest expense
5,207
6,056
6,532
6,654
24,449
Net interest income
5,487
5,268
5,548
5,393
21,696
Provision for loan losses
28
15
81
7
131
Non-interest income
1,604
1,525
2,199
1,548
6,876
Non-interest expense
4,885
4,450
4,857
4,485
18,677
Income before income taxes
2,178
2,328
2,809
2,449
9,764
Income taxes
615
682
845
743
2,885
Net income
$ 1,563
$ 1,646
$ 1,964
$ 1,706
$ 6,879
Earnings per share:
Basic
$ 0.51
$ 0.54
$ 0.64
$ 0.56
$ 2.26
Diluted
$ 0.50
$ 0.53
$ 0.63
$ 0.55
$ 2.20
QUARTER
2007
1
2
3
4
Total
Interest and dividend income
$12,360
$12,606
$13,366
$13,477
$51,809
Interest expense
7,078
7,010
7,453
7,365
28,906
Net interest income
5,282
5,596
5,913
6,112
22,903
Provision for loan losses
---
33
214
209
456
Non-interest income
378
1,658
2,263
1,630
5,929
Non-interest expense
3,797
4,553
4,796
5,055
18,201
Income before income taxes
1,863
2,668
3,166
2,478
10,175
Income taxes
488
825
1,019
688
3,020
Net income
$ 1,375
$ 1,843
$ 2,147
$ 1,790
$ 7,155
Earnings per share:
Basic
$ 0.45
$ 0.61
$ 0.71
$ 0.59
$ 2.36
Diluted
$ 0.44
$ 0.59
$ 0.69
$ 0.58
$ 2.30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures: The Company carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are operating in an effective manner.
Management Report on Internal Control over Financial Reporting: Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting
isas defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
- Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
- Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
- Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31,
2007.2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework.Based on its assessment, management believes that as of December 31,
2007,2008, the Company’s internal control over financial reporting is effective, based on the criteria set forth by COSO in Internal Control – Integrated Framework.The Company’s independent registered public accounting firm has issued an audit report on the effectiveness of the Company’s internal control over financial reporting. This report appears within Item 9A of this report on Form 10-K.
Changes in Internal Control Over Financial Reporting: No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Attestation Report of the Company’s Registered Public Accounting Firm
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Bar Harbor Bankshares:We have audited Bar Harbor Bankshares’ (the "Company") internal control over financial reporting as of December 31,
2007,2008, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31,
2007,2008, based on criteria established in Internal Control – Integrated Framework issued by COSO.We also have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Bar Harbor Bankshares and subsidiaries as of December 31,
20072008 and2006,2007, and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31,2007,2008, and our report dated March13, 200816 2009 expressed an unqualified opinion on those consolidated financial statements./s/ KPMG LLP
Albany, New York
March13, 200816 2009
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE OF THE REGISTRANT
Directors and Executive Officers: Information required by Item 401 of Regulation S-K with respect to the directors and executive
officer is incorporated by reference fromofficers will appear under thesections entitledheading "DIRECTORS AND EXECUTIVE OFFICERS" in the Company’s definitive Proxy Statement for the20072009 Annual Meeting of Shareholders, whichwas filedthe Company intends to file with the Commissionon March 17,within 120 days of the end of the Company’s 2008(thefiscal year (hereinafter the "Proxy").and is incorporated herein by reference.Compliance with Section 16(a) of the Securities Exchange Act of 1934: Information required by Item 405 of Regulation S-K with respect to Compliance with Section 16(a) of the Securities Exchange Act of 1934
is incorporated herein by reference fromwill appear under thesection entitledheading "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" in the Company’sProxy.Proxy and is incorporated herein by reference.Stockholder Nominees to Board of Directors: There have been no material changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors. Those procedures
arewill be set forth in the Proxy undersectionsthe headings entitled "CORPORATE GOVERNACE" – "Governance Committee" and "OTHER MATTERS" – "Nominations by Stockholders" and are incorporated herein by reference.Audit Committee: Information required by Items 407(d)(4) of Regulation S-K
is incorporated herein by reference fromwill appear under thesection entitledheading "CORPORATE GOVERNANCE" – "Audit Committee" in the Company’sProxy.Proxy, and is incorporated herein by reference. Information required by Item 407(d)(5) of Regulation S-Kis incorporated herein by reference fromwill appear under "Appendix A" Report of the Audit Committee, contained in the Company’sProxy.Proxy and is incorporated herein by reference.Code of Ethics: Information required by Item 406 of Regulation S-K
is incorporated herein by reference fromwill appear under thesection entitledheading "OTHER MATTERS" "Code of Ethics" contained in the Company’sProxy.Proxy and is incorporated herein by reference.ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 402 of Regulation S-K will appear under the heading "COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS-COMPENSATION OF EXECUTIVE OFFICERS," in the Company’s Proxy, which information is incorporated herein by reference.
The information required by Item 407(e)(4) of Regulation S-K will appear under the heading
"CORPORATE GOVERNANCE""Compensation Committee Interlocks and Insider Participation" in the Company’s Proxy, which information is incorporated herein by reference.The information required by Item 407(e)(5) of Regulation S-K will appear under the heading "Report of the Compensation and Human Resources Committee" in the Company’s Proxy, which information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Information required by Item 201(d) of Regulation S-K appears in this Report as Part II, Item 5, under the heading "Market for Registrant’s Common Stock, Related Shareholder Matters and Issuer Purchases of Equity Securities" "Incentive Stock Option Plan," which information is incorporated herein by reference.
Information required by Item 403 of Regulation S-K
is incorporated by reference fromwill appear under thesections entitledheading "VOTING SECURITIES AND PRINCIPAL HOLDERSTHEREOF."THEREOF" in the Company’s Proxy, which information is incorporated herein by reference.ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information required by Item 404 of Regulation S-K will appear under the heading "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" in the Company’s Proxy, which information is incorporated herein by reference.
Information required by Section 407(a) of Regulation S-K will appear under the
headingheadings "Directors and Nominees" and "CORPORATE GOVERNANCE"- "Board of Directors" in the Company’s Proxy, which information is incorporated herein by reference.ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this item
is incorporated by reference towill appear under thesection entitledheading "INDEPENDENT REGISTEREDACCOUNTANTS"ACCOUNTANTS," in the Company’sProxy.Proxy, which information is incorporated herein by reference.PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. All Financial Statements
Filed herewith atThe consolidated financial statements of the Company and report of the Company’s independent registered public accounting firm incorporated herein are included in Item 8 of this Report as follows:
Item
Page
Report of Independent Registered Public Accounting Firm
90
Consolidated Balance Sheets
91
Consolidated Statements of Income
92
Consolidated Statements of Changes in Shareholders’ Equity
93
Consolidated Statements of Comprehensive Income 94
Consolidated Statements of Cash Flows
95
Notes to Consolidated Financial Statements
95
2. Financial Statement Schedules
Filed herewith at Item 8Schedules have been omitted because they are not applicable or are not required under the instructions contained in Regulation S-X or because the information required to be set forth therein is included in the consolidated financial statements or notes thereto.
3. Exhibits:
The following exhibits are included as part of this Form 10-K.
EXHIBIT NUMBER
3.1
Articles of
Incorporation.Incorporation, as amended to date
Articles as amended July 11, 1995, are incorporated by reference to Form S-14 filed with the Commission March 26, 1984 (Commission Number 2-90171).Filed herewith3.2
Bylaws, as amended to
date.date
Bylaws as amendedIncorporated herein by reference todate areForm 8-K, Exhibit 3, filed with the Commission on December 17, 20084
Instruments Defining Rights of Security Holders
4.1
Certificate of Designations, Fixed Rate Cumulative Perpetual Preferred Stock, Series A
Incorporated herein by reference to Form 8-K, Exhibit 3.1, filed with the Commission on January 21, 2009
4.2
Form of Specimen Stock Certificate for Series A Preferred Sock
Incorporated by reference to Form 8-K, Exhibit 4.1, filed with the Commission on January 21, 2009
4.3
Letter Agreement with U. S. Treasury for purchase of Series A Preferred Stock
Incorporated by reference to Form 8-K, Exhibit 10.1, filed with the Commission on January 21, 2009
4.4
Warrant to Purchase Shares of Company Common Stock issued to U.S. Treasury
Incorporated by reference to Form 8-K, Exhibit 4.2, filed with the Commission on January 21, 2009
4.5
Debt Securities Purchase Agreement
Filed herewith
as exhibit 3.2.4.6
Form of Subordinated Debt Security of Bar Harbor
Bank & TrustFiled herewith
10
Material Contracts
10.1
Deferred Compensation Plans
Incorporated by reference to Form 10-K filed with the Commission March 31, 1987 (Commission Number 0-13666)
.
10.2
Supplemental Executive Retirement Plan
Adopted by the Board of Directors on
September 16, 2003, and effective as of
January 1, 2003, providing Joseph M. Murphy,
President and CEO of the Company, Gerald
Shencavitz, the Company’s Chief Financial
Officer, and Dean S. Read, former President of
the Bank, with certain defined retirementbenefits.benefits (the "2003 SERP")Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349)
.10.3
Joseph M. MurphyEmployment ContractAmendment No. 1 to the 2003 SERPIncorporated by reference to Form
10-K Item 15(a)(10.2),8-K, Exhibit 10.6, filed with the CommissionMay 27, 2003 (Commission File Number 001-13349).on November 24, 200810.4
Joseph M. Murphy
Amended and Restated Employment Contract
Incorporated by reference to Form 8-K, Exhibit 10.10, filed with the Commission on November 24, 2008
10.5
Change in Control, Confidentiality, and Non-competition Agreement between the Company and Joseph M. Murphy
Incorporated by reference to Form 8-K, Exhibit 10.6, filed with the Commission on November 24, 2008
10.6
Supplemental Executive Retirement Plan, Section 409A
Incorporated by reference to Form 8-K, Exhibit 10.7, filed with the Commission on November 24, 2008
10.7
Incentive Stock Option Plan 2000
Incorporated by reference to Form 10-K, Item 14(a)(3) filled with the Commission March 28, 2002 (Commission File Number 001-13349)
.
10.5
Amendment to Employment Agreement,Change in Control, Confidentiality andNon-competition Agreement between theCompany and Joseph M. Murphy.
Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.610.8Amended and Restated Change in Control, Confidentiality, and
Non-competition Agreement between the
Company and GeraldShencavitz.Shencavitz
Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.7
Change in Control, Confidentiality, andNon-competition Agreement between theCompany and Daniel A. Hurley III, Presidentof Bar Harbor Trust Services.Incorporated by reference to Form 8-K, Exhibit
99.1, "Form of Change in Control, Confidentiality and Non-competition Agreement,"10.9, filed with the Commission onJune 30, 2005 (Commission File Number 001-13349).November 24, 2008
10.810.9Amended and Restated Change in Control, Confidentiality, and Non-competition Agreements between the Company and Daniel A. Hurley III, Senior Vice President of the Bank and President of Bar Harbor Trust Services; Michael W.Bonsey, Senior Vice President of the Bank Credit Administration; Gregory W. Dalton, Senior Vice President of the Bank Business Banking
Incorporated by reference to Form 8-K, Exhibit 10.8, "Specimen 409A Change in Control Confidentiality and Non-competition Agreement" filed with the Commission on November 24, 2008
10.10
Change in Control, Confidentiality, and Non-competition Agreement between the Company and Marsha C. Sawyer, Senior Vice President Human Resources
Incorporated by reference to Form 8-K, filed with the Commission on November 24, 2008, and Form 8-K/A, Exhibit 10.1, filed with the Commission on November 26, 2008
10.11
Change in Control, Confidentiality, and Non-competition Agreement between the Company and Cheryl D. Curtis, Senior Vice President Marketing and Community Relations
Incorporated by reference to Form 8-K, Exhibit 10.2, filed with the Commission on November 24, 2008
10.12
Change in Control, Confidentiality, and Non-competition Agreement between the Company and Craig Worcester, Managing Director Bar Harbor Financial Services
Incorporated by reference to Form 8-K, Exhibit 10.3, filed with the Commission on November 24, 2008
10.13
Change in Control, Confidentiality, and Non-competition Agreement between the Company and Joshua A. Radel, Chief Investment Officer, Bar Harbor Trust Services
Incorporated by reference to Form 8-K, Exhibit 10.4, filed with the Commission on November 24, 2008
10.14
Change in Control, Confidentiality, and Non-competition Agreement between the Company and David W. Thibault, Senior Vice President Operations and Information Systems
Incorporated by reference to Form 8-K, Exhibit 10.5, filed with the Commission on November 24, 2008
10.15
Purchase and Assumption Agreement between
Bar Harbor Banking and Trust Company and
Androscoggin Savings Bank, dated October 24,2003.2003Incorporated by reference to Form 10-Q, Part II, Item 6 filled with the Commission November 13, 2003 (Commission File Number 001-13349)
.
10.910.16
DescriptionSummary of the2007 Two-tiered ExecutiveCompensation Arrangements2008 Annual Incentive Plan not pursuant to a
written plan oragreement.agreement
Filed herewithIncorporated by reference to Form 10-Q, filed with the Commission on August 11, 2008
10.1010.17Infinex Agreement third party brokerage
services.servicesIncorporated by reference to Form 10-K, Part III, Item 15(a)(10.10), filed with the Commission on March 14, 2005 (Commission File Number 001-13349)
.
10.1110.18Somesville Bank Branch Lease dated October 27,
2005.2005Incorporated by reference to Form 10-K, Part III, Item 15(a)(10,13), filed with the Commission on March 16, 2006 (Commission File Number 001-13349)
10.19
Merchant Portfolio Purchase Agreement between Bar Harbor Bank & Trust and TransFirst, LLC ("TransFirst") and Columbus Bank and Trust Company, dated September 30, 2008
Incorporated by reference to Form 10-Q, Exhibit 10.1, filed with the Commission on November 10, 2008
10.20 Merchant Portfolio Assignment and Assumption Agreement Incorporated by reference to Form 10-Q, Exhibit 10.2, filed with the Commision on November 10, 2008 10.21
Referral and Sales Agreement between Bar Harbor Bank & Trust and TransFirst dated September 30, 2008
Incorporated by reference to Form 10-Q, Exhibit 10.3, filed with the Commission on November 10, 2008
10.22
Credit Card Account Purchase Agreement between Bar Harbor Bank & Trust and U. S. Bank National Association D/B/A Elan Financial Services
Filed herewith
10.23
Letter Agreement (including the Securities Purchase Agreement – Standard Terms incorporated by reference therein (the "Purchase Agreement"), between the Company and the U. S. Treasury pursuant to which the Company issued and sold to Treasury (i) 18,751 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value, having a liquidation preference of $1,000 per share and (ii) a ten-year warrant to purchase up to 104,910 shares of the Company’s common stock, par value $2.00 per share, at an initial exercise price of $26.81 per share (the "Warrant"), for an aggregate purchase price of $18,751
Incorporated by reference to Form 8-K, Exhibits 4.2 and 10.1, filed with the Commission on January 21, 2009
11.1
Statement re computation of per share earnings
Statement re computation of per share earnings (Data required by SFAS No. 128, Earnings Per Share, is provided in Note 1 to the Notes to Consolidated Financial Statements in this report).
13
Annual Report to Shareholders
FiledFurnished herewith14
Code of Ethics
Incorporated by reference to Form 10-K, Part III, Item 15(a)(14), filed with the Commission on March 16, 2006 (Commission File Number 001-13349)
21
Subsidiaries of the Registrant
Filed herewith
23
Consent of Independent Registered Public
Accounting FirmFiled herewith
31.1
Certification of Chief Executive Officer
under Rule13a-14/13a-14(a)/15d-14(a)Filed herewith.
31.2
Certification of Chief Financial Officer
under Rule13a-14/13a-14(a)/15d-14(a)Filed herewith.
32.1
Certification of Chief Executive Officer
under 18 U.S.C. Sec. 1350.Filed herewith.
32.2
Certification of Chief Financial Officer
under 18 U.S.C. Sec. 1350.Filed herewith.
(c) There are no other financial statements and financial statement schedules, which were excluded from this report, which are required to be included herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
March 17, 2008 BAR HARBOR BANKSHARES
March 16, 2009 BAR HARBOR BANKSHARES
(Registrant)//
s/Joseph M. MurphyJoseph M. Murphy
President and Chief Executive OfficerPursuant to the requirements of the Securities Exchange Act of 1934, the following persons have signed this report in the capacities indicated on behalf of the Registrant.
/s/ Thomas A. Colwell
Thomas A. Colwell
Chairman, Board of Directors/s/ Joseph M. Murphy
Joseph M. Murphy, Director
President and Chief Executive Officer/s/ Robert C. Carter
Robert C. Carter, Director/s/ Robert M. Phillips
Robert M. Phillips, Director/s/ Peter Dodge
Peter Dodge, Director/s/ Gerald Shencavitz
Gerald Shencavitz
EVP, Chief Financial Officer and Treasurer/s/ Martha Tod Dudman
Martha Tod Dudman, Director/s/ Kenneth E. Smith
Kenneth E. Smith, Director/s/ Jacquelyn S. Dearborn
Jacquelyn S. Dearborn, Director/s/ Constance C. Shea
Constance C. Shea, Director/s/ Lauri E. Fernald
Lauri E. Fernald, Director/s/ Scott G. Toothaker
Scott G. Toothaker, Director/s/ Gregg S. Hannah
Gregg S. Hannah, Director/s/ David B. Woodside
David B. Woodside, Director/s/Clyde H. Lewis
Clyde H. Lewis, Director